Over the past few years, the tone of investment discussions on sustainability has changed. Some asset managers have softened their language, some investors have stepped away from climate initiatives altogether, and the political debate around ESG has become increasingly polarised.
It would be easy to interpret this as evidence that the transition to a low-carbon economy is no longer a major force shaping the real estate markets and the regulatory landscape. That would be a mistake.
In the UK, for example, the government has confirmed its intention to raise EPC standards for large, non-domestic buildings. The EU’s revised Energy Performance of Buildings Directive introduces minimum energy performance standards for non-residential buildings, targeting the worst-performing stock. It also requires new buildings to achieve zero-emission status by 2030 and encourages solar installations on certain types of buildings.
Investor interest in sustainability has not disappeared either. There have been several cases of pension funds – including The People’s Pension or PME – scrutinising their asset managers’ approach to responsible investment and, in some cases, withdrawing mandates as a result.
The net zero transition has not stopped, although in many respects it perhaps has become less talked about. This creates a concerning disconnect which might lead to some market participants losing focus on the financial consequences of the economy decarbonising.
A risk that investors acknowledge but still struggle to price
Transition risk – the risk of financial losses associated with the shift to a low-carbon economy – has been a mainstream consideration in boardrooms and investment committees since the Task Force on Climate-related Financial Disclosures published its recommendations in 2017. Many of the world’s largest investors acknowledge the issue explicitly. And yet it is still not reflected in investment decisions consistently.
The problem is partly methodological. Investment models are, by design, grounded in evidence from the past. Rents are estimated using comparable transactions. Operating costs are projected from historical performance. Exit values depend on market evidence. Even assumptions about growth and obsolescence are usually extrapolated from established trends.
Transition risk is different. It is inherently forward-looking. Its financial consequences depend on future regulation, technology, energy prices, carbon costs, occupier preferences and investor sentiment - variables that may not follow historical patterns.
This creates a paradox. A risk can be recognised as material at a corporate level while remaining largely invisible in the financial models used to value an individual asset.
The financial impacts of inaction
That invisibility matters because it leaves many investment teams making decisions based on an incomplete picture. Traditional models do not fully account for the cost of inaction – the financial consequences of not investing enough in decarbonising a building. For many asset managers, improving carbon or energy performance of a building is yet another upfront cost that must be justified by tangible returns: lower energy bills, selling excess power to the grid, complying with existing regulation or responding to current tenant and investor demand.
However, this may not be enough to ensure an asset remains competitive in a rapidly changing economy. Operating costs, energy prices, compliance costs, rental income, void periods and, ultimately, exit yields will be reshaped by evolving market and regulatory conditions. A building may perform well today while carrying significant financial risks that are not yet fully reflected in its valuation.
The deeper challenge is to recognise that the future may not resemble the past closely enough for historical evidence alone to provide a reliable basis for investment decisions.
Pricing in uncertainty
This requires a shift in mindset. Investors and managers need to become more comfortable with uncertainty. We cannot predict the future with precision, so it is increasingly important to stress-test investment models against a range of possible scenarios.
Of course, scenarios are not forecasts. They are structured ways of testing how an organisation or investment might perform under different future conditions, helping investors translate potential risks into cash flows, costs and valuation assumptions that underpin investment decisions. This is particularly important for transition risk which depends on how markets and regulations evolve – not simply on what has happened in the past. That is why ULI developed Preserve, a tool designed to link specific transition risks directly to discounted cash flow models. Rather than treating transition risk as a separate ESG assessment, the methodology connects it with the financial variables investors already use.
Preserve also provides a standardised methodology for doing this consistently. Scenario analysis inevitably involves judgement and uncertainty, but that does not make it arbitrary. A common framework can help make assessments more transparent, credible and comparable across assets and portfolios.
The investment industry is already comfortable modelling interest rates, inflation and macroeconomic shocks. Transition risk deserves the same treatment.
The ESG conversation will continue to evolve, but the underlying transition of the economy is not waiting for the debate to settle. For investors, it means moving towards financial models capable of quantifying the cost of inaction on net zero – before the market does.
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