Catella Residential Investment Management (CRIM) is in talks with investors over a plan to decarbonise existing assets potentially via an annual budget to at least bring properties in line with EU sustainability targets.
CRIM, which is one of Europe’s largest institution owners and managers of residential property with around €8 bn of AUM across nine countries, is hoping to persuade investors to invest fresh equity sooner rather than later or else face a tougher situation in the future.
Xavier Jongen, managing director of Catella European Residential Investment (CRIM), says: ‘What we are proposing – and it is debate we are actually having with our investors – is they should force us to decarb to a minimal level per year now, rather than delay. By integrating climate change into an investment strategy, we are saying that this is what investors should be asking us to do.’
In an in-depth interview, Jongen explains what he has been presenting to capital partners – which is a model of a climate mitigation strategy encompassing pricing in costs of decarbonisation to meet increasingly strenuous sustainability regulations and the EU’s Green Deal interim targets of 55% emission reductions by 2023 on the way to a net carbon neutral economy by 2050.
According to him, it is too early to say what the eventual outcome will be to his thesis as each investor has differing viewpoints and pressures. Over time, perhaps debates like these could even lead to evolutionary or pioneering financial structures that make sense for investors, manager, and end-users.
Jongen is a recognised figure in the real estate establishment: from 1996 to May 2005, he worked in parallel as a public speaker for the European Commission in Brussels on EU integration for target priority groups such as politicians, journalists, and CEOs. He chaired the first INREV EU Public Affairs committee and the first ULI European Residential committee and is a Global ULI Trustee.
He was also the first to introduce a pan-European residential investment fund in 2007. CRIM’s residential portfolio has since grown to around €8 bn via different funds and mandates.
His starting point is that the residential sector is said to be responsible for 28% of CO2 emissions globally via heating and cooling systems, steel, glass and other materials. With a very significant proportion of the population struggling with affordability of their homes, ordinary citizens are hard pressed to afford decarbonization themselves.
Impossible triangle
In order to fund decarb and meet targets, he says the world needs economic growth. But the problem is there is 0.98 correlation between economic growth and carbon emissions. If oil consumption is supressed, for example, economic growth might be slowed, leading to an affordability issue again. This is what Jongen calls the ‘impossible triangle’.
He says: ‘So, what we are trying to clarify is a financing strategy to make sure we decarb whilst keeping unaffordability levels within limits.’
Cost machine
There are four costs to greening the economy: Mitigation, Adaptation, Insurance, and CO2 Reduction through carbon capture without which climate change would simply continue, which taken together will cost an estimated $300 trillion globally according to experts – more than three times global GDP.
Mitigation is the most important cost, he said, which involves replacing fossil-based energy with greener energy. This cost has a substitution element, for example replacing ageing gas heating systems with heat pumps means you can green at the lowest possible price point. The later the mitigation, the higher the three other cost components automatically become, according to Jongen.
And this is due to the multiplication factor. If an owner does not green an asset, CO2 emissions rise leading to greater adaptation, insurance and CO2 capture costs. Adaptation, to take an extreme example, is having to move a building away from the area of a regularly flooding river.
‘When we understand the logic behind the cost machine, then we understand that the later we leave this, the more impossible the finance trap becomes, and the whole process derails. So, we have an interest to bring these costs down by maximising mitigation.’
In his opinion it is pension funds and sovereign wealth funds and similar investor who have the resources to minimalize costs to prevent larger bills later; as long term owners they will also be the big losers of inaction.
Solution
He proposes that investors provide an annual budget to at least bring assets in line with the EU targets. However, investors have been hit by myriad issues such as the dire bond market and interest rate rises and falling returns, so it is little wonder many are reluctant to invest more money to decarb assets when faced with competing issues.
Debates with investors have involved the idea to sell some assets that require investment. However, this runs into the problem of discounted valuations due to decarb requirements and therefore an unpredictable sales income.
In his estimation, around 15%-20% of investors agree with him, while 40% of investors are reluctant to put in fresh equity, and the remaining 40% and unsure and prefer to wait things out.
‘It is a very complex situation. Part of the reason we are having only moderate success is that the market is difficult, so investors are shying away from extra costs.’
It is for that reason Jongen has written a paper on the subject to set out his thoughts.
Catella’s latest European Residential Vision 2024 research report concludes that the acceleration in global warming is building up pressure on residential real estate investors to integrate fundamental “climate finance” strategies into their portfolios if they are to avoid the risks of stagnation in values and stranded assets.
It names the E-shaped trifurcation of pathways - first decarbonisation, then adaptation “tipping points” defined by brown discounts and third, green premiums. These will evolve into a 'new hierarchy' assets relatively resilient to the growing physical risks of climate change.
