Property market stakeholders who ignore the impact of climate change do so at their peril, warn Darren Stolzenberg and Edward Craft

A few years ago sustainability was the buzz word on everyone's lips in the real estate industry. The credit crisis then pushed the sustainability agenda to the back of many investors' and fund managers' minds. However, with an ever-increasing raft of legislation, sustainability remains at the  front of the minds of governments and regulators. Investors, occupiers and fund managers who ignore the impact of climate change on their assets do so at their peril.

Risks and opportunities
Regardless of an organisation's views on climate change, financial performance will be impaired if certain rules and trends are ignored. Because of a direct link to the assets, real estate investors are uniquely placed to take direct action:

Offence or defence: Owners and occupiers who take an offensive strategy may be able to deliver best-in-class assets. Further, they may be able to increase profits by delivering additional revenue and saving money. Those who act defensively will struggle to understand and comply with complex regulation and risk penalties for non-compliance. Reputation: Those owners and occupiers who seek to develop or invest in sustainable buildings may be able to win important accreditation, demonstrating green credentials and enhancing market reputation. Investor demand: Ultimately, buildings with a lower carbon footprint should attract both investors and tenants. Investors will want buildings that are future-proofed and desirable to tenants. Similarly, tenants will want to know that the buildings they occupy offer a competitive advantage, including lower energy costs than comparables.

The regulatory landscape
The UK government has announced that all commercial new builds must be zero-carbon by 2019 (residential buildings by 2016). However, new builds constitute only a small proportion of the available population of buildings. Conversion of existing buildings offers by far and away the greater challenge and it is here that the greatest carbon saving can be made.

The current regulatory landscape is complex and confusing and is the result of a number of, often conflicting, schemes and initiatives.
Key themes of current government initiatives are to:

Change corporate culture to make climate change the concern of all; and Make environmental impact a key investment decision.

To date, the UK government has preferred specific (generally market-based) schemes. However, the UK is now moving towards a subsidised tariff model.

CRC Energy Efficiency Scheme (CRC)
Energy use in buildings is a primary source of carbon emissions in the UK. The CRC is the UK's new cap and trade system for high volume non-energy intensive organisations which will commence on 1 April 2010. The main aspects of the scheme are:

A ‘CRC group' with annual electricity consumption of more than 6,000 megawatt hours through half hourly electricity meters will be obliged to participate (as a rule of thumb, those with an annual electricity bill in excess of £500,000 are likely to fall into the scheme); CRC participants will need to buy carbon allowances for expected energy use (initially at £12 per tonne; however, from 2013, the number of available carbon credits will be reduced and sold at auction, which is likely to lead to an increase in price); and Organisations will be ranked in published league tables by reference to their relative reduction in energy use - they will also receive sums back and either be awarded a bonus or pay a penalty based on league table performance.

CRC presents a number of challenges and opportunities to fund managers, owners and occupiers:

Defining a ‘CRC group' may be complicated, particularly where fund managers, funds, minority interests and joint ventures are involved; A landlord may find that its corporate group is responsible for the energy consumption of its tenants and will need to work with them to improve energy efficiency to prevent the landlord being penalised for their actions; and Each member of a ‘CRC group' will be jointly and severally liable for the group's responsibilities.

Incentives for low carbon generation
The Renewables Obligation (the RO) is the UK's current principal incentive for renewable electricity generation. To date, the RO has encouraged investment in renewables projects, but principally large scale projects backed by international utilities. The RO will, in April 2010, be supplemented by a Feed in Tariff (FiT) which aims to encourage a wider range of direct investors in low carbon electricity generation. As such, owners or occupiers of buildings who are able to install low carbon electricity generation plant on site will be able to benefit from the scheme.
The key features of the FiT are:

The electricity supplier will make a fixed payment to the low carbon generator for every kilowatt hour generated, together with an additional payment for every kilowatt hour exported to the wider electricity market; and Electricity generated on site will be offset against electricity that would otherwise have been bought from the main electricity supplier.

Investors are waiting to see what the legislation actually says and whether new tariffs will be structured at a level sufficient to incentivise investment. Electricity generated from on-site plant does not bear transmission costs. FiTs may become an attractive option to both reduce energy costs and permit revenue generation by landlords and tenants.

Over the years, industry has become comfortable with a vast array of environmental legislation, including that dealing with water pollution and contamination to land, which has ultimately been reflected in valuations. Whilst climate change issues are yet to be fully reflected in lease terms or valuation, in time this will happen. For example, an increased operational cost of an asset, such as a boiler or cooling system, compared with a competitor property will make the site less attractive to prospective occupiers and, in time, valuation methodologies will inevitably evolve to reflect such impairment in both rental and capital values.

A changing landscape
While it is never possible to stand still, the landscape of climate change is both confusing and daunting. Advances in building regulations are forcing change in how buildings are built, refurbished and used. Plant obsolescence presents an opportunity to cut energy bills when this is replaced by more efficient plant. On-site generation can deliver new revenue streams for asset owners (benefiting from price subsidies) and deliver "green" dividends. Identifying and capturing these opportunities should therefore enhance the value of real estate assets and impair the value of otherwise comparable assets.

Darren Stolzenberg and Edward Craft are both members of Nabarro's climate change and energy group