Dirty real estate assets are stuck in a “carbon bubble” with valuations that do not yet take into account the cost of making them fit for a zero-carbon world, according to Sophie van Oosterom, global head of real estate at Schroders Capital.
The favourable economic conditions of the last decade – which have helped private markets investors in particular – are “reversing on all fronts” but “not all of that is priced into the different risk profiles”, said van Oosterom, speaking at PEI Group’s Women in Private Markets Summit. “That valuation adjustment hasn’t really happened yet.”
“There is a bubble in more secondary-type assets that are no longer the right assets for the future,” said van Oosterom.
On the other side of the coin there is “definitely a green premium arising”, said van Oosterom; tenants have sustainability and wellbeing high on their agenda, and there is a “wilingness to pay for the best buildings with the right sustainability criteria”.
“What hasn’t happened enough yet, but will become a feature of the market, is the ‘brown discount’,” she continued. These are the assets that are not yet on the path to reach net-zero carbon emissions. “There is not enough discount to justify the capex relating to the investment needed to get them on the right path.”
The ‘brown discount’ is, however, apparent in the private debt market, said Alice Cavalier, partner and co-head, capital solutions, Arcmont Asset Management. “You can clearly see it,” she said, “both in the secondary and primary markets” in sectors like oil and gas. “Fewer and fewer lenders want to lend […] New issues for this type of asset – even if they are healthy, good quality – are being done at a very high price.”
“You have a big chunk of industry or the economy that is going to struggle to find financing… at least on the debt side,” said Cavalier.
The topic of the panel discussion was how private markets are evolving amid the rapidly changing economy, but much of the discussion focused on sustainability. Arcmont’s Cavalier described the private debt firm’s approach to ESG: “On the debt side there are certain things we can’t do,” she said, referencing the fact that as lenders they do not take board seats. Instead the firm focuses on the exclusion of certain sectors, and giving discounts to borrowers if they hit certain bespoke sustainability targets. This, she said, is “a big focus for us”.
Van Oosterom said Schroders’ ESG investment considerations in real estate incorporate physical climate risks in the due diligence process; the cost of upgrading the asset to “put them on the right path” is taken into account; and finally the manager engages with the tenants on behaviour. “You can have a very sustainable building with all the right credentials, but if it is run with the windows open and people giong up and down the elevator all day, it’s not a sustainable outcome,” she said.