Brown discounts, not green premiums, are driving real estate sustainability, say managers

Real estate assets with poor sustainability credentials are trading at a discount, rather than green assets commanding a higher price, according to panellists at PERE Network Decarb Forum in London yesterday.

“I would say that we don’t see that very, very often,” Diana Louis, head of alternative assets ESG integration at German asset manager MEAG, said when asked about green premiums. “We’re more likely to see brown discount in the market… it’s all about energy efficiency and carbon intensity.”

“I think green premiums have been used as an excuse to support expensive investments in sustainability interests,” said Urban Partners co-CEO Claus Mathisen. “There are certainly buyers out there for whom the [EPC] rating is part of their acquisition mandate [and] need for a certain certification [but] we don’t see that as the most prevalent buying behaviour in the market.”

Urban Partners was formed last May as an umbrella platform for four businesses collectively aiming to undertake impact investment in city settings. The platform is led by the bosses of Danish real estate GP NREP which, with €19 billion of assets under management, accounts for most of Urban Partners’ circa €20 billion of AUM.

“The scarcity and the ability to continuously finance, to continuously insure… can be increasingly linked to the sustainability. And so for us sustainability and reducing the production of carbon intensity is about expanding the option field that we have as an owner and as an operator and, eventually, as someone that has to exit the asset,” Mathisen added.

The question of how sustainability improvement relates to financial performance is a hot topic in the real estate space, as investors seek return on the capex required to improve assets’ environmental credentials. The evidence is currently patchy: industrial properties with Energy Performance Certificate ratings of ‘B’ or higher delivered a total return of 3 percent compared with 3.5 percent for properties with an EPC of ‘C’ of lower between Q1 2021 an Q2 2023, according to research from property consultant CBRE. Inefficient industrial assets also delivered stronger rental growth, recording a rental value increase of 25 percent over the last 10 quarters and 9.3 percent per annum. Efficient assets, by contrast, delivered 19.7 percent rental growth, equating to 7.5 percent per annum.

While any brown discount is small today, the “difference between green and brown will increase in the future”, according to Annachiara Torciano, head of ESG and communications at Slättö, a Nordic real estate manager with over €1.8 billion AUM. This is due to banks and investors, as well as commercial tenants, having their own decarbonisation targets.

Panellists were asked whether they were factoring sustainability into their underwriting for assets. Urban Partners has implemented a carbon tax of €90 per tonne across all of its investments, Mathisen said. “This is high enough that it has a marginal impact on the investment decision and drives an awareness as to how do I get the reduction of carbon my underwriting. Then we proxy that on the return side by saying that a lower carbon footprint will convert into higher liquidity of the exit, higher financability.”

For Slättö, ESG is embedded through the prism of alignment with the European taxonomy. “We now have a target of taxonomy alignment, so basically a considerable improvement in the EPC rating. In the underwriting phase, the due diligence phase, we need to look at how much does it cost to get that rating increased,” Torciano said.

Panellists differed on whether this included embodied carbon. Mathisen explained that Urban Partner’s carbon tax applied to embodied carbon in the same way as emissions, while Louis said that “we don’t really take that into account in our investment decisions” due to the lack of reliable data.