Conversations about Net Zero

This is an ongoing conversation between José Ortiz, ExcelSense's Chief Research Officer, and Carlos Infantes, ExcelSense's founder and CEO, on the subject of carbon emissions and how the effort to achieve net zero targets will impact real estate asset managers and investors. It will be updated on a weekly basis, as we advance in our goal of creating a modeling tool to measure emissions inferring data from our financial modeling tool.

5. Pathways and stranded assets

Understanding how pathways work and how some assets will become stranded soon.

October 31, 2021

Carlos

Hello José,
Unfortunately, we couldn't find a bit of time to talk last week. Still, a few days ago, we had the opportunity to go over some of the modelings you are working on, and there are a couple of things that caught my attention—precisely the idea of pathways and their profound impact on assets and portfolios. 

Let me start today by asking what is the carbon-neutral pathway?

José

Hi Carlos, think about this in terms of a route map to "holding warming" below a certain level. Pathways are a decreasing annual budget of carbon emissions that can be broken down by country, the commercial real estate sector, portfolios, and individual assets. They are a roadmap for individual properties and portfolios on how to reduce carbon footprints over the next decades until 2050. If aligned with the Paris agreement, they are designed to limit median global warming to 1.5°C throughout the 21st century.

Carlos

It is clear, so there are different pathways for different types of assets defining the maximum emissions it can generate for each year from now until the 2050 goal date. This pathway has to consider many parameters, including the negative impact from construction, renovation, and demolition of assets and natural events like volcanic eruptions or wildfires over the next decades. On the positive side, the effect of regulatory measures, probably. The idea, I assume, is that if we each manage to keep our assets under that line at all times, we should be on the safe side of the tipping point. Who is in charge of drawing this line, and should we expect variations of it as we get more info into the system?

José

Anyone can create a pathway, but it is generally accepted that, for it to be ‘valid,’ it must align or be more ambitious than the goals of the Paris agreement. Valid pathways are based on science, considering many complex and interrelated factors, and will require updating if we do not collectively follow the global pathway in the years to come. 

The most comprehensive and up-to-date assessment of Paris Agreement compatible mitigation pathways can be found in the recent IPCC Special Report on 1.5°C (SR1.5).

©IPCC: Different 1.5°C pathways Schematic illustration

Carlos

Yes, I can't wrap my head around the complexity of these calculations, but assuming that the line is our reference, in any case, the line is declining at a dramatic rate; for residential assets, the decline is more than 10x in less than 30 years. What happens when an asset sits comfortably under the line today, but crosses the line, let's say, in 8 years?

José

The decarbonisation path is ambitious indeed. This decreasing line represents the decarbonisation pathway of a specific building type in a specific country that aligns with a certain climate target (1.5°C/2°C) and must not be exceeded if a property intends to be “Paris-proof”. If the emission intensity is above the target value, “stranding” occurs. In that case the asset would have a carbon-footprint that is above the fair-share derived by breaking down the carbon budget to property level.

Carlos

So basically, when an asset crosses the line, it becomes a toxic asset, right?


José

That’s a way to put it. We refer to it as the asset becoming ‘Stranded’. The key is to avoid the asset becoming toxic by implementing retrofit actions beforehand. These will keep the asset below the line. You can do this through deep dive retrofit interventions once (before the asset crosses the line) or by a staged or stepped approach with several interventions during the life of the asset...

Carlos

Stranded assets may very well be the name of the game in a decade then!. ...Ideally, you want to reduce carbon emissions as fast as possible. Still, we all know that from an investment point of view, the longer you wait to retrofit your assets, the higher the chances of leveraging the latest technology, and probably at a lower cost. So from a pure investment point of view, it seems to me it makes sense to wait until the asset line is very close to the pathway line to act. Is there any incentive for an asset manager to accelerate the retrofitting actions over their portfolios?

José

As you know, we are using CRREM to evaluate our clients’ portfolios. They explain it well in their Reference Guide: once a property reaches its stranding point, any  subsequent  emission above the permissible values of the selected pathway (so called ‘excess emissions’) can be seen as having a significant effect on the financial risks associated with the marketability of the property. The economic obsolescence of that property is associated with its stranding  date; the higher the excess emissions, the greater the probability of economic obsolescence occurring

It is all about managing risk but it doesn’t sound wise waiting for some technology unicorn to come and rescue you in the years to come. The investments associated with improving the energy performance of buildings are significant and it makes sense to distribute them throughout the next 20 to 30 years by implementing a prioritisation policy informed by the stranding risk of all the properties in your portfolio. As carbon emissions are constantly raising their profile in the Real Estate market, any enhancement of the carbon footprint of properties will increasingly be seen as value added. 

Look at it this way, perhaps next time an asset manager gets in the market to sell a property in their portfolio, one of the first questions they get asked is ‘When is the stranding date of that property?’... That might be quite an incentive, wouldn’t you think?

Carlos

Yes, I can absolutely see that happening as standard practice within the next five years. The challenge for everyone is to model the cost/benefit analysis of retrofitting assets in relation to their yield and valuation within the pathway framework, considering that there will be increasing pressure in terms of taxes applied to stranded vehicles. I believe we are going to see a whole underwriting sub-discipline growing very fast. How important, in your opinion, is to have good data as soon as possible to handle all this?

José

Good data and, most importantly, the knowhow to convert it into proper information that enables you to understand the risks and opportunities are and will become even more important in the near future. This is what we are passionate about in ExcelSense and where we are adding real value to our customers. I cannot emphasise enough the importance of this.Hopefully this series is helping to understand the reasons why this is such a critical issue for the Real Estate industry and I look forward to future discussions on this.

Carlos

Good for today, thank you José and looking forward to more next week.

José

Same here.

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