Stranded Assets: Climate Change Could Put CRE In A Precarious Position

Commercial real estate (CRE) owners who want to preserve the value of their assets must ensure they reach certain sustainability levels within the next 10 years or risk losses.

While many municipalities and states are mandating compliance with laws aimed at reducing greenhouse gas emissions, prudent property owners are responding to demand from tenants and their own corporate policies to ensure their buildings are as energy efficient and environmentally friendly as possible. 

“Renewable energy is a really important part of the whole equation,” said Kenneth Lang, senior sustainability consultant for Altus Group, a provider of asset and fund intelligence for commercial real estate.

Brookfield, for example, plans to power its One Manhattan West Building in New York City with 100% renewable energy — one of the largest renewable energy deals for a single building in the state.

“Every tenant will be able to say they have zero emissions,” Lang said. “It’s interesting to see the market evolve in that way — capitalism is driving this on its own.”

Climate Risk

But while renewable energy is important, building owners also must assess what Lang terms “climate risk” for their investments. It’s a three-pronged approach.

First, there’s physical risk that includes events such as hurricanes, wildfires, drought and flooding.

“If you have a building, you can’t take it out of the way of a wildfire or a hurricane,” said Lang, noting that Altus has partnered with climate risk data provider ClimateCheck to provide physical risk assessment for its clients.

Next, there’s transition risk. More jurisdictions require buildings to comply with regulations designed to cut emissions greenhouse gas emissions from buildings.

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In New York City, for example, Local Law 97 will require most buildings larger than 25,000 square feet to meet newer energy efficiency and greenhouse gas emissions limits by 2024, with stricter limits going into effect in 2030. The goal is to reduce the emissions produced by the city’s largest buildings by 40% by 2030 and 80% by 2050.

“Tenants are having to disclose their environmental, social and governance (ESG) profiles, so the market is going to be demanding from landlords that buildings are as efficient as possible and potentially net zero so they can show they’re sustainable as well,” Lang said. “If you don’t meet that, it’s called a stranded asset. If in 10 years, you’re not complying with the laws and market demands, you’re going to have a building that’s not worth very much.” 

Banks also are under pressure to ensure to disclose their ESG exposure in the properties they have extended loans to, which could make it difficult to get loans for buildings that aren’t adhering to measures aimed at reducing climate change.

“We might have stranded assets sooner than we think,” Lang said. “If banks are under pressure to have portfolios of loans that are in more sustainable buildings, you may have trouble getting a loan.”

The third climate risk investors should consider is the market. Miami’s real estate market is hot with many people migrating to the Sunshine State to live and work. But the city is in the path of hurricanes and a rising sea level.

“It defies logic,” Lang said. “This is part of the complications we face when we’re looking at valuations. You have to look at what people are paying. If other people are paying large sums of money to be in Miami or other at-risk places, you can’t ignore it. The industry is in a bit of a bind at this point.”

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