Sustainability, combating planned obsolescence
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Roman technology from 2,000 years ago has a thing or two to teach the cement business of today, whose industry is responsible for about 8% of planet-warming carbon dioxide emissions. Ancient Roman concrete was durable and able to withstand earthquakes and bad weather by "healing" its own cracks when it came into contact with water, due to a unique chemical reaction. Modern concrete by contrast tends to crack pretty quickly. Modern cement also releases one metric tonne of carbon dioxide for every tonne of concrete made. If the cement industry were a country, it would have the third-highest emissions in the world, after the US and China.
Effecting change isn’t easy. The Romans tried many different combinations over a long period of time before they figured out how to make the best concrete mix for each job. The experimental phase can be costly. The biggest toy company in the world, Lego, said two years ago that it had tested a prototype brick made of recycled plastic bottles (RPET) instead of ABS, which is made from oil. But Niels Christiansen, CEO of the family-owned Danish group, told the Financial Times that using RPET would have increased carbon emissions over the lifetime of the product because it would have needed new equipment. The group still plans to spend DKK 3 billion ($430m) a year on sustainability by 2025, which is three times as much as it spends now.
When there’s the right intent, incremental changes do work however. Coldplay’s "Music of the Spheres" World Tour, which started in March 2022 and has sold more than seven million tickets, has so far produced 47% less CO2e emissions than their previous stadium tour in 2016–17. FIFA, on the other hand, has shown rather less intent, announcing that the 2030 tournament will take place in six countries in six different time zones.
The political backdrop also matters. In 2022, Europe maintained its leadership in sustainable investing, attracting the majority of global inflows and holding 83% of global sustainable fund assets, totalling $2.1tn by the end of the year according to Morningstar's Global Sustainable Fund Flows report. Hortense Bioy, Morningstar's Global Director of Sustainability Research, noted that Europe's rebound in sustainable fund inflows was fuelled by strong investor interest and a supportive regulatory environment. In contrast, the US ESG fund market faced challenges due to various macroeconomic and political factors, including prominent figures speaking and acting against ESG investing.
Lisa Pham of Bloomberg writes that a study by analysts at Goldman Sachs Group Inc found that asset managers are finding it "increasingly hard" to sell funds in Europe if their products are not ESG registered. Goldman's analysis shows that since 2019, when the Sustainable Finance Disclosure Regulation (SFDR) was first passed, its two ESG categories, Articles 8 and 9, have had 3.4 times more client flows than Article 6, which is not an ESG category. Evan Tylenda and Grace Chen, two Goldman analysts, wrote in a note that the new global regulatory order has had a "significant effect" on capital flows. "It's getting harder and harder to sell Article 6 funds," they said.
In terms of returns, so far the risk is being rewarded. A new report from the Morgan Stanley Institute for Sustainable Investing called "Sustainable Reality" says that sustainable funds had a median return of 6.9% in the first half of 2023. This was higher than traditional funds' return of 3.8% and made up for their poor performance in 2022.
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Some countries also think that it is worth taking the risk. Luxembourg imports about 95% of its energy and has the highest GHG emissions per person in Europe at 20.6 tonnes per year, but Luxembourg wants to go beyond the EU's goal of reducing carbon emissions by 55 percent by 2030 and to net zero by 2050. At the same time, it also wants to do more to make energy more affordable and secure. Even though meeting these goals will be hard, Luxembourg thinks that it will be good for its businesses, which will play a key role in the transition. If they focus on reducing emissions up and down the value chain in addition to direct and indirect emissions they hope to take advantage of opportunities for green growth and keep their competitiveness.
Deciphering the impact of sustainable products and services is highly uncertain and beset by psychological influences. For example, Dessaint and Matray (2017) found that corporate managers who saw hurricanes in nearby areas began to overestimate the risk of hurricanes and increase the amount of cash in their portfolios. Similarly, So, Hong, Li, and Xu (2019) show that stock markets don't think about the effects of droughts that are expected to get worse until after they happen. The growing news coverage of extreme climate events could have an effect on the asset classes, sectors, and regions that are most affected by it.
The impacts on real estate are already being felt. In a survey of European real estate managers covered by Funds Europe last year, more than half of the respondents saw property values increase by up to a quarter as a result of greater sustainability characteristics. Data provider Deepki said the higher pricing power of more sustainable buildings triggered a rise in asset values for 250 commercial real estate managers across the UK, France, Germany, Spain and Italy. Katerina Papavasileiou, associate director of real estate ESG and responsibility at fund manager Federated Hermes, says that occupiers are moving away from stated commitments to sustainability and toward performance-based certifications that focus on real energy savings. "There is a growing need for new assets that have low upfront embodied carbon or whole-life carbon," she says. "The carbon agenda is being aggressively pushed by buildings that are being designed now instead of those that are being built."
Much needs to be done. According to analysis by Cushman & Wakefield, the current European office stock can be split into three groups: 24% was built in the last decade, fits modern office needs, and is in high demand, 62% requires repositioning to avoid deterioration, and 14% is ageing, hasn't been updated, and is in many ways already obsolete.
The real estate industry alone is responsible for about 40% of all carbon emissions in the world, so making the building industry more environmentally friendly has become a top priority, but it's not clear whether the transition represents an investment opportunity.
The Klosters Forum, an event focused on sustainable urban development, highlighted the urgent need to transition the construction industry towards sustainability. The built environment, a major source of global carbon emissions, necessitates a shift towards greener practices. During the forum, experts from various fields emphasised the importance of moving beyond net zero, aiming for regenerative and restorative approaches in urban development. But it isn’t clear whether the transition represents a profitable investment opportunity.
By the same token, developers and entrepreneurs, find it hard to obtain large-scale financing for what are sometimes ambitious projects with novel approaches to sustainability, resilience and inclusion. This yawning gap in financing represents a significant barrier to the sustainable transition.
The estimate from AEW is that the climate risk premium for prime assets across Europe stands at 19 bps. This means that property investors need to reserve 19 bps of additional energy efficiency capex annually to comply with decarbonisation requirements. To estimate these costs investors can undertake technical due-diligence. This early assessment allows property owners to gather a robust set of information regarding their assets, helping them de-risk their portfolios and position themselves favourably for refinancing. It involves engaging with experts like Hollis, a real estate consultancy, to conduct thorough technical reviews and surveys. These surveys can include vendor reports, pre-acquisition investor surveys, and vendor surveys. In 2013, 20% of Hollis' building surveys were vendor reports. By 2016, this had increased to 30%, and last year it was 42%, as investors sought to understand the scale of their challenges.
Nuveen Real Estate's latest analysis shows that commercial real estate debt funds in Europe that offer investments with a strong track record of being sustainable are likely to get more investors in the near future. The third annual EQuilibrium global investor survey by the company shows that almost 75% of institutional investors think about or plan to think about how their investments affect the environment and society. About 83% of respondents think about or plan to think about climate risk when making investment decisions, and about 47% want to increase their allocation to private credit. Nuveen says that these results suggest that debt funds that focus on investments that are good for the environment could become a "favourite" among investors. Other businesses are gearing up to lend too. After lending more than €350 million in green loans across Europe last year, LaSalle Debt Investments has added "a dedicated focus on sustainable lending" to its senior-secured debt strategies.
Designing buildings to minimise upfront embodied carbon or whole-life carbon is a change in mindset for an industry that has been guilty of ‘planned obsolescence’. Planned obsolescence is a business strategy in which products or services are sold with an artificial expiration date. They do this by making products that go bad quickly on purpose or by using clever marketing to make them feel old faster than they would on their own. This helps them increase sales and create regular customers. Alfred P. Sloan, the CEO of General Motors, was the first person to use planned obsolescence as a business strategy. He did this in the 1920s to compete with Henry Ford, the founder of the Ford Motor Company. Sloan's plan worked, and people started buying new models to keep up with the times. In reference to the debate for sustainability in real estate, it’s Ford’s strategy that should prevail.