PAT Cast #8: Decarbonising the built environment

Greg Morsbach 00:00

Buildings are responsible for nearly 40% of global greenhouse gas emissions. And we cannot slow climate change if we don't decarbonise the built environment. But what steps will take us there and how quickly can we do it?

Georgia Elliott-Smith 00:15

This is the greatest design challenge that we've ever faced. You know, we really need to fix this problem and we need to fix it quickly.

Greg Morsbach 00:22

I'm Greg Morsbach and a warm welcome to the PAT cast, the podcast from PATRIZIA, the leading investment manager and partner in global real assets. In this podcast series, we offer you insights on a range of hot topics from the real assets industry, from important sector trends to key business developments and strategic decisions.

In this edition, we're finding out about the big and small changes we need to make to decarbonise real assets.

Ben Lonsdale 00:50

It can't just be greenwashing. It can't just be marketing spin. We really need to now invest in our properties, in our real assets.

Greg Morsbach 00:57

That's Ben Lonsdale, Director of Fund Management at PATRIZIA.

He joins our panel alongside Georgia Elliott-Smith, MD of sustainability consultancy, Element Four, who you heard from at the beginning. We're also joined by Konrad Hedemann, European ESG Manager at PATRIZIA.

Konrad Hedemann 01:17

I think all real estate investors are signalising that you need to do something when it comes to decarbonisation, but I think not all are knowing yet how to do that.

Greg Morsbach 01:26

The World Green Building Council says every building on the planet must be net zero carbon by 2050 to keep global warming below two degrees celsius. They say it's achievable, but not without rapid and collective action. The question is, are we seeing that kind of action? So just how serious are the impacts of the built environment on climate change? Here's Georgia.

Georgia Elliott-Smith 01:53

We know globally, 40% approximately, give or take a couple of percent here or there, is around the contribution in each country of the built environment. So it's significant. It's actually, it's huge in terms of its impact. Obviously a large part of that is residential property, but large portfolio holders, commercially and industrially, also have a huge part to play in that.

Greg Morsbach 02:16

Thanks Georgia, and sort of how should we imagine carbon emissions and the built environment? Is it just the energy that the buildings consume or does it go much further than that?

Georgia Elliott-Smith 02:30

Carbon emissions is a, it's a huge story really. We use carbon as a proxy term. Really what we're talking about is greenhouse gases. So, in their operation, there are multiple greenhouse gases that are used operationally for buildings, but also the embodied carbon, which is contained within the materials that are used to construct and refurbish those buildings and furnish them. Obviously, buildings go through multiple refurbishments during their lifetime and I think fit out and retrofit is an area that we've not really looked at in terms of its embodied carbon over the life of built assets. And then you know, all of the associated emissions as well. So things like logistics, waste movements, you know, demolition and all of the tenant occupier and user emissions that are associated with those buildings. So really operational carbon emissions is the tip of the iceberg. You know, increasing with an increasing volatile climate, we've got a lot more refrigeration, so air conditioning units going into buildings and they have a huge impact, the gases contained within those units can be very destructive on the climate too. So, yeah, it's, uh, once you start picking at the seams, you find that this whole thing becomes really enormous, quite a challenging problem.

Greg Morsbach 03:49

I mean, you just mentioned obviously climate change and the fact that we are now seeing climate change related events such as obviously changes in weather patterns. We are seeing flooding, we are seeing forest fires or bush fires depending on where you live. What is that, all of that, going to do to the built environment in terms of, you know, climate change risk?

Georgia Elliot-Smith 04:13

Yeah, we're going to see huge quantities of buildings become practically uninhabitable. You know, we are gonna see with heat waves, certainly this is gonna be causing problems for people. We're also gonna be seeing extreme rainfall, flooding events and so on. And we've seen, you know, in the UK, as I say, where I live, huge floods in Central London even where you see cars floating down the road last winter.

We've also seen over the summer, you know, sewage, raw sewage being pumped out into the sea. Well, that's because of these storm water events and the built environment has a huge part to play in that, you know, we've concreted and tarmacked over huge amounts of land, which would naturally soak away the water slowly.

So all of these things are linked to climate change, and we are starting now to see, particularly in the west, you know, these things in developing nations and in the global south have been a reality for quite some time. But we are now seeing this creeping into the global north and major cities like London and Paris.

Greg Morsbach 05:09

Decarbonisation is clearly then a word that's used quite a bit to denote the fact that we have to reduce greenhouse gases all across the world. Clearly the built environment is just one industrial sector, but when we look at the term decarbonisation, what do we understand by that term commonly, particularly for the built environment?

Ben Lonsdale 05:35

For the real estate sector, we're following the energy hierarchy and that's how we will achieve net zero. And the first phase of that is to significantly improve the energy efficiency of our buildings and our infrastructure. So using a lot less energy, using much better efficient material, machinery and equipment, and then hopefully that will lead to a reduction in demand.

So that's the first priority. The second priority is the type of energy that we consume, so we can either generate that electricity ourself through installing solar panels or wind turbines over the renewable technologies on our buildings.

Greg Morsbach 06:10

And when we look at maybe the needs of our tenants, clearly they also have very, very clear needs.

If we take for example, you know, a logistics operator and they are the tenants at our logistics warehouses, clearly they too are under pressure to decarbonise. Ben, can you give us some examples what a typical logistics tenant would be looking for from an asset manager/investment manager, for example like PATRIZIA, to decarbonise.

Ben Lonsdale 06:42

We've got some real examples of working with our tenants who also have net zero carbon strategies in place. So this isn't something that we as asset owners are doing independently. Major corporates are also adopting net zero, and therefore we are working together to achieve net zero for the whole building, not just for the bits that we control or the bits that they control.

And there's a good example within our PATRIZIA portfolio whereby we've worked with the tenant to install solar panels on the roof of the building, and that's been driven both by the tenant and landlord. And then we're investigating ways to improve the building jointly together. So changing lighting, changing machinery and equipment together, installing car charging points for their vehicles, for example.

So there are plenty of opportunities where the tenant and landlord are completely aligned or achieving the same target, and it's about collaboration rather than it just being the landlord doing this independently.

Greg Morsbach 07:35

Konrad, you're fairly new to PATRIZIA and obviously on day one you found out that overall the corporate target of PATRIZIA is obviously to decarbonise the corporate operations of PATRIZIA by 2040 at the latest, and do the same for the assets in real estate held by PATRIZIA.

I mean, when you heard that target, did you think, my goodness, you know, what have I let myself in for? Or did you think actually this is quite achievable, realistic?

Konrad Hedemann 08:08

Well, compared to our peers, I think it's quite ambitious, which I think is quite good. We need to step up I think the whole real estate industry to really bring decarbonisation as a priority one because if we do not do this, then we are faced for more risks when it comes to regulatory requirements, but also climate risks.

So we definitely need to step up and I think the PATRIZIA ambitions that are out there are really ambitious, but also needed for the real estate sector.

Greg Morsbach 08:35

What is, what is the overall mood in our industry sector?

Konrad Hedemann 08:40

Some are a bit overwhelmed on really how to set up a strategy on how to identify high impact buildings, so buildings that are exceeding these climate pathways.

And I think that's what needed a standardised approach among the real estate industry. There's clear definitions on how to really see ESG or how to define ESG and then set up a strategy. I think that is currently differs quite differently from real estate investors. I think the institutional investors are quite far when it comes to their ESG strategies and specifically insurance companies.

Greg Morsbach 09:15

Ben briefly touched on one example of decarbonisation there in terms of the logistics assets, but there are a multitude of areas that need to be addressed if we are going to decarbonise. From low hanging fruit and low cost solutions to more wide scale changes. So what is PATRIZIA's strategy?

Ben Lonsdale 09:37

I think the first phase of applying a net zero carbon strategy is actually more data and analysis based.

So really understanding the portfolio in terms of the carbon footprint of the assets in that portfolio, how energy efficient are the buildings. And that's really the first phase to prioritise what you then do next. Which assets do you need to work on first, which are gonna cause you the most problems in terms of physical risk or stranding risk?

And by doing that portfolio analysis, using tools like CRREM, which is effectively analysing where your property sits today against a decarbonisation pathway required to meet net zero. That's really an essential first phase to then say, okay, this asset, whether it's an office or logistics or residential, this asset needs attention first.

We then look to instruct, you know, ESG consultants to really understand what is causing this energy inefficiency, what is causing this high carbon footprint in the building? And then they recommend, okay, you need to improve the machinery and equipment by 2030. You need to install solar panels by 2035. You need to change the behaviour of the tenants immediately.

And all of these things add up to an improvement in the decarbonisation pathway of that asset. And that will guide when we spend money, which assets we should do first, then apply that to the rest of the portfolio. So we've got plenty of examples of that within PATRIZIA where we're already doing that analysis and that's then flowing through into asset specific decarbonisation plans.

Greg Morsbach 11:06

So let me, that's a nice segue to turn this over to Georgia because you did mention the work of the consultant, Ben and, here's the question to you, Georgia, when you, you know, get called in by a big investment manager with huge amount of assets, some of the things that you'll be first focusing on are probably the quick wins, right, Georgia, to sort of, to drive a difference.

So how do you actually go about identifying the low hanging fruit and, you know, give us some examples of that?

Georgia Elliott-Smith 11:37

You have to prioritise. You can't do everything at once. You know, you've gotta start now and you've gotta start acting. So let's get all of these together, work out which are the trickiest propositions, which are the ones that we can sort very quickly.

And yeah, the, the CRREM curve is amazing. We take a look at buildings and once we've identified those priority buildings, we do know from our experience on hundreds of properties that pretty much universally around 20% of energy can be cut through relatively straightforward, no cost interventions, or low to no cost interventions. So things like, you know, streamlining your building management system. Making sure that you don't have plant running when it's not required. You know, some fairly simple behavioural interventions and making sure that your facilities management team, your building managers, are really on the ball with various energy efficiency techniques. And then, you know, we often find that once kit has been installed in a building and the designed construction team has moved on, it's just not running efficiently. So there's an awful lot that we can do with just streamlining what you've already got to realise efficiencies. And then beyond that, as Ben described, so what we do is we will take a look at portfolio level as I say, prioritise key buildings. We wanna make sure that for our clients like PATRIZIA, that you're spending your money on the most effective measures that you can. So you're not wasting time, you're not wasting money. That all that money is going into the most effective measures possible at this point in time with the technology available.

And so we create a model of each building, a computer model of each building. Because what we want to discover is what is the absolute upper limit of what can be achieved in this particular building. Because you know with every building there is an upper limit. There's gonna be a point at which you just keep throwing money at it and it goes into a black hole.

And so we want to find out what is the best package of measures for this building that's going to help you achieve the best decarbonisation and certainly decarbonisation that's in line with the Paris Agreement, which is our 1.5 degrees trajectory. And so really practical, practical measures that says, right, here's what you have to do this year. Here's what you have to do next year. Here's what you have to do over the next five years to get you to that position and to make sure that you are keeping this building relevant, you're keeping it low-carbon, and that you've got a pathway to decarbonise over time.

Greg Morsbach 14:03

How do you then go about bringing about, you know, behavioural change, for example, in a multi-family house, you know, with 40 or 50 different apartments. How do you do that?

Georgia Elliott-Smith 14:16

Well, first of all, education. You know, I think particularly at the moment with the cost of energy going up exponentially, you know, people are really being hit in the pocket. I mean, the property has to be well designed in the first place. You know, it has to be well designed so that they have, people have intuitive systems, they know how to use those systems.

They work, you know, and they're well designed, sized for that building. But then beyond that education, you know, I think certainly within commercial buildings and then again maybe in rental properties as well, or hospitality type properties, there is a sense of learned helplessness around facilities. You know, people tend not to touch the lights or touch the blinds and things like that. You know, and there's, we need to sort of teach people how to engage and how to influence

the space that they're in, what they can and cannot touch. And you know, that goes for facilities managers as well. You know, tech is moving on very quickly and I think building management systems are not the same from one building to another and we really need to get people much more engaged in tweaking, playing with their buildings, working out how they can be optimised.

But I do feel like, you know, we are being hit in the pocket at the moment. And that's, I think the primary driver now is really, it's much sharper attention on that now to try and cut costs, which is great.

Konrad Hedemann 15:32

I can definitely support the answer that Georgia just gave, that's definitely education. Same as property management, same with facility management, but also with the tenants who are responsible for 80% of the energy consumption within a building.

So we can't do everything by ourselves. So from landlord side, we definitely need engagement from the tenants, from property managers and also from facility managers. What real estate investors are currently doing, and we are also doing that, is to provide guidelines to provide workshops on education, incentivising the tenants, etc.

So trying to set up strategies to really speak to the tenants. That's what's missing among real estate investors currently only focusing on the landlord side. But of course, actually the biggest part of decarbonising the built environment is engaging with the tenants, speaking to the tenants, and giving them an awareness of sustainability.

Ben Lonsdale 16:24

And we're also increasingly looking to include green lease clauses. So these clauses give us some control as a landlord to say, tenant, please can you, you know, if you're gonna make a, improve or fit out of the building that you consider these materials and the operation of your building, please think about sustainability issues at all time.

Please share data with us. So that is one way that the landlord can get some control over the way that the building is operated. I think tenant engagement is gonna be the most effective way, for example, setting up, for multi that office building, setting up a sustainability forum for the building where each tenant sends a representative to this meeting with the landlord or the property manager, and we can discuss sustainability issues on how should we improve the building together.

And make it more of a collaboration rather than the landlord forcing the tenant to do something and seeing it as some kind of punishment, as opposed to a collaboration to both achieve the same final result.

Greg Morsbach 17:18

Let's look at the fact that all the real estate that will exist in the year 2050, 80% of that exists already, right?

Which is a really important statistic to have at the back of our minds. So knowing that it's probably not a case of building from new, building from scratch, but actually making sure that the existing stock is refurbished and retrofitted in such a way that it's future proof. But what kind of challenges does that sort of bring?

Georgia Elliott-Smith 17:52

It does bring huge challenges because I think that we are not really there yet when it comes to embodied carbon calculations. You know, all of this is really embryonic and although people have been talking about carbon and climate impacts and so on for a long time, really studies in this work in this is pretty, is brand new really.

And so we are trying to work out on buildings with, you know, really forward thinking clients, exactly what does whole life carbon look like? You know, we've talked about the fact that a building will be refurbished multiple times over its life, but we haven't been great at collecting data on that.

And so, you know, furniture, replaceable fittings, fixtures, equipment, you know M&E equipment is a massive embodied carbon to replace in a building. However, the structural elements of a building are so, so important and retaining those is very important if you can. And so now we're starting to look, as I say, at whole life carbon rather than just bits and pieces, like just looking at operational carbon.

So all buildings now should, or significant developments should now be looking at whole life carbon assessments and actually the Mayor of London has now made that mandatory for major developments. A lot of planning authorities in the UK now require a whole life carbon assessment. But one thing I would say is that with a lot of clients that we are working with on whole life carbon assessments, it's doing the assessment almost after the horse is bolted.

We're not there yet, in most cases, on conducting the carbon assessment first, on the options that are being put forward for refurbishment or for build. And then designing the buildings based on the findings of the whole life carbon assessment. So that's what we call a dynamic whole life carbon assessment rather than just a static one.

A static one just tells you what you've designed and what its carbon impact is. A dynamic assessment is where we really ought to be so that we can then look at all the different architectural options and say, right, this is the best bet for you based on carbon. But I think that will come over time as we get more sophisticated. You know, we are just looking for more clients who can build that into the design process.

And that leads me to another point, which is that our procurement processes and our design processes for building at the moment are not set up for these studies to necessarily be done at the right time. So quite often the sustainability consultant and these carbon assessments are done quite late into the design work rather than being done right at the very beginning, you know, at stage zero when we're actually just talking about the concept of the project, that's when we should be starting to devise our sustainability strategy and deciding what are the perameters.

Konrad Hedemann 20:36

What I definitely see within the built environment is that there are limits when it comes to decreasing CO2, but also kilowatt hours.

So I think at some point if we do, for example, other measures that are currently undergoing also within our portfolio, I think there are limits to that economically, but also ecologically. So that's definitely a challenge for the future. And also what I am bit concerned about is that investment managers or investments are currently only focusing on top A or B locations.

But of course, we also need to decarbonise all the bit environment in D or E locations to fulfill the regulatory requirements to really decarbonise the assets, to minimise risk, etc. But of course within those regions there are also limits when it comes to example to rental increases or carrying out refurbishments. So that's definitely a challenge for the future.

Greg Morsbach 21:29

Let's look to the future now. We are living through a time of economic uncertainty. Energy costs are rising, inflation is spiraling, supply chains are often broken. It's hard to see past today and think long term. So how do we keep our clients engaged in sustainability and especially decarbonisation?

Ben Lonsdale 21:53

I would say that the institutional investors in our funds are one of the key drivers of the adoption of net zero. They've really pushed this forward, probably more than government sector and regulators, to be honest. So they are fully signed up to the challenge, and if anything, they're pushing goes harder to achieve our stated objective. So, and it's a long term strategy, right? So this is a target to achieve net zero by 2040. It doesn't mean that everything has to be done tomorrow. So decisions can be made in the short term. You know, we've got very high inflation that's flowing through into building cost inflation.

So some projects are becoming too expensive to do right now, but they can be delayed until they become more financially viable. But no, I think our institution investors are fully behind us. And are really pushing goes forward to achieve net zero by 2040.

Greg Morsbach 22:43

I'd be keen to hear from Konrad on the sort of tenant perspective and you know, the economic challenges that everybody's facing, you know?

Konrad Hedemann 22:51

When it comes to, for example, to commercial tenants, there's split incentives or landlord tenant dilemma. So actually we as a landlord invest in specific ESG measures, however the tenant is benefiting from it. So that's quite an ongoing discourse with the tenants because they of course pay then less energy costs, whereas we have the investment costs, so there needs to definitely be a change within the rental contracts or within the regulation. When it comes to residential tenants, it's quite difficult there. For example, if you want to say within the contract that they should use green electricity, given a certain situation electricity prices are increasing and then adding on top of it green electricity is quite critical.

Georgia Elliott-smith 23:32

Adding on to what Konrad says there as well, there is of course the issue of increased asset value. The carbon performance of the building is linked to its value, and therefore the investment that the asset owner puts into that building will be realised when they come to sell it, because it will result in an increased value.

And I think we're just at the start of that now. It's not, we're not quite there, but we can definitely see that in the future.

Ben Lonsdale 23:57

There's a clear financial case for investing in net zero, and I think as Georgia is suggesting, we're not there yet, but I think within the next three to five years, if you have a building which is energy inefficient and has a high carbon footprint, that property will devalue. There will be increased CapEx liabilities included against that valuation, and also there'd be a pricing impact because investors don't want to buy that kind of asset in the future. So there's a clear financial case for addressing climate risks for investing in the properties and protecting our investors from the downside risks of climate change.

Konrad Hedemann 24:31

I mean, there's currently a lot of regulation coming up. For example, the Netherlands, their letting restrictions coming to law for next year when it comes to office buildings, but also for residential buildings by 2030. So actually landlords are obliged to do something for decarbonising the energy performance or decarbonising the property, because otherwise they will face liquidity losses.

Greg Morsbach 24:55

Well, one thing is obviously the regulatory environment and that's clearly getting tougher and tougher and stricter and stricter. And so it should, in order to actually prevent climate change in accelerating. But the question is, should we go way further than legislation?

And I'm now looking at you, Georgia, because you are obviously somebody, and not many people know this about you, you're an Extinction Rebellion activist in your spare time, when you have a bit of spare time. So should we all be climate change activists, do you think?

Georgia Elliott-Smith 25:28

Yes. Very short answer, yes. And the reason for that is that I think we have to move more quickly.

You know, we've known, I started my career in the early nineties, we already knew that climate change was coming. You know, we called it global warming back then, but we've known about it for such a long time, and so little has been done. And so all of us know that what we're doing is not enough. We feel very restricted by business as usual. You know, there are certain systems, the way the economy works, the way the industry works, that hold us back from being able to do what we would like to do more quickly, and I think the only way to really get around that is to be more activist.

Greg Morsbach 26:07

Maybe just to round off this discussion, I've heard your thoughts. you know, there's clearly a lot of good things are happening, but yet there are challenges out there and there's a lot that still needs to be done. Quick question to each of the three of you. I mean, how optimistic are you about the future?

I'm optimistic that for the first time maybe ever, governments, regulators, investors, lenders and tenants are all pretty much aligned that we need to do something.

Ben Lonsdale 26:29

I guess the pessimist in me thinks that it won't be enough, and we maybe won't avert the worst effects of climate change, but I think for the first time, in my working life, I feel like there's some genuine momentum behind doing something.

Konrad Hedemann 26:58

What I'm a bit concerned is about other countries.

They are not that far as European Union, for example. So we really need to work on a worldwide framework on sustainability, understanding of sustainability in order to really achieve our climate targets. Because if we do only this on a European Union basis, then of course we do not achieve the targets

Georgia Elliott-Smith 27:18

Yeah, finally, I mean, I'm very optimistic, otherwise I couldn't do this work.

And I do have to say that is peppered sometimes with bad days where I just think, Oh God, we're all doomed. But you know that you can't carry on like that. We've gotta put one foot in front of the other and we've gotta fix this problem. You know? This is the greatest design challenge that we've ever faced. You know, we really need to fix this problem and we need to fix it quickly.

I think, you know, the biggest threat that we have is complacency, and I think it's people expecting other people to move first, is waiting for people to take them along by the hand. You know we all need to step up and we need to be asking the questions and challenging ourselves and each other to do better.

Greg Morsbach 28:02

Thanks to our guests, Georgia Elliott-Smith, Ben Lonsdale, and Konrad Hedemann, and thanks for listening. I'm Greg Morsbach, and you've been listening to the PAT Cast from PATRIZIA. You can subscribe to the show on Apple Podcasts and Spotify or wherever you listen to your podcasts. And don't forget to head over to our website, patrizia.ag, to find out more. Stay safe and healthy, until the next time.

This podcast is produced by OG Podcasts. Find out more at ogpodcasts.co.uk.