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15 February 2022

Are buildings ready for the energy transition? We have no standard way to tell

There is no universal standard for determining real estate’s risk to climate change or climate action. Efforts are under way, but some say common metrics for lenders should be the first priority.

By Dave Keating

An increasing focus of the fight against climate change is empowering consumers to let their wallet do the talking by creating trusted, standardised metrics to evaluate what spend will contribute to climate change – and what will help stop it. The recent dust-up in Europe over an EU taxonomy list of investments that can be considered green is the latest example.

However, when it comes to real estate, consumers and investors face a confusing set of metrics that are not standardised internationally. Buildings make up a third of global energy consumption, and account for 36% of greenhouse gas emissions in the EU. Consumers and investors buying real estate could make a big difference by prioritising properties that use less energy. A property’s energy use will also make a big difference to how much it costs the owner to heat it.

How the energy use of real estate is assessed varies widely around the world. In the US, only a handful of states and jurisdictions such as California and Portland, Oregon, require some form of home energy disclosure during residential real estate transactions. For most such transactions in America, the buyer completes the purchase without having any idea what the energy use of their new home will be. In the EU, standardised energy performance certificates (EPCs) must be shown to prospective property buyers. However, studies in Ireland and Germany have shown these certificates can be wildly inaccurate.

In the EU, standardised energy performance certificates must be shown to prospective property buyers, but how accurate are these studies? (Photo by Getty Images)

Even within countries, many different metrics for assessing a home’s energy efficiency can exist and they can produce unreliable results. A study by Heriot-Watt University in the UK – which is still using the EU’s EPCs in spite of Brexit – found “multiple assessors evaluating the same property can produce quite markedly different results”.

The European Commission has acknowledged some of the system’s flaws and proposed a revision of the Energy Performance of Buildings Directive to “update the framework for EPCs with a view to increasing their quality and availability [including] greater harmonisation”. Fixing the EU standards would also help encourage home renovation. Even if the EU’s EPCs improve, however, that doesn’t necessarily help the situation globally where these metrics are so divergent.

It is not just energy use metrics that are not standardised. Climate risk – measuring a building’s vulnerability to the effects of climate change – is of increasing interest to property investors. According to Matthew Kahn, a professor at the University of Southern California, a new ratings industry is emerging to help homebuyers assess climate risks, such as an increase in severe weather. The problem is that the ratings are still widely divergent.

“Like any emerging industry, spatially refined climate prediction has grown unevenly,” he says. “Some models are scientifically sound and highly precise, while others are lower quality. In a normal market, consumers would select the winning products through market competition – but for climate risk forecasts, it may take years to assess which offerings are most reliable.”

Standardising standards

Last month the Science-Based Targets initiative (SBTi) and the Carbon Risk Real Estate Monitor initiative (CRREM) announced a partnership to develop a common decarbonisation trajectory for the real estate sector consistent with the Paris Agreement goal of keeping temperature rise below 1.5°C. The project, says CRREM head Sven Bienert, “will ensure that market participants have free access to global decarbonisation pathways that are scientifically robust, anchored with investors and industry bodies, and fully aligned with the SBTi target validation protocol”.

It is one instance of different metrics providers trying to form a common understanding so investors are faced with fewer models to sort through. The aim is to make the joint trajectory the only basis for real estate companies and corporates with real estate holdings to set science-based targets for their investing – but there is significant work ahead to combine the SBTi’s and CRREM’s different methodologies. The underlying assumptions, carbon budgets and methodological foundations need to be fully aligned.

Some say this vision of a global standard to measure real estate energy use is a pipe dream, and that energy should instead be directed elsewhere. “Fifteen years ago I held a hope that it would be possible to develop like-for-like comparisons for properties across the world, and I was working to align climate and energy-related components of leading labels to build consensus for financiers,” says Peter Sweatman, CEO of Climate Strategy, a Madrid-based consultancy with a particular focus on energy efficiency. “But now this seems to me like asking if everybody is going to be speaking the same language across countries. The danger is [if we] focus on this, we might still be working towards it in 20 years. Investors don’t need label harmonisation as much as data transparency.”

The problem is, he adds, that organisations have invested a lot of money and time into developing their own metrics, and any work towards consolidating those into a global standard would essentially be putting themselves out of business. “If you are a certification business you depend on people speaking your language,” Sweatman notes.

Target the lenders instead

The problem is not so much the lack of a global standard but that the standards are targeting too many parties, the Climate Strategy CEO continues. Trying to get millions of developers, homeowners and homebuyers across the world to use the same metrics is a big task. However, lenders are comparatively small in number – and they are involved in almost every real estate transaction.

“There are as many developers as there are plots of land, but there are only a handful of lenders,” he says. “Developers will deliver whatever is cheapest to deliver within the confines of the rules, but the good news is there is a very concentrated group of lenders that cover the majority of mortgages in Europe – and they can set the rules.” 

It might be difficult to change the culture of developers, who have a profit incentive to spend only as much as they have to or risk being outmaneuvered by a competitor. However, they are also very thinly capitalised, Sweatman says, and rarely use their own money to build a building. Instead they rely on banks, and if those banks started using common metrics to assess their risk to future climate developments, both regulatory and weather-related, that trickles down to guarantees for the real estate buyer.

“Just because today there isn’t a particular law that says you can’t have a gas boiler, or you will have to pay a carbon tax, that doesn’t mean it won’t come,” Sweatman argues. “If Europe intends to reduce emissions to net zero, it has to.”

He is lobbying EU lawmakers to include a requirement for such due diligence by lenders in the revision of the Energy Performance of Buildings Directive, as well as the accompanying revision of the Energy Efficiency Directive. He says lawmakers, once they understand the concept, see the utility of such a requirement. One idea is to create mortgage portfolio standards, emulating the green portfolio standards for other areas of investment like automotive or power generation. The standard, he says, would be an essential understanding of the building’s preparedness for the changes to come with mitigation of and adaptation to climate change. It would not only be good for the planet but also for the lenders themselves, who could better protect themselves. It would also be good for real estate buyers, who would have a guarantee that any given development is climate-proof in the eyes of the lender – even if consumer-facing labels remain inaccurate, contradictory or confusing.

"I’m not asking them to understand climate models, nor transition risks, but I do expect a financial institution implementing a portfolio standard for mortgages to understand and explain it to the customer,” Sweatman says. 

Getting the whole world to speak the same language on the energy efficiency and climate resilience of real estate may be a tall ask, but getting real estate lenders on the same page may be easier – especially if the EU sets a standard that is emulated by banks worldwide. The key will be whether lawmakers are willing to bring regulatory pressure to bear, and whether energy use data worldwide is easily accessible, even if it is not standardised.

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