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IPCC 6AR Report: Our Analysis

August 10, 2021/in Insights /by Jessica Moore

The UN Intergovernmental Panel on Climate Change (IPCC) published the first part of its Sixth Assessment Report (6AR) today on the physical science of climate change. Further reports on adaptation and mitigation are due in Q1 2022.

6AR’s findings are arresting – more so when we appreciate that it represents wording moderated by what 60 countries could all agree. Each of the past four decades has been warmer than its predecessor. By 2020 we were already at 1.09°C of warming, and even in the best case scenario, the iconic 1.5°C will be reached by 2040 – and most likely around 2034. The Arctic is likely to be practically ice-free before 2050; already polar ice loss and glacial melting have caused a near tripling in the rate of sea level rise. Some changes are now irreversible, particularly those to the oceans, such as ice cap depletion, sea level rise, and the acidification and deoxygenation of the seas.

The restrained scientific language sounds apocalyptic, but the consequences – on which 6AR is largely silent – are more so. 6AR limits itself to physical science and does not expand on the impact on life. The changes to the oceans, chronicled by 6AR, imperil humanity by threatening the marine plants which produce over half the oxygen we breathe and by collapsing the ecosystems which support our fisheries. The unavoidable sea level rise to which “in the longer term” 6AR warns we are “committed”, means our least-bad outcome sees major cities such as Miami and Bangkok under water, and whole countries wiped off the map as oceans swallow island nations. Sea level rise alone will cause political turmoil and mass migrations, even before other aspects of the changing climate such as conflicts over water and other resources are considered.

Already we have seen extreme weather which scientists agree would have been “virtually impossible” without climate change: distortions to the jet stream, caused by the Arctic heating 3 times faster than the global average, have brought record-breaking and fatal extremes across the northern hemisphere, from heavy snow in southern Texas, to heatwaves and wildfires in northernmost latitudes, and flooding in Europe and China. These billion-dollar climate-driven impacts did not inform 6AR’s conclusions, as the data deadline was 1 January 2021 – but they ensure an attentive audience. With increases in the frequency and severity of unprecedented weather “virtually certain”, 6AR offers particularised regional information on climate’s impacts.

We do still have a chance to avert the worst impacts on the planetary systems on which our lives depend. “Immediate, rapid and large-scale reductions” in emissions are imperative, as natural carbon sinks become less effective and feedback loops intensify. This includes urgent cuts to methane (a by-product of decay, released both by human activities such as extractive industries and agriculture, and also through the impacts of global warming, such as melting permafrost and drying wetlands). The arithmetic is stark: a further 300 gigatonnes of carbon emissions is all that 6AR estimates we can afford to add to have a good chance of avoiding 1.5°C – for context, even 2020’s global industrial pause emitted 32 gigatonnes. At 500 gigatonnes, our odds are 50-50. Concerningly, such climate models were being re-appraised shortly before 6AR’s publication, as evidence mounted of impacts in 2021 which scientists had not expected to witness before 2090. Reassessments suggest that only modest warming takes us closer than we had realised to tipping points beyond which no amount of intervention can be effective.

The global consensus on the problem, as articulated in 6AR, is not reflected in agreement on the solutions. In a year in which both the Amazon and the Arctic tipped from carbon sinks to net sources, the “last chance” climate forum COP26 increasingly looks incapable of braking the nosedive. Coal is a key sticking point, as the single largest source of carbon dioxide emissions, and its consumption has “surged above pre-Covid levels” according to the IEA, “driven by Asia”. China’s consumption of coal increased in 2021, causing the price of Australian thermal coal to rise. India maintains that it is entitled to continue to burn coal to fuel its development, just as the wealthy nations did in causing the bulk of the problem; its delegation did not even attend preliminary talks recently, saying it had made its position clear at the G20. And while said wealthy nations are reducing their coal usage, it remains a non-negotiable part of the US economy and its significance to Poland holds back the EU’s wider green programme.

So often in negotiations, money is the infinitely flexible element that can bridge gaps between parties. However, developed nations have failed to mobilise the $100bn annual investment promised to poorer states by 2020. Three quarters of the $78.9bn provided is in the form of lending; the IMF was warning of spiralling debt in the developing world even before 2020’s “debt pandemic”. The Biden administration has noisily stormed the sliver of moral high ground exposed by China overtaking the US as the world’s greatest emitter. However, it has only promised $5.7bn – and in 2024, casting doubt on whether it will indeed emerge from the shadow of the presidential election. By contrast, the EU provided $24.5bn in 2019. The greater contrast, however, is between such public finance, and private: on a single day in July, two asset managers raised nearly $12.5bn for climate investments.

Averting systemic collapse will require levels of leadership, resourcing and agility which appear beyond the compromises of international relations, but corporates are already filling the vacuum. The IPCC explicitly called on investors and businesses, as well as governments, in launching 6AR. Private finance is increasingly the universal lubricant easing the sticking points which immobilise public policy. Companies across the developed world are leading climate initiatives; globalisation extends innovations into even carbon-wedded countries, and corporate networks of relationships amplify their impact across value chains. Financiers are engaging with shifting market forces away from incentivising consuming finite resources, destroying planetarily-critical habitats and emitting carbon.

Straddling the gap can be uncomfortable for commercial entities. Danone’s CEO was axed when its shareholders did not consider the company’s exemplary sustainability efforts to be supporting an ailing share price. However, the tide of shareholder sentiment has turned, with 2021 boardroom revolutions demanding more climate action, not less. Headline instances at ExxonMobil, Chevron and others are echoed in shareholder engagements amongst our own clients. The costs of inaction are increasingly apparent and must be reflected in corporate risk-management to protect shareholder capital.

Yet there are historic opportunities for companies which develop the technologies underpinning the largest industrial revolution since mechanisation. This too is evident in our advisory work, with individual clients investing over $100m in the transition, undeterred by governmental hesitancy. Regulation inevitably trails innovation: companies which do not allow their ambitions to be limited by the political context have always been those which have profited most. Never let a good crisis go to waste.

Are your investments climate proof?

January 21, 2020/in Insights /by Amie Shuttleworth

We are currently in the midst of a climate emergency. The latest intergovernmental report released by the IPCC (SR15) states that the world is on course for a disastrous 3 degrees temperature rise, based on the current level of government commitments. On the 15th of January, The World Economic Forum released their Global Risks report for 2020 and climate now tops the risk agenda – dominating the top 5 long term risks in terms of likelihood. This is because climate change is striking harder and more rapidly than anyone had expected. In 2019 we saw extreme flooding in Mozambique, a super typhoon rip through Japan during the Rugby World Cup and of course the fires that still rage today in Australia. Insurance companies estimate these increased climate related disasters have cost $150 billion USD, during 2019.

Risks to assets and business continuity

As the global population becomes more urbanized, there is an acute need for climate resilient buildings and infrastructure in order to ensure they (and we) are protected from the physical and transitional risks posed by the expected increase in extreme weather. Unsurprisingly, there is a developing concept, supported by academic research, that an asset which is climate resilient will also have an associated increased value, and a discount applied to those without – so if you haven’t got a climate resilient asset, it is probably going to become stranded in the future.

One of the key issues is that, even though many businesses have been considering the environmental, social and governance (ESG) impacts of their businesses or assets, until recently the vulnerability or resilience of a building or infrastructure to cope with or mitigate against the impacts of a changing climate have often have not been considered.

So, what needs to change in order for resilient assets and developments to be the new norm? In the UK, for example, perhaps local authorities will introduce climate adaptation conditions attached to planning consents, above and beyond the commonly applied requirement for a Flood Risk Assessment to be undertaken. Perhaps insurers and lenders will become more discerning and explicit about the future climate risk exposure of the assets they are underwriting and reflect that in their premiums, loan rates and covenants. And perhaps asset owners and managers will find it harder to transact without clear evidence of the resilience of assets and portfolios. Whilst there are signs that many of these things are beginning to happen, future climate risk remains an under-stated consideration in strategies and appraisals.

Unfortunately, there is currently a lack of appropriate methods or metrics available for measuring climate resilience at the building or asset level. The current practice of ESG reporting does not reflect how well a building or company is prepared for the risks posed by a changing climate, as the focus has been on mitigating their contribution to exacerbating climate change – greenhouse gas emission reporting / carbon foot-printing. The TCFD, chaired by Michael Bloomberg for the Financial Stability Board, has been an evident catalyst for change, with an increasing number of companies and funds beginning to assess and explain the resilience of their assets under a changing climate, with scenario analysis being undertaken by a small but growing number of real estate organisations. However, when it gets to the more ‘street level’ questions of “which of our assets are at risk to which climate perils and by what magnitude?”, “how might that impact on the returns they generate?” and “to what extent have the measures we’ve undertaken to improve resilience protected our portfolio from downside risk?”, TCFD does not provide such a framework.

Indeed, ask several climate risk modelling vendors to provide a quantified assessment of risk exposure at the individual asset and portfolio level, and you are likely to get several (sometimes very) different answers. This makes the ambition of the TCFD to encourage the issuance of comparable, decision-useful intelligence for investors and lenders across the market something of a stretch, and also means that individual companies and fund managers will need to be confident about the assumptions, data models and methodologies used for any assessments they commission.

Meanwhile, design codes and related modelling conventions are no longer fit-for-purpose, as they are based on historical weather patterns. In addition, sustainable design standards such as BREEAM and LEED, do not make it mandatory to account for exposure to future changes to climate to achieving any certification level – meaning you could be investing in a BREEAM ‘Outstanding’ or LEED ‘Platinum’ building, but it may not be designed to cope with what the future may hold. This makes it very difficult for investors or developers to know that their asset will be fit-for-purpose, both immediately and in the future.

What is the solution?

At Hillbreak, we believe that the industry needs to develop, collaboratively, a unifying climate resilience framework for real assets, that can help to address the ‘street level’ challenges of climate risk – particularly from a physical risk perspective. This tool would enable a clear understanding of whether an office building, for example, has enough capacity to provide cooling in a hotter summer, or if it could be subjected to regular flooding due to more intense rainfall predicted, or if the wind loading is sufficient to withstand predicted future hurricane, typhoon and storm intensity.

In order to make it simpler for investors and developers alike, the logical solution would be to integrate it into existing sustainable assessment tools, making it a mandatory, pre-conditional element to secure any form of rating. However, if these existing tools are not able to change fast enough (history suggests that would be highly probable!), a standalone ‘climate resilience’ certification may have to be most transparent way to communicate and facilitate this, at least in the short-term, applicable to both new and existing assets.

We would be really interested to get your views on this, so please do comment or email us if you have any observations, questions or suggestions.

Implications of the UK Green Finance Strategy for real estate

July 4, 2019/in Insights /by Jon Lovell

The UK Government has published its Green Finance Strategy, which seeks to tune capital markets to the ambitions of its Industrial and Green Growth Strategies and its commitment to the Paris Agreement on Climate Change. Significantly, the new Strategy looks beyond aligning and unblocking capital flows to green assets and solutions (“Financing Green”) by placing equal emphasis on the imperative to integrate climate and environmental factors into financial decision-making across all asset classes (“Greening Finance”). In addition, it seeks to cement the UK as a global centre for green financial products and services (“Capturing the Opportunity”).

The new Strategy gives a strong signal of intent, with some notable measures, but it is lacking in the detail and level of commitment that owners and managers of commercial and residential property ought now to expect.

Objectives

The two central objectives of the Green Finance Strategy are:

to align private sector financial flows with clean, environmentally sustainable and resilient growth, supported by Government action; and
to strengthen the competitiveness of the UK financial sector.

There are many parallels to be drawn with the ongoing efforts of the European Union, through its Action Plan on Sustainable Finance, to:

reorient capital flows towards sustainable investment, in order to achieve sustainable and inclusive growth;
manage financial risks stemming from climate change, environmental degradation and social issues; and
foster transparency and long-termism in financial and economic activity.

The combined and accelerating weight of effort both domestically and at the European level to address capital market deficiencies in relation to the climate and ecological emergencies should, therefore, not be underestimated by investors or their fiduciaries. Indeed, the new Green Finance Strategy commits the Government to at least match the ambition of the three key objectives included in the EU Action Plan.

Climate and environmental integration

Considerable emphasis is placed on clarifying and enhancing the roles and responsibilities of an array of market regulators, such as the Financial Conduct Authority and Prudential Regulatory Authority, combined with a commitment to develop Sustainable Finance Standards. There is also a clear signal that Government policy will drive stranded asset risks, including through its push for complete divestment from unabated coal facilities.

Alongside the European Union’s own regulatory programmes for improved ESG disclosures, there are also specific proposals to mandate disclosure in accordance with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) for listed companies and large asset owners by 2022. This is catalytic; within the real estate sector, whilst some REITs such as the BMO Commercial Property Trust and LandSec have begun to incorporate disclosures expressly aligned to TCFD, these are very much the exception to the market rule.

Financing green buildings

For real estate owners and managers, there are a number of notable declarations, some of which have admittedly been trailed previously. Examples include the commitment to explore further the disclosure of operational energy use within buildings, including a strong nod to the Design for Performance work of the Better Buildings Partnership, as well as a commitment to consult formally on the future trajectory for Minimum Energy Efficiency Standards (and for which a programme of Government dialogue with the industry is already underway). For the domestic sector, funding support for private sector pilot projects to trial green mortgages and other innovations are notable, especially bearing in mind that all existing PRS leases will fall within the purview of Minimum Energy Efficiency Standards in nine months’ time. Potential financial measures to support the existing aspiration to upgrade homes to EPC band C by 2035 are also set out, including the possibility that lenders will be mandated to help homeowners finance energy improvements, alongside improvements to the much-maligned Green Deal framework.

Hillbreak verdict

In our view, the new Green Finance Strategy is significant for real estate asset owners and managers, particularly in relation to the measures proposed to green the finance system through, for instance, enhanced mandatory disclosures, improved sustainable finance standards and clearer oversight responsibilities. However, although there are several notable statements that relate specifically to the financing of climate and environmental solutions in property, these remain, for the most part, tentative and subject to further consultation and investigation. Given the pivotal role of the built environment in the context of the climate emergency and environmental breakdown, together with the extensive work and engagement that has already been undertaken on many of these proposed measures over the last decade, the time for provisional measures has arguably now passed. Whilst there are several welcome elements within the Strategy, as a package of measures it falls short of the market transformation that is needed.

The trouble with Science Based Targets

May 9, 2018/in Insights /by Jon Lovell

Background

Formally-approved Science Based Targets (SBTs) are a scheme of the Science Based Targets Initiative (SBTi), a venture of the UN Global Compact, CDP, World Resources Institute and WWF. They have been gaining much attention and some traction amongst corporates and institutional investors; at the time of writing, 105 companies have in place targets formally approved by the SBTi.

In essence, these are targets adopted by companies to reduce emissions proportionately in line with the level of decarbonisation required to meet the <2^oC global warming goal of the Paris Agreement on Climate Change.

Certainly, SBTs have useful application at a macro or portfolio level. For example, they can be a tool for policy-makers to establish future carbon budgets and related policy instruments for individual economic sectors, or they can assist investors in setting climate mitigation goals across their respective investment universes. However, a principal benefit often cited of SBTs is that they provide evidence-based pathways against which to pin the carbon reduction strategies of individual entities, including within sector-specific contexts. This, we challenge.

Whilst SBTs have their place, including a welcome shift in thinking towards corporate climate action being proportional to associated global impacts, we question their role and utility at the individual entity level in the absence of sector-wide agreements to meet the necessary pathways.

Indeed, rather than being a force for rapid progress on the urgent need to mitigate climate change, they may actually have an unintended and dangerous dampening effect on the rate and extent to which individual companies – and sectors – achieve their full carbon reduction potential.

Of the various methodologies recognised by the SBTi, the Sectoral Decarbonisation Approach (SDA) is the most applicable to real estate organisations, with a normalisation approach based on floor area and a carbon intensity pathway of 55 percent by 2050 from a 2010 baseline.

Driven by perceived or directly expressed investor requirements, a number of real estate organisations have established formal SBTs to demonstrate their commitment to the <2^oC goal of the Paris Agreement. They have, understandably, received plaudits and achieved enhanced brand profile for taking an early stance in line with their market leadership on responsible property investment.

A race to the bottom

Aside from certain methodological limitations (including, in particular, on the question of how best to deal with Scope 3 emissions in a real estate context), we have a more fundamental concern with SBT-compliance being assumed by the industry as a badge of leadership for responsible investment when the SDA pathways represent the average level of decarbonisation needed of individual sectors. If organisations at the front of the ESG agenda are adopting targets based on the global sector average, the chances of those sector pathways being realised – and the goals of the Paris Agreement as a consequence – become very remote indeed.

There will be many real estate organisations with portfolios centred on advanced jurisdictions, such as the UK, where very little or no real action will be required of them, either because the continued decarbonisation of the grid will essentially do the job of achieving SBT-compliant trajectories for them, or arrangements can be made to purchase 100% of electricity from renewable sources at rates competitive with brown electricity. Worse than that, the efficiency of portfolios could actually regress, and an SBT could still be realised. There may also be unintended consequences relating to technology selection.

A problem amplified

In addition to specific investor requirements, the rationale for establishing SBTs at a house or entity level has been amplified by their positive recognition in the latest assessment framework of the Global Real Estate Sustainability Benchmark (GRESB), the most widely utilised portfolio-level barometer of attendance to ESG issues for the industry. By attaching ‘points’ to compliance, GRESB participants will have an added incentive to pursue formal SBT accreditation. Recognition is similar in the latest edition of the CDP Climate Change Module.

It means that schemes such as GRESB and CDP will be of limited effectiveness in driving the necessary sector-wide performance because they will be rewarding participants for setting out to achieve what should be considered a floor-level trajectory. In those cases where entities can rely entirely on grid decarbonisation in the jurisdictions in which they operate, this amounts to nothing more than recognising and rewarding an administrative process, albeit one that has involved a good deal of technical work undertaken in good faith by those wishing to demonstrate leadership. Perhaps this does warrant some time-limited credit, but the impact of true portfolio performance indicators on industry benchmark positions will be diluted in the meantime.

A better approach for investors

Investors that recognise the risks of climate change to capital market stability and investment performance, are, quite rightly, motivated to use their engagement activities with investee funds and companies as a means of positive influence to help drive decarbonisation. Requiring or encouraging the adoption of SBTs by those entities in which they are invested is, therefore, a seemingly obvious responsible investment tool. Interestingly, their widespread application across the asset classes may actually help to reinforce the merits of increasing capital allocations to real estate as part of comprehensive portfolio decarbonisation strategies.

However, we contend that, especially in mature markets, investors should not treat SBT compliance by individual entities as a marque of responsibility. Instead, they could aim to move towards science-based targets being a ‘lowest common denominator’ indicator for their allocations, complemented by stipulating clearer requirements on real estate companies and funds to demonstrate how, and by when, they will achieve (net) zero carbon status.

Towards net zero

In the meantime, and depending on case-by-case circumstances, we will continue to recommend and support our real estate clients’ efforts to pursue SBT compliance because of the increasingly clear demands for them to do so by investors and analysts. We will do this, however, with full acknowledgement of the limitations of the SBT approach, and will typically be encouraging greater emphasis on total decarbonisation pathways as part of a positive investor engagement and climate risk management journey.

This article was authored jointly by Jon Lovell, Co-Founder & Director of Hillbreak, and Dave Worthington, Managing Director of Verco.

Climate Risk & Resilience – A Hillbreak Call to Action

May 17, 2017/in Insights /by Jon Lovell

Hillbreak was privileged to be invited to participate in the inaugural GRESB Spring Conference at Siemens’ inspiring building, The Crystal (dual-rated BREEAM Outstanding and LEED Platinum), in London earlier this month. Miles Keeping, co-founder of Hillbreak, was asked to join the first panel of the day, to discuss Climate Risk & Resilience, a session moderated by Sarah Ratcliffe of the Better Buildings Partnership. Specifically, Miles was asked to provide a challenge to the industry on what more needed to be done to ensure that climate factors are better incorporated into investment and asset management decisions, and professional practice across the sector more broadly.

That’s not the sort of invitation that needs extending to us twice! We were more than happy to oblige with a no-punches-pulled provocation to a number of key industry actors: investors; owners and managers; vendors; and industry bodies. Our headline messages to each are stated clearly in our short slide-deck, which you can view by clicking on the image below. The headline warning to all concerned was that disinterest in climate risk now amounts to a form of professional negligence and/or incompetence; those failing to give it due regard or demonstrate the capabilities necessary to address it are simply not providing the duty of care that is required of them.

Hillbreak Slides for GRESB Spring Conference

Miles was joined on the panel by Professor Sven Bienert from the University of Regensberg, who discussed his research for the Urban Land Institute on climate change and extreme weather, their effects on property values and the so-far inadequate response of the real estate sector to factor these into strategic asset allocations. Tatiana Bosteels, Director of Responsible Investment at Hermes Investment Management, discussed a number of key industry initiatives which have sought to bring better decision-making frameworks to bear in the market, whilst Andrew Rich, Fund Manager for TH Real Estate‘s flagship European Cities Fund, talked candidly about how sustainability and climate risk are integrated into the Fund strategy and its decision-making processes.

Miles Keeping, Hillbreak on the Climate Risk & Resilience Panel

The slides of all speakers can be found here.

Hillbreak verdict on Government “MEES” guidance

March 3, 2017/in Insights /by Miles Keeping

The Government recently published its guidance to landlords on Minimum Energy Efficiency Standards for non-domestic property, a matter on which much confusion and uncertainty has prevailed. So, have the outstanding issues now been resolved, or do material unknowns continue to cast a headache for the real estate industry? Miles Keeping, who chaired the succession of commercial property groups which advised Government on the regulations, provides his comprehensive take on the new guidance.

Brief background

The Energy Act 2011 (the Act) introduced the concept of MEES in England & Wales. As we know, this introduced a timetable to make unlawful the letting of privately rented property which failed to meet a minimum energy standard of efficiency. In its wisdom, the government decided that energy efficiency should be measured by virtue of an Energy Performance Certificate (EPC) rating, and the minimum standard would be an E (on a scale of A (most efficient) to G). The timetable is:

1^st April 2018 New non-domestic leases and lease renewals
1^st April 2020 All residential privately rented properties
1^st April 2023 All existing non-domestic leases

New guidance was issued by the government on 23^rd February 2017.

Uncertainty & doubt

At the time of the publication of the Act, there was a deal of uncertainty as to whether subsequent regulations would actually be enacted – that it would all be too difficult to organise and that the necessary political will would fall away in response to business opposition. Indeed, at the time, there was seemingly a lot that needed to be arranged if regulations were to be forthcoming. The then Department for Energy & Climate Change (DECC) reached out to the commercial and residential property sectors to ask how best to frame the regulations. I was asked the chair the commercial property group and, with significant support from Patrick Brown at the British Property Federation, populated the group with a range of environmental, commercial, legal and technical specialists. The group worked hard, efficiently and openly to support DECC officials.

The regulations (inconveniently named the “Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015”) arrived and, barring certain issues, were a decent attempt to incorporate a balance of policy intention and commercial practicality. What was clear, however, was that guidance was certainly required in order to put some flesh on the bone in terms of how the regulations should be applied – to get Rumsfeld about it, there were definitely some unknowns, both known and unknown. Some of those concerns related to factors such as how the regulations might apply with regard to Listed Buildings, buildings with whole or partial EPCs and where voluntary EPCs had been registered. There was also confusion as to how MEES might be affected by other law, e.g. the 1954 Landlord & Tenant Act and would MEES apply to licences or just leases?

The commercial property sector reached out to government and offered to pen some guidance. I again chaired the working group which delivered draft guidance to government, after which there was a long hiatus that inevitably refuelled the doubters into voicing opinions that the regulations wouldn’t be implemented. And then, last week, the guidance was published unheralded.

So what does this new guidance tell us that we didn’t already know?

Perhaps the key question to ask is whether the guidance addresses the known unknowns? Well, it does a bit. Let’s have a look at issues settled by the guidance… and where some confusion still exists…

First to remember is that the guidance only covers the non-domestic property regulations; we’ll have to wait for the residential counterpart. Secondly, it only covers England & Wales, Scotland’s s.63 Regulations and Northern Ireland’s 2014 Energy Efficiency Regulations being quite different kettles of fishes.

“Sub-standard property”

The guidance sets out its stall early on by noting that a property which fails to meet MEES is to be known as “sub-standard property”. A small point perhaps, but it’s a phrase which would no doubt stick in the craw of most letting agents; how many landlords would want to go to market with sub-standard properties?

MEES relies on EPCs

Yes, I know you know that, but what some still perhaps don’t appreciate is that MEES only apply to properties where a valid EPC is in place for the property in question and that this has implications in the following situations:

Voluntary EPCs: Some buildings have EPCs which were commissioned for general asset management purposes (i.e. were not procured because they were legally required such as for a letting of a property). The guidance states that in such circumstances, the existence of a voluntary EPC will not trigger a MEES compliance requirement. Clearly, this will only be relevant at the 2023 trigger date.
Where whole building EPCs exist but only part of a building is being let: Some buildings, e.g. shopping centres, have EPCs to cover the whole asset as well as for individual units. In such cases, the guidance states that where a whole building EPC exists, only the property being let (e.g. a retail unit in a shopping centre) needs to be improved.
Listed Buildings: The guidance notes that there is a misconception that listed buildings or those in a conservation area do not require EPCs, because they do unless energy efficiency improvements would unacceptably alter their special character. This is a significant issue and many landlords have chosen to ignore MEES in listed buildings – more about this below.

MEES applies to lettings

I know you know that too, but what constitutes a letting? The guidance is both clear and unhelpful when it states: “the PRS Regulations only apply to properties which are let under a tenancy, non-domestic properties which are occupied under other arrangements, for example properties let on licence, or ‘agreement for lease’ arrangements, are unlikely to be required to meet the minimum standard”. “Unlikely”… What makes it “unlikely”? We need to know whether marketing a property for occupation under a licence would trigger MEES or not? I think we can take it that licences are out of scope of MEES. But what about tenancies at will, for example? Again, our discussions with legal specialists suggest that these would also be out of scope, but a more definitive line from government on such matters would be welcome.

Other exemptions

Other exemptions from MEES exist and it had been thought that an exemption of any nature could negate any need to comply with MEES. The guidance carefully explains that this is not the case – a thread running through various of the exemption categories is that exemptions must be considered as individual issues, rather than in blanket terms. For example, if a suggested improvement measure to a building would have the effect of devaluing the property sufficiently to trigger that exemption, other measures which would not have that effect would have to be undertaken (provided no other exemption applied). Whilst we’re on devaluation, the guidance makes it clear that claiming devaluation will be a rarity.

Another exemption exists when legally required third party consent to undertake improvements cannot be received, such as from a planning authority, superior landlord or tenant; some leases require landlords to obtain a tenant’s consent to undertake improvements within their demise. In such circumstances, the guidance states that landlords must “make, and be able to demonstrate to enforcement authorities on request, ‘reasonable effort’ to seek consent” and thereafter register the exemption in that they “could not carry out the proposed improvements without the consent of the tenant or tenants of the property, and one or more of the tenants refused to give consent”.

Such an exemption would only be temporary, lasting for up to five years or until a tenancy change enabled a new tenant to be approached regarding the improvement. A question which landlords would need to ask themselves is whether the lease provides for them to be able to enter the property to make improvements – presumably, if so, such an exemption would be negated.

Part 2 of the Landlord & Tenant Act 1954 provides security of tenure provisions to tenants at lease end. The guidance is clear that sub-standard property status does not provide a complete exemption from MEES in such circumstances but does allow for a six months exemption from renewal for necessary works to be undertaken. Equally, landlords cannot refuse a renewal nor tenants prematurely terminate a lease because the property is sub-standard.

Landlords and tenants seeking to let or sublet sub-standard properties will need to be aware that whilst any measures which fail the seven year affordability payback test will not need to be undertaken (but registered as such, with three quotes from suppliers and calculations which prove that point) but any measures which do meet the affordability test will have to be undertaken. In other words, one expensive measure does not negate the need to undertake cheaper measures, so landlords will need to ensure they check all potential measures included in their energy assessor’s reports. Furthermore, assessors may suggest that measures which individually fail the affordability test be packaged together such that they then pass the affordability test. However, landlords are not required to install packages if they opt to install a discrete measure instead.

Registration of exemptions

All exemptions must be registered on the publicly available PRS exemptions register – importantly, this must be undertaken prior to an exemption being relied upon. It is also worth noting that should an affordability exemption be relied upon, its registration must be made before any price changes (e.g. in energy or potential improvement measures) have the effect of making potential measures affordable.

Those registering exemptions will need to provide evidence to support their view that an exemption is appropriate and in some cases this might be quite extensive. For example, exemption from undertaking potential measures because they would fail the seven-year payback affordability test will require the submission of a spreadsheet of calculations for all suggested measures and quotations from three suppliers/installers with cost information to support the exemption case.

So where are we now?

The new guidance does give us some clarity relating to how MEES will need to be implemented but it also throws up some new uncertainty. I feel certain, for example, that landlords with listed buildings will be rightly unsettled by the guidance which reminds us of the poorly drafted EPC regulation: It’s a nonsense, impractical and open to differing interpretations. I’m also sure that the uncertainty in the guidance about licences being “unlikely” to be required to meet MEES will delight the legal profession but not landlords and tenants. There will no doubt be some confusion about which EPCs might be considered as “voluntary” and those relying on exemptions will perhaps be surprised by the amount of work which will have to be undertaken for these to be able to be relied upon.

What should landlords be doing?

Example of a Hillbreak dashboard highlighting F&G rated properties within an investment portfolio

As in most circumstances where there is uncertainty or doubt, landlords facing the prospect of MEES will be best placed if they can reduce the potential impact of uncertainties. In this regard, ensuring that they have as much relevant information as possible will be vital and to do that, landlords must review their portfolios with a view to understanding where there MEES risks lie at individual asset level. Having high quality information is vital, as is drawing upon sufficient expertise to undertake risk-based thinking which accounts for EPC data in the context of factors such as rental income at risk due to lease events, lease types and provisions as well as forthcoming asset management activities. Savvy landlords will also review their leases to better understand how they can provide protection of rental income from MEES risks.

Final thoughts

The MEES regulations rely upon EPCs which are not an ideal basis for such regulations given their all-too-frequent inadequacies. The blame for this can be spread far and wide but should in part land on those who procured EPCs very cheaply and got sub-standard results – they are now reaping what they sowed. There is a role for landlords, the property industry generally and for government in dealing with inevitable mess:

Landlords must attend to the risks in their portfolios by procuring high quality advice and data reviews;
the property industry, principally professional and accreditation bodies, must ensure that EPC provision improves radically and quickly; and
the government must clarify outstanding and confusing issues with competent guidance, keeping an eagle eye on how MEES is rolled out.

Jon Lovell…in conversation with ULI Connect

November 21, 2016/in Insights /by Jon Lovell

Jon Lovell, co-founder of Hillbreak, was recently interviewed by ULI Connect, the official newsletter of the ~40,000 worldwide members of the Urban Land Institute (ULI). He discusses the impacts of the Paris Agreement on Climate Change for the global real estate industry, the risks and competitiveness drivers of climate change and evolving market expectations, and what motivates him to challenge convention in the industry.

The interview was prompted by Hillbreak’s recent authorship of the major ULI report, L’Accord de Paris: A Potential Game-Changer for the Global Real Estate Industry.

Jon is a long-standing member of ULI and is currently vice-Chair of ULI UK and chairs its Sustainability Council.

You can read the article here.

Real Estate Industry Must Address Climate Change to Maintain Competitiveness

September 21, 2016/in Insights, News, Resources /by Jon Lovell

L’Accord de Paris

Hillbreak was the principal author on a major new report on the global real estate implications of the Paris Agreement on Climate Change, published today by the Urban Land Institute. The publication of the report coincides with the gathering of world leaders at the United Nations in New York, during which progress on the ratification of the Paris Agreement gathered significant pace.

The central element of the Paris Agreement is the aggressive scientific objective of holding the increase in the global average temperature to well below 2°C above pre-industrial levels and of pursuing efforts to limit the temperature increase to 1.5°C. The agreement is expected to have significant and far-reaching implications for national and municipal policy making and for business and investment decisions.

Here’s today’s press release on the report:

REAL ESTATE INDUSTRY MUST ADDRESS CLIMATE CHANGE TO MAINTAIN COMPETITIVENESS, SAYS NEW RESEARCH FROM THE URBAN LAND INSTITUTE

Paper analyzes the real estate implications of UN Paris Agreement on climate change

WASHINGTON (September 21, 2016) – As world leaders gather at the United Nations this week to ratify the Paris Agreement on climate change, a new paper released today by the Urban Land Institute (ULI) argues that many real estate organizations are not adequately prepared for the implications of the agreement, which was made at last year’s 21st annual Conference of the Parties in Paris (COP-21).

Entitled L’Accord de Paris: A Potential Game Changer for the Global Real Estate Industry, the paper provides an overview of the key issues that arose from the COP-21 agreement and outlines steps that the real estate industry can take in response. Since buildings account for nearly one-third of global climate-changing carbon emissions, the agreement could trigger significant changes in requirements for building design, development, operations and management. In order to remain competitive, the industry must proactively limit and respond to the effects of climate change, the paper says.

It notes that from a business perspective, taking action to address climate change can help real estate organizations manage risks and capitalize on new opportunities. Investors and developers who proactively respond to impacts of the Paris agreement can ensure that their buildings remain competitive within changing policy, market, and climate conditions. They are also likely to see bottom-line benefits, as improving energy efficiency to reduce the carbon impact of buildings is one of the most cost-effective solutions to mitigating climate change.

“As leaders in the responsible use of land, ULI’s global members have a pivotal role to play in addressing some of the greatest challenges facing our rapidly urbanizing world, including the pressing threat of climate change,” said Patrick Phillips, ULI’s Global Chief Executive Officer. “The Paris Agreement on climate change will have important implications for both developed and emerging real estate markets, including new business and investment opportunities. ULI has published this paper to support our members in navigating the implications of this agreement, and charting strategies for success.”

ULI leader Jon Lovell, cofounder of Hillbreak and principal author of the report, said, “the Paris Agreement was undoubtedly a landmark diplomatic success, but was only possible because of the groundswell of demand, action and support from business leaders, investors, mayors and industry bodies from across the world.” He added, “Given the value at stake and the weight of evidence collated by this paper, it would be naive to think that investors, tenants and regulators won’t all begin to turn the screws on real estate companies and asset owners. The message is clear — act now to address the implications of the Paris Agreement or face irrelevance in the market.”

According to the paper, the Paris Agreement has catalyzed a change in attitudes and expectations surrounding the real estate market. Organizations are under increasing pressure to divest from carbon-intensive companies and assets, and to engage with policymakers and stakeholders on sustainability issues. Furthermore, they are expected to demonstrate a heightened disclosure of carbon performance and the risk posed by climate change to their assets, and to retrofit development standards through new technologies and financing models. Assets that do not conform to these new standards risk low demand and suppressed value.

The first priority for real estate organizations, says the report, should be to audit their resilience against post-COP-21 impacts. The audit should include a review of the risk exposure of their assets and the capabilities and expectations of their stakeholders. The paper suggests a list of specific questions on the topics of climate risk, client and stakeholder expectations, competitor approaches, policy change, asset performance, value chain, people and processes.

L’Accord de Paris: A Potential Game Changer for the Global Real Estate Industry is a precursor for a more detailed report, including case studies, scheduled for release in October.

About the Urban Land Institute

The Urban Land Institute is a nonprofit education and research institute supported by its members. Its mission is to provide leadership in the responsible use of land and in creating and sustaining thriving communities worldwide. Established in 1936, the institute has nearly 40,000 members worldwide representing all aspects of land use and development disciplines. For more information, please visit uli.org or follow us on Twitter, Facebook, LinkedIn, and Instagram.

For more information, please contact Trish Riggs Senior Vice President of Communications at 202-624-7086 email: trisha.riggs@uli.org or Peter Walker, Vice President of Strategic Communications: +44 (0)20 7487 9586 or e-mail peter.walker@uli.org

About Hillbreak

Hillbreak is the new name in training and advisory services for organisations seeking competitive advantage in a changing urban world. Its mission is to expedite the transition to a sustainable policy, business and investment environment by bringing intelligence, challenge and inspiration to its clients and stakeholders. Please visit hillbreak.com for further information of follow us on Twitter, Facebook, and LinkedIn.

For more information, please contact Jon Lovell, Co-Founder & Director at +44 (0)7825 531031 or e-mail: jon@hillbreak.com, or Miles Keeping, Co-Founder & Director at +44 (0)7971 457959 or e-mail miles@hillbreak.com

Reflecting on GRESB 2016 Results

September 8, 2016/in Insights /by Jon Lovell

The 2016 GRESB Results – published yesterday – show a record level of participation and a continuation of year-on-year growth in the quantum and value of real estate assets included in the Survey. With 759 entities across 63 countries participating in 2016, accounting for 66,000 assets with a combined GAV of $2.8 trillion, there’s little doubt that GRESB is tightening its hold on the market and is here for the long-haul. Resistance is futile, it seems!

Launched to a packed JLL house in London, the headlines of the Survey results were presented with the customary swagger and aplomb of GRESB CEO, Nils Kok.

We suspect that plenty will be written in the coming days about the results and what they mean, both for the reputation of individual entities in the responsible investment arena and their ability to attract capital from discerning investors, as well as on the extent to which the industry overall is addressing particular global challenges such as climate change and resource conservation. On this latter point, let us mention that the two percent reduction in carbon emissions reported this year on a like-for-like basis across the GRESB ‘universe’ falls a good way short of being sufficient to deliver the real estate sector’s fair contribution to the goals of the Paris Agreement. Let us not deny, however, that this is progress.

Market sentiment

Rather than focusing too heavily on the nuts and bolts of GRESB though, some of which we continue to believe are rather loose and ill-fitting, we thought we’d channel the mood music of those on the receiving end of the results. The real estate market is, after all, driven just as much by sentiment as it is by science.

Questions and challenges posed by members of the audience at the results launch were limited but somewhat perennial in nature. They were concerned with the efficacy of the approach to scoring performance on asset-level indicators for energy, water, waste and carbon, and to the new method of ascribing a GRESB Star rating to each participant depending on their score relative to the total GRESB universe (thereby ignoring geography, entity type or portfolio composition when arriving at a rating).

These questions, and others which crop up frequently when GRESB is a topic of discussion, are perfectly justified. And sure, GRESB still means that many sustainability professionals, whether working in-house for asset owners or externally as consultants, put much of their lives on hold for the three months or so leading up to the Survey deadline. This continues to be the subject of much eye-rolling when chatting with peers and there is, perhaps, an irony in the fact that the submission process can become an overbearing feature of a real estate sustainability professional’s workload, taking them away from the business of facilitating and delivering practical change within business and asset-level operations.

Heightened engagement

But we sense that attitudes to GRESB by many participants are changing; there’s a genuine acknowledgement of the fact that GRESB results now create a real point of engagement on ESG issues with the Executive Committees and Boards of property companies and fund managers. In this sense, rather than being seen simply as a burden, GRESB is actually becoming a catalyst for the empowerment of some heads of sustainability or responsible investment who have hitherto been peripheral to internal strategy conversations and the execution of core business.

The impact is not limited to internal engagement either. It remains clear from our discussions with investors that many of them view the Survey and its results with a dose of scepticism – its relevance to what they’re really interested in when it comes to the entities in which they are invested (and the governance of them in particular) is, by-and-large, limited. By the same token though, they’ll usually admit that it’s the best tool available to them for providing an indication of the rigour with which property companies and real estate fund managers attend to a range of ESG issues. Whilst imperfect, it provides a basis for structured engagement with their fiduciaries and some are taking a more sophisticated, proactive and discerning approach in this regard.

Market transformation?

Perhaps this is a sign of GRESB beginning to realise the ‘market transformation’ to which it aspires?

Admittedly, there is still some way to go; many (but by no means all) of our fund manager clients continue to find investor engagement quite weak. But as Nils Kok pointed out, the impending ratification of the Paris Agreement on Climate Change will almost certainly put a rocket up a good number of those who are only flirting with climate change – and ESG more broadly – in their real estate allocations.

In the meantime, we hope that GRESB will become more focused on matters of real importance to fund managers and their investors and, because of that, less burdensome on those having to spend so much time counting beans rather than sowing the seeds of change. Goodness knows we need the change and at a faster rate than is evidenced in these results.

Summary of ULI Event: Implications of the Paris Agreement on Climate Change

April 5, 2016/in Insights /by Jon Lovell

Hillbreak Director, Jon Lovell, recently chaired an Urban Land Institute event on the implications of the Paris Agreement on Climate Change for the real estate industry. It featured an outstanding keynote speech from Sir David King, the UK’s permanent Special Representative for Climate Change, and panelist contributions from the Department of Energy and Climate Change, K&L Gates LLP, Hammerson, Willis Towers Watson and the World Green Building Council.

Here’s a summary of what went down.

climate change ARCHIVE