Super-efficient buildings are all the rage. Owners want to own them and occupiers want to occupy them – the former being driven, in part, by the latter. For owners, best-in-class operational energy and carbon efficiency are increasingly linked to value and liquidity. This helps owners meet their climate commitments. Similar drivers exist for occupiers, as efficient buildings help them meet their own decarbonisation targets and decrease operational costs. 

Through this lens, operationally efficient buildings are going to drive investment performance (in certain locations, at least). Indeed, there is an increasing bank of evidence to suggest that efficient buildings attract a stronger return . In principle, being financially rewarded for efficient buildings is great, as by reducing energy demand, we get straight to the root of global issues around resource inefficiency, over-consumption and energy security. 

Embodied versus operational carbon emissions

But what costs do these market dynamics pose to the environment? We can’t forget about the carbon that’s emitted when constructing operationally efficient buildings (embodied carbon). Nor can we forget about older and inefficient buildings, where there’s no business case for optimisation and they fall into disrepair. We therefore need to strike a balance and achieve operationally efficient buildings as resourcefully as possible.

We only have a limited carbon budget available before surpassing the 1.5°C warming threshold as set out in the Paris Agreement . Yet the real estate market is often guilty of focusing on only one part of the carbon emissions pie – operational carbon emissions. But the embodied carbon associated with creating low-operational emissions is eating away at the same carbon budget, and worsening climate change. For some buildings, their embodied carbon footprint can be equivalent to the emissions associated with two or more decades of their operation.  As Carl Elefante, the well-known architect, famously said, “the greenest building…is the one that already exists” . The market must therefore reward owners of resourcefully retrofitted buildings, not just operationally efficient ones. This will require supportive policies and evolving industry guidance.

The industry has made significant progress in reducing embodied carbon through better emissions data and evolving industry frameworks and regulations (e.g. the Carbon Risk Real Estate Monitor (CRREM), the Energy Performance of Buildings Directive (EPBD), and the UK Net Zero Carbon (NZC) Building Standard). However, the embodied carbon of new builds is not linked to asset value in the same way as operational carbon. This needs to change. 

How do we decarbonise buildings?

abrdn’s climate risk analysis evaluates buildings against current and future regulations and the CRREM 1.5°C pathways. This helps us to understand any necessary interventions and costs, and to maintain asset value and liquidity.

Measurement against science-based decarbonisation pathways helps us to anticipate future policy alignment (for example the recently revised EPBD guides EU member states in setting decarbonisation trajectories). While it remains uncertain how such regulations will interact with existing frameworks like CRREM, our strategy is based on anticipating regulatory shifts that maintain the long-term value of investments.  

The question of how much capital expenditure (CAPEX) to account for in budgeting and underwriting for decarbonisation remains challenging. This is mainly because of uncertainties in regulation, market positioning, and future technological costs. We address this by evaluating the total CAPEX necessary to align an asset with the 2050 CRREM energy and carbon pathways. This figure is then refined through a series of questions that consider the practical reality of the asset. These include the energy performance certificate rating, tenants’ sustainability commitments, the timing of interventions against planned refurbishment cycles, potential value increases, the age of the building, and the likely impact of embodied carbon. The goal is to ensure that assets remain future-fit without unnecessary interventions that could increase embodied carbon emissions.

What next for emissions?

Focusing solely on operational efficiency without considering the impact of embodied carbon will not lead the real estate industry towards its decarbonisation goals. While it’s essential to transition assets towards operational efficiency, this must be done resourcefully, considering the broader implications of embodied carbon. From an investment perspective, this means accounting for decarbonisation costs that align with market trends and future asset value. At the same time, we need to avoid overspending on measures that may not be reflected in future valuations or that waste resources and increase carbon emissions.

Another key challenge in achieving decarbonisation lies in addressing regional disparities. While retrofitting buildings to high operational standards is economically viable in areas with strong rental demand, a significant portion of the global real estate market remains inefficient due to a lack of demand. The industry may need to adopt simpler policy instruments (e.g. carbon taxes) and other innovative strategies to reduce consumption and transition these underperforming buildings – particularly in disadvantaged areas.