“The future is not some place we are going, but one we are creating.” – John Schaar, Legitimacy in the Modern State (1981)
Although the quote above isn’t directly related to the topic of climate change, it fits the ongoing debate about our changing weather patterns. It is now accepted that the vast majority of scientists in this area of study believe that there is global warming (the observed data can’t refute this view) and that it has been, at worse, caused specifically by human activity or, at best, it is a natural change exacerbated by excessive carbon emissions. There are always voices in the wilderness that say otherwise (most notably Donald Trump, the President of the USA) but the vast majority of countries around the world have accepted the evidence and signed up to a treaty to try to reduce our global emissions and halt, or at least limit, the warming of the earth. Indeed, only last week, the “Hothouse Earth” report concluded that unless decisive action was taken to curb emissions, then it is possible that the world temperature will rise to a level where human life can not be sustained on large tranches of currently inhabitable land. The report refers to the danger of a tipping point and says:
“What we do not know yet is whether the climate system can be safely ‘parked’ near 2°C above pre-industrial levels, as the Paris Agreement envisages. Or if it will, once pushed so far, slip down the slope towards a hothouse planet.”
Of course there are detractors that believe it is all a hoax and indeed historic evidence suggests that extreme weather and a hotter world have come and gone throughout human existence. Just look at the streets on the London Monopoly board and we are reminded of “Vine Street” as an indication of the vineyard that stood there in Roman times; Europe was much hotter back then. Likewise, between 1600 and 1814, it was not uncommon for the River Thames in London to freeze over for up to two months at time. The world climate was different then. But, that doesn’t change the fact that in the last 15 years we have had 9 of the 10 hottest years on record and three of the driest. The world climate is changing.
UK Property and Energy Efficiency
It is fair to say that the UK market has pretty much “won the war” on new builds being sustainable and energy efficient. The BREEAM certification scheme, together with a market place where occupiers of new builds wanted and, by default, demanded the highest rated buildings, has meant that the vast majority of new build commercial properties in the UK since the early ’90s have met stringent sustainability targets both for construction and ongoing use. It is the, roughly, the other 95% of existing buildings that is the problem in terms of carbon emissions and poor energy performance.
In a free market, sustainability will only have an impact if the occupiers of these types of property consider that the “sustainable elements” make a contribution (perceived or real) to the bottom line and thus retrofitting becomes a viable option. Occupiers will only pay for specifications that impact positively upon their businesses. The level of retrofitting in the late 90s and early twenty first century suggest that, for the majority, that tipping point was not reached. In the early 2010s, there was a feeling that the UK real estate market would start demanding more energy efficiency from the existing stock as the cost of energy on the world stage was spiralling and occupation cost was becoming a more significant item on the P&L account of most businesses. But, as quickly as this spike in energy costs happened, a massive increase in supply from the OPEC nations prompted a fall in world prices. The market led demand for retrofitting halted as quickly as it had started. So how do you entice markets to act? Legislation.
In April 2018, the UK government introduced Minimum Energy Efficiency Standards (MEES) on investment buildings for all new lettings. There is a schedule to extend these regulations to continuing lettings in 2020 and 2023 for domestic buildings and non-domestic buildings respectively. Full details of the legislation can be found in the RICS Insight Paper (RICS, 2018). But the simple truth is that, if this legislation works and is expanded over time, that will mean that carbon emissions for property will fall substantially and the UK has a chance of meeting its obligations under the Paris Agreement. But will the efforts of a few nations be enough to stop the temperature rise?
Climate Change and Valuation Assumptions
The hothouse earth scenario mentioned above envisages that sea levels will rise and that, in some parts of the UK and the rest of the world, reinforcing the sea defences will not be a viable option and the land will be left to be reclaimed by the sea. We will lose properties. Likewise, extreme climate may make other locations difficult as flooding becomes a norm and, in most buildings, the energy savings made above will be countered by more heating in the colder winters and more air-conditioning in the hotter summers. The truth is that we don’t know what will happen but we do know there will be change.
No self respecting ostrich has ever really put their head in the sand but that misplaced metaphor is what we are doing when it comes to looking at property and the potential impact of climate change. With investment property we always assume that the buildings will be income producing forever. Indeed, we value incomes in perpetuity. Mathematically, that might only equate to 70 – 80 years, but that is still a bold assumption. At the moment, investors do not seem to be pricing in any climate change uncertainty into the prices paid for existing stock. And so, as valuers reflect the market and do not make it, the valuation of such property is still ignoring long-term sustainability albeit, for some property, the short term impact of MEES will be factored into Market Value.
So what is this article trying to say? Nothing more complicated than “be careful”. Investors need to start to question the assumptions of perpetual incomes. Valuers need to adopt valuation models that look more at reversions and less at income continuation. And we all need to be realistic about climate change. It doesn’t matter if it is man-made or not. It is happening. If we assume that the change in climate will make some locations inhospitable whilst, in other locations, if sea levels rise, properties may simply disappear, a prudent investor will surely want to price this into their bids for investments.
