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Family offices should review their real estate holdings as the sector looks vulnerable to climate change

The post-pandemic real estate sector has revived, or so it seems. Global fund inflows hit a record $757 billion in the first nine months of 2021.

But doubts remain. The pandemic may not be over. Economic growth and tenant demand are uneven. 

To make matters worse, a climate change challenge has arrived, requiring owners to achieve net zero emissions from their buildings by 2050.

Wecken & Cie is currently reviewing the future of its controlling stake in German real estate group Demire

Investors are threatening to walk away from deals involving buildings with poor environmental credentials. 

Recent data suggests US real estate exposed to rising sea levels is already selling at a 7% discount, according to the Journal of Financial Economics. Apart from constructing sea walls, there are limits to the prevention of further decline.

Mike Prew, managing director of Jefferies, the investment bank, believes climate change is now the sector’s biggest challenge. 

Family offices that fail to reduce emissions from their properties in their portfolios run the risk of it becoming obsolete, unless they act.

They have a little time with investors currently keen enough to lock into yields of 4% by buying prime property. They believe the sector offers more protection against inflation than bonds, which they are inclined to sell.

But JLL accepts the happiness of the first three quarters of this year can only stretch so far: “The recovery remains uneven, with investment activity strongest in the Americas.” Europe was helped by a bounce for the UK but activity in Asia Pacific was relatively subdued. 

Purchases are heavily skewed to logistics, storage and multifamily residential property. Demand for offices, retail and hotels is more sporadic.

According to agents, families are maintaining their exposure to real estate. But agents say some are prepared to take advantage of this year’s recovery to sell into strength.

Wecken & Cie is currently reviewing the future of its controlling stake in German real estate group Demire alongside its partner Apollo, the US private equity group. 

They say they have enjoyed a good ride but want someone new to take Demire to the next level.

Wecken first bought a stake in 2015. Demire has tripled funds from its German commercial property business since 2018, when Apollo became involved. In September it owned property worth 1.6 billion euros.

Wecken & Cie is a family office led by Klaus Wecken, a prolific buyer, and seller, of businesses in technology and real estate. In 1997, he sold KHK Software to Sage Group and went on to invest in a total of 45 tech ventures in later years. 

JLL expects a revival in cross-border deal flow towards the end of the year, as international travel picks up. But sentiment remains vulnerable to a resurgence in Covid-19, with parts of Europe a concern. There are definite signs of a return to the office, but progress is halting.

The consensus view from economists is that we shall see a hike of 50 to 75 basis points in interest rates, plus a rise in bond yields. Property can be a hedge against inflation, but this requires sufficiently healthy tenant demand to keep rents in line with inflation when they are reviewed.

The impact of climate change costs on owners of buildings are starting to dawn on investors following Cop 26.

Advisory firm Deepki offers an environmental audit of buildings to sector participants. It has just published a survey where 73% of respondents expect buyers to walk away from deals involving buildings with a poor ESG footprint.

It adds: “Owners are seeking to divest assets which perform poorly, underlying the fact that sustainability is not a choice but an imperative.”

Auxadi says buildings use 40% of the world’s energy and accounts for 20% of carbon emissions, leading to tougher requirements for control of emissions and energy use. 

The European Union is set to enforce rules on sustainability on real estate valuations next year.  The RICS’ current consultation in the UK says valuers will penalise inefficient buildings, or those vulnerable to climate extremes, such as fire or floods.

This will reinforce a two-tier system where green buildings will enjoy a valuation premium while others trade at a discount or, at worst, fail to find buyers, Crestbridge, a family office adviser, expects the discount to be significant.

According to the RICS consultation: “Valuers should consider the extent to which such risks will be expected to present an immediate, or transitory risk to value.”

Valuers should take account of retrofitting: “However, in some cases, this may not be possible at an economic cost and the property’s life could be compromised.”

The banks are under pressure to reduce their own carbon footprint and could also become unwilling to roll over credit on legacy buildings, as they build up green loans.

Where terms can be agreed, borrowers will need to agree to meet ESG improvement targets. 

Tenants will also be expected to enter into sustainable leases requiring cooperation with landlords over carbon emissions.

The World Built Environment Forum says: “Many existing properties will be rated as not future proof and will successively fall behind when competing for customers and occupancy rates and investors in the mid to longer term.”

Alan Carter, a salesman at Stifel says large property companies like British Land and Land Securities have the skill, and resources, to deal with the challenge, whose costs can be exaggerated. But landlords with legacy assets could face a more dystopian future.

Specialist providers, like Deepki and Auxadi, are keen to tout their services, while a Dutch organisation called GRESB has developed a benchmarking service for assets worth $5.3 trillion fast becoming an industry standard. Family offices have no choice but to get involved.

 

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