Regulatory environment

In 2015, the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures (TCFD) was established in an attempt to standardise carbon reporting1. An explicit TCFD recommendation for investment managers was to provide estimates of ‘carbon intensity, where data are available or can be reasonably estimated, for each product or investment strategy’2. In real estate debt investments, carbon intensity is necessarily derived from the underlying assets being financed. Therefore, to provide investors with an indication of the carbon intensity of their investments, it is necessary to first estimate the carbon intensity of the assets underlying our loans.

Carbon Risk Real Estate Monitor (CRREM) approach

One approach to estimating the carbon footprint of loan portfolios is underpinned by the use of the Carbon Risk Real Estate Monitor (CRREM), which was developed by a consortium of research institutions with funding from the European Union. In addition to estimates of the carbon intensity of real estate assets, this model provides asset owners and asset financiers with estimates of the downside financial risks associated with assets, or a portfolio of assets, as a result of carbon exposure3.

Carbon intensity reporting benefits for investors

Apart from being an essential step for reducing real estate carbon emissions, we think carbon intensity reporting offers at least three key benefits for investors. Firstly, we believe estimates of the carbon footprint of investment portfolios are increasingly likely to become a mandatory component of financial reporting for real estate investments. Investors that can provide a breakdown of the carbon intensity of their real estate debt investments at both a portfolio level and a property level will therefore be well-positioned for regulatory changes.

Secondly, carbon analysis can help to identify assets of concern that are underperforming relative to the decarbonisation pathways consistent with the Paris Agreement. This can be utilised with other types of analysis to assess various impacts, and to engage with borrowers on improving the sustainability credentials of real estate assets and reducing carbon risks. One specific way in which borrowers can be incentivised in this regard is through the use of sustainability-linked KPIs within loan agreements.

Thirdly, having quantifiable data on the carbon intensity of assets can improve real estate investors’ decision-making going forward. In particular by screening out weaker assets and improving alignment with specific investor requirements.

Our approach to carbon intensity reporting in real estate

In collaboration with our real assets Environmental, Social & Governance (ESG) team, at abrdn we have developed a proprietary model which estimates the carbon intensity of our real estate debt portfolio. In particular, we use the aforementioned CRREM approach, which is combined with the broader expertise of our real assets ESG team. This helps to inform our Impact Dial framework, with which we engage with borrowers on improving the sustainability credentials of our real estate assets, which in turn can help to reduce the carbon risks our investors are exposed to.4

Where no actual data exists, we continue to engage with our borrowers to ensure this can be provided in the future. Our expectation is that the accuracy of our carbon intensity estimates can only improve over time as more real data is incorporated into our modelling.

“By combining carbon analysis with the outputs of our proprietary Impact Dial framework, we aim to have a market-leading sustainability approach through which we can look to drive meaningful, positive changes in the real estate sector.” Neil Odom-Haslett, Head of Commercial Real Estate Debt, abrdn

Case Study

We currently have a loan in place which is secured against a Grade A office asset located in Scotland. The property is built to a very high specification and has excellent sustainability credentials, achieving a BREEAM rating of Excellent and an EPC rating of A13.

When subjected to our carbon analysis, this asset performed strongly. Our research implied that this asset has the lowest carbon footprint (per square metre) of all offices underlying our loan portfolio, with estimated emissions approximately 12 percentage points below the average estimate for office assets.

However, our analysis also showed that even the best assets will face value impairment and costs as a result of carbon exposure. For example, our modelling predicted that, in the absence of any refurbishment or retrofit, this asset would face annual carbon costs equating to 0.07% of property value by 2030, with this amount expected to increase annually.

The key message here is that while many properties underlying loan portfolios may be performing well relative to decarbonisation targets, action will still be required to maintain this performance over time. This underscores the need to engage with borrowers to effect positive changes – in order to meet decarbonisation targets, limit the carbon costs for borrowers, and to minimise the carbon risk borne by investors.

References 

Task Force on Climate-related Financial Disclosures website. (https://www.fsb-tcfd.org/).

Task Force on Climate-related Financial Disclosures. Implementing Recommendations of the Task Force on Climate-related Financial Disclosures. (https://assets.bbhub.io/company/sites/60/2020/10/FINAL-TCFD-Annex-Amended-121517.pdf).

Carbon Risk Real Estate Monitor website. (https://www.crrem.eu/objectives-and-benefits/).

abrdn will begin reporting to clients on the estimated carbon intensity of its real estate debt holdings from May 2022 onwards. From this time, carbon analysis and the Impact Dial framework will also become inputs of the investment process for all future transactions.