Magnus Persson, EVP and CFO at Skanska Group, and Thorsten Slytå, Managing Director and Head of Nordic Real Estate at BlackRock, share their view on these questions. Each has a valuable perspective on the changing investment landscape.
Managing climate risk
Real estate development requires significant financial investment. To maximize return on investment and safeguard against potential failure, developers and investors must be aware of, and protect themselves from, investment risks. And as Thorsten Slytå from BlackRock says, environmental, social and governance risks now have to be considered in the same way as credit or liquidity risks.
Buildings are an important contributor to global carbon emissions, a key driver of climate change. This, in turn, poses significant risks to the built environment. Worsening heat waves, for example, increase energy usage and cost. At the same time, intense hurricanes and coastal flooding can lead to devastating damage to buildings and infrastructure. It is, therefore, in the best interest of developers to integrate climate resilience into their investment strategy to mitigate these risks.
Resilience refers both to adapting to protect against acute climate shocks (like extreme weather events) and working to mitigate long-term climate effects. Outfitting buildings to better withstand high winds or flooding is an example of short-term climate resilience. These measures protect the built environment (and thus investors) from expensive repairs and rebuilds that can accompany climate disasters.
Long-term resilience aims to reduce the frequency and intensity of such events over time by reducing the carbon emissions of the built environment. There are several ways to help the built environment take steps toward net-zero carbon emissions such as designing energy-efficient buildings, moving away from dependence on fossil fuels and utilizing resources such as low-carbon concrete. These initiatives can involve a higher upfront investment. Indeed, in years past, these and other ESG (environment, social and governance) integrations were viewed as costs, but the long-term returns from climate-resilient buildings provide a powerful financial incentive for pursuing sustainability in the built environment.
Protecting long-term values
Sustainability doesn’t only safeguard against the physical risks that accompany climate change. As Magnus Persson at Skanska notes, investing in sustainability also helps developers avoid financial risks. These risks come both in the form of shifts in property value and regulation changes. For example, seaside properties in low-lying coastal areas may begin to lose value over coming years as sea-level rise contributes to more coastal flooding. An investment in a seaside development may seem profitable in the short term but could prove costly in the long term as its value dips.
In addition, legislative pushes for sustainability regulations that seek to mitigate these climate effects could also hurt an investment that doesn’t take sustainability into account. Mandating the construction and maintenance of sea walls to prevent flooding, or requiring energy-efficient buildings as energy becomes scarce, could create significant additional costs for investors who didn’t factor sustainability into their initial investment plans.
Failing to be proactive in anticipating this evolving physical, regulatory and economic landscape can create stranded assets. This means that an investment, like a new real estate development, loses the ability to generate a return long before the end of its expected economic life cycle. It becomes a sunk cost that’s no longer a financial asset – instead, it’s a liability. That seaside property, for example, may become so prone to flooding and weather damage that it cannot be occupied, and so cannot generate revenue from tenants. It must either be updated to better withstand coastal flooding (an expensive additional investment), or the project must be abandoned. In either case, there is a significant financial motivation to invest in a sustainable built environment.
Generating alpha
Thorsten explains that sustainability isn’t about the mere avoidance of losses, however. More than protecting against risk, pursuing sustainability can actually generate alpha (active return on investment). The global economy is in the midst of a transition toward renewable energy and a consequent reduction in carbon emissions. First movers have the potential to produce returns that beat benchmarks set by others who are slower to embrace this transition. Taking steps to reach net-zero emissions and make climate-resilient investments then becomes a proactive, rather than reactive, investment strategy. It is another example of how financial incentives are an important factor in paving the way for environmental and social sustainability.
The power of the consumer market
Magnus discusses how the market economy has historically been a significant force in shaping our societal approach to problem-solving. Many technological innovations of the past few decades were supported by financial incentives.
Nowadays, individual consumers are opting for low-carbon transportation alternatives and sustainable, healthy living spaces. There is a greater demand for these projects than in previous years, and the promise of meaningful returns is driving investors toward these types of developments.
These consumer-level trends have knock-on effects on a much bigger economic scale. It’s not only sustainable retail products and residential buildings that hold economic promise. Whole industries are now making a shift toward sustainability in an attempt to appeal to consumer desires. When multinational businesses use carbon neutrality and sustainability as market differentiators, the ground-level infrastructure that supports global operations becomes a profitable investment as well. In other words, it’s not just retail electric vehicles that become economically viable, but also a sustainable global supply chain supporting the production and transportation of those vehicles.
Currently, changing attitudes at the consumer and corporate levels are shaping a global economy that rewards sustainable investments. As carbon-neutral buildings and renewable energy sources continue to enjoy broad support and widespread adoption, investment in such projects will only grow, and sustainable practices may soon become ubiquitous, thanks to increasing financial investment.
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