There’s a niche corner of dealmaking that’s quietly making inroads in the battered market for commercial real estate.
It involves buying buildings with big carbon footprints and investing in green refurbishments. Asset managers Bloomberg interviewed spoke of doubling their clients’ money in just a few years by renovating older buildings, adding 20% to rents and then cashing in on gains when they sell.
As a model for real estate investing, it’s simply “irresistible,” says Paul White, who runs a specialized fund for Hines, a Houston-based developer with more than $90 billion of assets.
Many investors Bloomberg interviewed said they plan to rely heavily on debt markets to amplify their financial clout, raising the stakes of such wagers. And analysts monitoring the market warn of rising capital expenditure, as well as a lack of skilled labor that could fan wage growth and significantly drive up renovation costs.
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Yet speculation on green refurbishments represents a sliver of optimism in a market that not long ago was pummeled by a post-pandemic spike in interest rates and volatile occupancy levels. MSCI said its indexes show that commercial property prices fell about 14 percent in Europe between March 2020 and June 2024.
Now, a new wave of environmental regulations and tenant preferences has a growing number of CRE fund managers looking to monetize the moment.
Europe’s revised Energy Performance of Buildings Directive went into force this year, and landlords have until the end of this decade to slash greenhouse gas emissions by at least 60% from 2015 levels. Owners of older buildings risk significant writedowns, with lawyers who advise the industry warning of “huge” refurbishment costs ahead.
Landlords that wait too long face a bigger bill further down the road, according to Sven Bienert, project lead at Carbon Risk Real Estate Monitor, which helps the real estate sector tackle emissions. He also says a lot of banks still haven’t grasped just how fast the collateral value of their CRE loans might be shrinking. It’s a “significant risk” on banks’ balance sheets, Bienert said.
There’s evidence that some landlords would rather keep their heads in the sand than realize losses at the point of sale. They’re “disinclined to sell and crystallize the loss,” according to White, who says that’s why Hines hasn’t managed to buy as many properties as it would like. In the end, though, landlords will “have to accept the reality of new regulations,” he said.
For now, flipping brown buildings to make them greener remains a niche undertaking mostly limited to investment managers willing to speculate on the risks. Asset managers creating funds that target the greening of commercial property include billionaire Tom Steyer’s Galvanize Climate Solutions, Fidelity International, Schroders and Ardian.
The stakes are high, with huge swathes of property in the crosshairs. In Europe, as much as 80% of the office market was built more than a decade ago, leaving it outdated and in need of green refurbishment, according to an analysis by Jones Lang LaSalle.
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A study published by Deepki, a sustainability-data provider for real estate owners and investors, found that over half of European CRE managers are now sitting on stranded assets equivalent to at least 30% of their portfolios because they don’t meet new green standards. At the same time, there’s evidence that a growing number are keen to invest in flipping brown buildings into green real estate. Of CRE managers surveyed, 87% “plan to increase the purchase of poor energy-performing buildings with a view to retrofitting them,” Deepki said in the study.
Schroders manages a £460 million ($600 million) investment trust that’s focused on improving the sustainability of about 40 UK commercial properties. The asset manager recently turned a Manchester warehouse into an operationally net-zero-carbon building, allowing it to charge up to 40% more in rents than older properties on the same estate. Schroder Real Estate Investment Trust says it’s now eyeing rental premiums as high as 30% across the portfolio.
Coima, an Italian asset manager, plans to raise €500 million ($540 million) for a fund it says will buy, renovate, rent and sell office and residential buildings in Rome and Milan. Fidelity International has a pair of funds targeting office and logistic buildings. Its investment committee initially balked at the high cost of buying and renovating a London office building, but gave the go-ahead when Fidelity negotiated a good price.
Institutional investors are taking note. White says Hines has attracted 35 pension funds and other investors for its €1.6 billion fund dedicated to flipping brown properties into green assets. By the time Hines closes the fund in 2030, the firm expects to have turned that €1.6 billion into at least €4 billion, he said.
“We usually sell pretty quick,” White said. “We can flip a building in three-to-four years.”
Banks, meanwhile, may not be reflecting the risks of brown real-estate loans on their books.
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Priscilla Le Priellec, head of real estate, structured and development lending at La Banque Postale, says her team has rejected loans on environmental grounds only to see the business get absorbed by competitors.
“It’s quite questionable,” she said in an interview.
But ignoring climate risk is likely to come with a sting, especially as insurers retreat from properties found to be unprepared, she said. “You have to make sure that your assets can be insured.”
BNP Paribas, the European Union’s largest bank by assets, sold a building in Madrid three years ago for €59 million, a 40% discount at the time relative to comparable grade-A assets in the area. The property is now the subject of a brown-to-green refurbishment project by French private equity firm Ardian.
Edmund Eggins, managing director for real estate at Ardian, says that as an asset, the building was on track to “become stranded by 2030.”
A spokesperson for BNP Paribas declined to comment.
Flipping the property, known locally as Faro, entails rebuilding the entire single-glazed facade, as well as replacing all the air-conditioning and ventilation. New plumbing will cut water use, while solar panels will generate clean electricity and heat. Eventually, a cluster of 900 hidden sensors will constantly monitor and adjust building performance to ensure emissions stay low.
The expected cost is €30 million, or roughly half the purchase price, Eggins says. Ardian, which has so far completed 70% of the work, plans to finish the project by the end of this year, after which it’s aiming for rents between 10% and 20% above the average in the building’s local area.
The goal is to make Faro “the first zero-carbon building in Spain,” Eggins said.
Spencer Corkin, head of value-add strategy at real estate manager AEW in Europe, says that “inefficient or non-compliant assets are at risk of becoming functionally obsolete and illiquid.”
The flipside, according to White at Hines, is that those who invest now stand to ride a sustained wave of growth.
“It is inevitable that the demand for sustainable real estate space will prevail,” he said.
