The real estate sector faces increasing climate-related risks, with much focus traditionally placed on physical risks like extreme weather. However, transition risks — stemming from the shift to a low-carbon economy are equally critical. These risks include rising costs due to carbon pricing, market effects, technological changes, legal liabilities, energy efficiency regulations, and reputational risks, all of which can impact property values.

Understanding transition risks

Transition risks in real estate arise from regulatory changes, market dynamics, and evolving stakeholder expectations as the world moves toward sustainability.

Key risks include:

• Regulatory and policy shifts: New energy efficiency and carbon emissions regulations are being implemented globally. For example, the European Union’s Energy Performance of Buildings Directive requires significant retrofitting to meet energy standards. Non-compliance could lead to hefty fines and reduced net operating income.
• Market repricing and stranded assets: Properties not meeting sustainability standards risk depreciation or becoming ‘stranded’ assets. Investors are increasingly favouring low-emission properties, applying higher discount rates to those seen as high-risk due to potential regulatory changes. This trend affects liquidity and raises financing costs, prompting a reassessment of investment strategies.
• Technological advancements and obsolescence: While innovations in green technologies, like smart building systems and renewable energy integration, can enhance property value, they pose risks for older buildings. The challenge lies in balancing retrofit costs against potential increases in market value and operational savings.
• Reputation and stakeholder pressure: Real estate companies face growing pressure from investors, tenants, and the public to demonstrate sustainability commitments. Failing to meet these expectations can result in reputational damage, loss of investor confidence, and reduced access to capital.

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Key factors influencing transition risk

Two key factors play a significant role in measuring transition risk in real estate: the costs associated with retrofitting buildings to lower energy consumption, greenhouse gas emissions and technological advancements. The expense of reducing greenhouse gas emissions tends to increase non-linearly; the greater the desired reduction in energy use, the higher the incremental cost.

Fortunately, technological advancements are expected to gradually lower these costs, with potential reductions in energy expenses ranging from 15 per cent to 95 per cent.

Both property owners and occupiers can contribute to reducing carbon emissions, though property owners generally have more direct influence. Depending on a building’s age and design, retrofitting can sometimes be more costly than demolishing and rebuilding from scratch. However, even minor modifications can yield significant benefits. It’s also important to consider that demolishing a building generates carbon emissions.

To illustrate, achieving a 75 per cent reduction in carbon emissions could cost a property owner roughly US$500 per square meter or US$46 per square foot. Some property owners, particularly those committed to environmental sustainability or with larger financial resources, might opt for retrofitting despite it often being more expensive than demolishing and rebuilding.

Strategic approaches to mitigate transition risks

To navigate these transition risks, real estate firms must adopt proactive strategies:

• Portfolio decarbonisation: Aligning with global climate targets requires setting clear emissions reduction goals, conducting energy audits, and implementing upgrades. Green certifications like LEED or BREEAM can enhance asset appeal to ESG-focused investors.
• Dynamic risk assessment and scenario planning: Incorporating climate risk scenarios into traditional risk assessments helps firms anticipate the financial impact of various transition pathways. This proactive approach allows better positioning against future regulatory changes and market shifts.
• Leveraging green financing instruments: Green bonds, sustainability-linked loans, and other green financing options provide capital for sustainability initiatives. These instruments often come with favourable terms tied to environmental performance, encouraging further investment in green practices.
• Enhancing data transparency and reporting: Digital tools like IoT and AI can be utilised for real-time energy monitoring and predictive maintenance, optimising building performance. Enhanced reporting aligned with frameworks like TCFD or GRESB improves compliance and investor confidence.

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• Tenant engagement and collaboration: Green leases, where tenants share energy responsibilities with property owners, foster collaboration on sustainability goals. Such agreements incentivise both parties to invest in energy efficiency and waste reduction initiatives.
• Geographic diversification and asset resilience: Geographically diversifying assets can reduce exposure to region-specific regulatory risks. Investing in climate-resilient infrastructure, such as flood defences and advanced cooling systems, helps maintain asset value amidst evolving climate conditions.

Conclusion

As the shift to a low-carbon economy accelerates, real estate firms must navigate the emerging transition risks by embracing sustainable practices. By focusing on proactive strategies such as portfolio decarbonisation, dynamic risk assessment, green financing, and tenant collaboration, firms can mitigate these risks and position themselves as sustainable real estate market leaders. Embracing sustainability is not just an ethical or regulatory obligation but a business imperative for long-term success in a future low-carbon economy.

Accacia’s climate risk assessment platform helps real estate stakeholders navigate challenges by providing advanced analytics, enabling investors and developers to meet regulatory standards and focus on resilient regions, shaping a sustainable future for Singapore’s built environment.

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