How did the building become worthless? To paraphrase Ernest Hemmingway, “Two ways. Gradually and then suddenly.”

4 minute read

Matthew Norris

Fund Manager, Director of Real Estate Securities

A recent McKinsey & Company paper forecasts that we may be entering the era of a ‘Great Repricing’ within commercial real estate, “a re-sorting of value in which some assets would be devalued, some would be stranded, and some would become more attractive.”

Rising interest rates and an increasing urgency to respond to climate change are the accelerants. At Gravis we highlight a quartet of underlying sustainability forces – owners (investing in green buildings), occupiers (leasing sustainable space), lenders (providing green financing) and legislators (setting higher standards) – that are primed to have a meaningful effect on valuations. These valuation effects, both positive and negative, may have been slow to date but now have the potential to accelerate.

As McKinsey & Company rightly highlights, investors “should get used to the idea that their entire portfolios will likely need to be re-examined through a climate lens.”

REIT
s owning modern assets have a valuable head start. On a look-through basis we estimate that 51%, and increasing, of the underlying assets within the VT Gravis UK Listed Property Fund are already 2030 compliant.

The rewards for the owners of the most sustainable buildings are becoming clearer. Knight Frank estimates in their September 2021 Sustainability Series Paper that 'BREEAM Outstanding' offices in central London command a meaningful 12.3% rental premium. Leasing velocity for the most sustainable space is likely to be significantly faster too.

If the ‘Great Repricing’ occurs, then we are likely to see a widening in the dispersion of future returns. Prime sustainable real estate, as owned by many specialist REITs, that can grow rental income is likely to outperform.

In contrast, secondary assets are likely to underperform as the cost to become environmentally compliant increases. Highly leveraged property portfolios are likely to be hit too, the years of exceedingly cheap borrowing are over. Refinancing debt is becoming more expensive, and particularly so for brown buildings.

Overall, now is the time to act and position property allocations on the right side of change before the accelerants release the full effects, both positive and negative, of sustainability forces on real estate valuations.

McKinsey & Company authors: Brodie Boland, Alastair Green, Daniel Stephens, Robert Palter, and Shally Venugopal
Knight Frank author: Victoria O.


Disclaimer: Capital at risk. This post is for information purposes only and does not constitute any form of investment advice or recommendation. For UK readership only.

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