Risk of Over-Eagerness (Part 2): Cost and Decarbonization Targets Ambiguity

Understanding the cost associated with reducing the carbon footprint of buildings is crucial for the CRE industry's decarbonization efforts which however pose a difficult challenge. The European Commission and the European Environment Agency do not always add towards better understanding as their explanations of the CRE industry decarbonization targets can differ, while allowing only an indirect perception of associated costs. More concrete estimates, such as those from Oxford Economics one, suggest that the cost of decarbonization to extend the existing building life, by up to 25 years is approximately 30% of the buildings' capital values. However, this estimation is somewhat ambiguous, as the dynamics governing real estate values and costs associated with building decarbonization differ. The Deutsche Bank research paper associates the cost of decarbonization of its CRE portfolio mainly with retrofitting expenses aiming to reduce energy usage per square meter of buildings. The paper indicates that the cost of retrofitting Deutsche Bank’s existing residential real estate portfolio to the currently adequate Energy Performance Certificate (ECP) is estimated at around €80 Billion, while retrofitting its commercial real estate portfolio costs is at least ten times more. In this case uncertainty related to decarbonization costs estimates arise due to the changing nature of regulatory framework. For example, German form of ECP (Energieeinsparverordnung – EnEV) was introduced in 2002 and then amended in 2007, 2009, 2014, 2017, 2023, each time bringing more stringent regulations that were becoming more expensive to implement. The Catella Residential Investment Managament research paper estimates that the cost of decarbonizing typical residential dwellings in EU could be in the range of €25,000 to €40,000. This implies that the cost of decarbonizing the existing residential stock in the EU could be in a range €6 - €10 trillion. Expressed as a percentage, this accounts for approximately 65% of the annual EU28 GDP, as shown in the table.

However, we note that neither of these assessments of decarbonization costs provide a better understanding in respect of the starting point - how much of carbon is ought to be reduced and at what cost per a unit of building area. In this context, two approaches are possible which are by no means mutually exclusive. The first approach, a hedonic one, in the strictest sense, implies a comprehensive assessment of each individual building, which is most likely prohibitively expensive if fully adopted. The second approach, a more generic one, focuses on estimating the cost of decarbonization per square meter of a standardized building, which is likely to be more cost-effective for the industry. In practice, it's highly likely that the CRE will need to incorporate elements of both approaches.

Given the urgency assigned to the decarbonization agenda within the CRE industry, one might assume that reasonable cost estimates for the CRE decarbonization initiative per unit of building area have already been established, which certainly was our expectation. However, the pursuit of these estimates turned into a challenging and difficult endeavour. We found ourselves navigating through a complex maze of information, with each new piece of data often adding to our confusion while being time consuming. The encountered cost estimates often contradicted one another, creating a wide and puzzling range between the lowest and highest estimates. Even attempting to sift through the data to eliminate outliers proved fruitless, as we struggled to distinguish accurate information from inaccuracies.

Our experience has led us to the conclusion that CRE decarbonization cost data faces at least two significant challenging issues. The first problem with the data itself, often being subjective and on ad hoc bases. For example, when two data sources attempt to measure the same aspect of decarbonization costs, they can produce significantly divergent results. This discrepancy arises from the lack of a rigorous data definition, making it impossible to compare data from different sources on a like-for-like basis. An even more significant challenge arises from the lack of clarity regarding what should be decarbonized within buildings, how this decarbonization process should occur, and what it will involve. Without such clarity it is impossible to determine the cost of decarbonization or the extent of carbon reduction achievable through the CRE decarbonization initiative.

To illustrate this issue, we will employ a seemingly trivial, albeit unusual example. Faced with the absence of clear guidance and plethora of contradictory information we began to comprehend the existence of a building in isolation, devoid of any interaction with human activity. To simplify this concept, consider paradoxical instances of carbon emission, such as those from, for instance, the Great Pyramid in Giza or any other unused building, which obviously emits zero carbon. Therefore, the operational carbon emissions associated with the CRE industry result almost entirely from human activities within these buildings. The environmental impact that arises from these interactions is determined by carbon footprint of energy sources used in the building and the building's inefficiencies, due to buildings construction features.

Given the self-evident nature of the points discussed above, one may wonder why they need mentioning at all. The reasons become apparent when we consider the challenges faced by CRE researchers in comprehending the seemingly nonsensical range of cost estimates related to the CRE decarbonization. It took us a while to unravel the underlying reasons, but we eventually realised that the primary factor contributing to this vast variance in cost estimates is the variation in assumed carbon emissions from buildings. These estimates suggest that the carbon output per square meter for similar buildings can vary significantly, ranging from 50kg/m² to 1000kg/m² per year. Therefore, starting from assuming a zero-carbon building emission appeared to be a sensible initial point to understand this large range spread.

To our surprise, we discovered that none of these carbon emissions figures was inherently incorrect; instead, they were measuring different aspects. The primary reason behind this disparity lies in the evolving nature of the debate surrounding CRE industry decarbonization. This debate encompasses various perspectives, including operational carbon emissions, embodied carbon emissions, emissions during the building's lifespan as well as changes in the regulatory framework. Consequently, estimates of decarbonization targets can substantially diverge based on these different perspectives. Adding to the complexity, variations in terminology and taxonomy further contribute to confusion. For example, some European institutions and some EU countries categorize energy renovation as a "transitional activity," while others classify it as a sustainable activity. These discrepancies unnecessarily introduce complexity and create confusion in the decarbonization challenges instead of facilitating a better understanding. We believe that wide range of cost estimates or carbon emission that we encountered is a direct consequence of such complications.

In this context, our reference to unusual and trivial examples serves as a reminder that the CRE decarbonization initiative could benefit from adopting principles of simplicity akin to Occam's razor. In conclusion, the ultimate challenge for CRE decarbonization can be summed up by the following point:

The real problem with the question, "what is the cost of decarbonization for CRE," is not the seemingly nonsensical answers, but the problem lies with the question itself.

Currently, the available information, lack of clear definitions, differences in taxonomy, and widespread contradictions do not permit a precise answer to this question. It seems that the right question to understand costs should initially focus on "how much operational carbon is produced per square meter of a building." This question should be extended to establish the concept of operational carbon emissions from a standardized building, which should serve as a benchmark. In the absence of the ability to benchmark operational carbon emissions to a standardized building, the commercial real estate (CRE) industry's decarbonization effort may become a moving target, obscuring both the decarbonization objectives and associated costs.

In conclusion we believe that by ultimately arriving to a point of asking the right question and after substantial wondering, we managed to explain to ourselves the challenges of estimating the cost of decarbonization. However, we honestly acknowledge that this process involved an element of good luck. In subsequent articles, we will further delve further into our experiences on this journey.