Mark Carney says net zero could be yet another disincentive for investors
Former Bank of England governor, Mark Carney, has warned commercial property investors that a significant number of buildings could become what he calls "stranded assets" as governments push toward achieving net zero carbon emissions. These stranded assets, often linked to older buildings that fail to meet strict environmental standards, pose serious risks to property owners and lenders alike.
Investors are currently grappling with a difficult combination of falling property values—exacerbated by rising interest rates, work from home—and growing demands to improve energy efficiency. For those with mortgages tied to commercial real estate, this challenge is particularly pressing. Carney emphasised, "There will be a tail of stranded assets . . . which are going to have to turn over and be refurbished if possible or knocked down and repurposed," referring to properties that may not survive the regulatory push to lower emissions.
Historically, stranded assets have been associated with fossil fuel industries. However, Carney highlighted that the transition to a greener economy now extends to real estate. A report by investment manager AEW indicates that European property investors must increase their capital spending by 30% annually to meet the targets set by the Paris Agreement. Many buildings across Europe, and particularly older structures, are far behind where they need to be in terms of energy efficiency.
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Rising Costs and Uncertain Returns
Some intermediaries are still positive about the sector. “Acute shortages in UK housing supply continue to create a favourable environment for investors and developers,” Ian Humphreys CEO of Brickflow told Mortgage Introducer. “The requirement for commercial property finance remains strong. Auction activity remains strong with motivated sellers, or their lenders, seeking a quick exit, so those with the ability to transact swiftly are benefitting, and bridging finance is undoubtedly flavour of the month right now.”
As regulations tighten, property owners face the prospect of substantial investment in energy upgrades. In some cases, such as older, less desirable office spaces, the costs of retrofitting may be prohibitive due to low demand and limited rental income. Carney also noted that demolishing outdated buildings—like the Marks & Spencer flagship store on Oxford Street—can be controversial. Retaining existing structures can be more sustainable, avoiding the carbon emissions associated with producing new materials like steel and concrete.
This dilemma is especially relevant as commercial buildings globally contribute 26% of energy-related emissions, according to the International Energy Agency. Accelerating efforts to achieve net zero in the real estate sector is crucial, as COP28 climate conference participants agreed to double the rate of energy efficiency improvements by 2030.
In the UK, commercial property owners are facing stringent deadlines to upgrade their buildings' energy efficiency by 2030. Yet, according to the Centre for Cities, 12% of commercial properties failed to meet energy rating requirements last year. Carney cautioned property owners and investors against assuming these deadlines will be extended. “There will be people . . . who either implicitly or explicitly think that these timelines are going to shift, or that somehow or another it is not going to become a binding constraint. But that is a big risk to take,” he said.
Financial Institutions Taking a Stand
Adding to the pressure, financial institutions are starting to hold property owners accountable for failing to address environmental risks. Dutch bank ING recently warned 2,000 of its largest clients, including real estate developers and landlords, that it would halt financing unless they made significant strides in mitigating their climate impact. ING identified commercial real estate as one of the slowest sectors in adopting climate disclosure and reducing emissions.
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The Mortgage Dilemma for Commercial Property Investors
For commercial property investors with mortgages, the road ahead looks increasingly complex. As the value of real estate assets decline due to rising interest rates, the costs associated with upgrading buildings to meet energy regulations continue to rise. Those investors who have borrowed heavily may find themselves in a precarious position. The upfront expense of retrofitting properties may outweigh the returns, especially for older buildings in low-demand areas where rents are not high enough to justify the investment.
Carney, however, expressed confidence that the financial sector would not face instability due to these challenges. “I am very sanguine about commercial real estate risks in the financial sector as a whole, because the risk is more broadly spread, there is less liquidity pressure than would have come in a bank-based commercial real estate sector,” he said. He noted that the process of working through these troubled assets has already begun.
Opportunities and the Future of Real Estate
Despite these risks, Carney remains optimistic about the real estate sector's ability to adapt. The growing demand for greener, more energy-efficient buildings presents opportunities for forward-thinking investors willing to modernize their portfolios. The property sector, particularly in Europe, is at a crossroads, with the potential to lead the way in sustainable development if it can meet the challenges of the net zero transition.
