Assessing the cost of going green

A new factor to consider in international real estate over the next decade will be the increasing costs required by companies to meet their Paris Agreement carbon targets, notes Fidelity’s Guillermo de las Casas. He also notes that green policing is not only coming from regulators—consumers and corporations are demanding it as well.

“Consider that 30% to 40% of total carbon emissions come from buildings,” says de las Casas, portfolio manager of Fidelity^® International Real Estate Fund (FIREX). “The key question will be, who will pay for the costs of becoming carbon dioxide neutral—the landlord or the tenant?”

He insists that much will depend on the supply/demand dynamics in overseas real estate markets.

In managing the fund, de las Casas emphasizes stocks that he believes do not fully reflect companies’ long-term growth potential. Given the cyclicality and short-term nature that typically characterizes international real estate investing, he targets firms that are less reliant on short-term factors and more driven by secular-growth business models.

Despite the impact of the work-from-home trend, for now, office landlords with low- or even zero-carbon buildings have been able to command a rental premium over higher-emission buildings, he contends. However, de las Casas points out that this may change as either the category catches up and/or as the global economic backdrop deteriorates.

On the other hand, he acknowledges that residential real estate companies may be at a disadvantage, as tenants may very well not be able to absorb the costs associated with carbon-neutrality.

De las Casas is mindful that it is easier for a building location where land costs are high—city centers or premium locations, for example—in terms of the affordability of carbon-neutral capital expenditures compared with the suburbs.

“I believe the combination of attractive location and green real estate will command some degree of premium until supply meets demand for green space, while less-fortunate geographies likely will not be able to afford to go green, let alone net-zero carbon,” he says.

Most importantly, he does not believe the cost of going green is embedded in current valuations for international real estate stocks, yet he does concede that soon there could be noteworthy adjustments.

Many companies claim that environmental compliance will require less than 1% of gross asset values, explains de las Casas, but he feels this is a gross underestimation.

The fund owns several positions in international real estate firms that, in his view, are accurately reflecting the impact of inflation, meaning the cost of going green should not negatively alter the strength of their balance sheets. At the end of December, these included sizable stakes in Mitsubishi Estate (MITEY), Vonovia (VNNVF) and CK Asset Holdings (CHKGF).

Although de las Casas thinks we are still in the early stages of understanding this complex transition, he expects this trend will eventually see a polarization of international real estate.

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