Depreciating the built environment
We need a technology-driven built environment revolution.
We are at the beginning of a long period of crisis, or tension. The tension is between the need for buildings which minimise waste, energy use and carbon emission, and the environmental and financial cost of producing those buildings. On the one hand, we need buildings and spaces which make a neutral or even positive contribution to the environment by operating efficiently, using limited energy, wasting little or no water; and on the other we need to conserve or not produce materials which consume energy in their production.
My colleague at Oxford and Pi Labs, Jimmy Jia, has opened my eyes to a novel way of thinking about this problem. Amazingly, the insight is based on accountancy.
If we are running a company, say a brewery, we can use old machinery to produce our products, in this case beer. The old machinery might not be very efficient. There is more waste, more chance of a slow or failed brew, more energy cost. Obviously, then, we should buy new equipment to reduce costs and increase our profit.
No, not obviously — new equipment costs money, and that capital cost will be depreciated in the profit and loss account. So it may not be good for profits to buy that new kit. In terms of the income statement, it may be that using the old kit makes sense, or buying new kit makes sense. It may also be the case that making some improvements to the old kit is the best profit-delivering option.
Switching back from beer to buildings, we have the same set of choices. Accounting rules and the absence of a proper market pricing mechanism for carbon might complicate this, but the principle is the same. Every building is a store of the carbon used in the manufacture of its constituent materials. Every year that goes by, we are using that carbon and depreciating the remaining balance. It may be that the energy saved by developing and using a brand new building is greater than the energy used as we depreciate it; it may not.
It’s fairly obvious which variables will shift these relative calculations. The initial cost of developing the asset is a big factor: building cost inflation mitigates against new development. Pricing the carbon which is used when developing the asset is another big factor: the current absence of a full market price for poisonous carbon encourages new development. When (as is inevitable) carbon is fully priced, we will have to focus on how we can make existing assets more efficient.
Increasingly, technology will be the critical factor in this enormous issue. Companies like Laiout and Bright Spaces help asset owners to optimise the use of space. Measurabl offers operational efficiency recommendations and tools that empower real estate teams to improve environmental performance. There will be many more.
We can envisage tech-enabled solutions to reduce waste in all areas of a building’s operations, as it is inevitable that occupiers will pay less rent for buildings which waste expensive resources/emit carbon and investors will also pay less for buildings which waste expensive resources/emit carbon.
The risk premium which investors require will increase in anticipation of falling values, falling rents or government penalties. Real rent growth will be damaged as occupiers seek more efficient /greener buildings. Depreciation rates for inefficient buildings will increase, expressed through higher operating expenses, higher and more frequent capital expenditure, and lower resale values. Full carbon pricing will rapidly accelerate this process.
According to real estate consultants Savills, the global real estate market is worth $280 trillion. Depreciated over 100 years, that’s $2.8 trillion every year to be attacked. We need a technology-driven built environment revolution, and the payoff will be huge.
For more Pi Labs research on environmental sustainability, download our white paper: Real estate and environmental performance — Bridging the gap with PropTech
