Are we headed towards a wall of 'stranded assets'?

A large proportion of Germany's buildings are more than 20 years old. How many of these can be developed to meet the new energy efficiency benchmarks being imposed by Germany and the EU? How high is the risk of loss of value on these properties? How large is their share in the portfolios of institutional investors?

These and other questions were the subject of a recent online survey carried out in August and September by Berlin consultants RUECKERCONSULT on behalf of Aurepa Advisors and PwC Germany. The asset managers surveyed had a combined AUM of more than €100bn. Aurepa is the investment and asset manager of the real estate fund subsidiary of Europe-wide investment manager Aurelius Gruppe.

The risk of assets becoming "stranded" is rising as demands from legislators, investors and users become ever more complex. ESG criteria, particularly for energy efficiency and CO2 reductions, have now become critical to the value of an asset.

In the survey, 65% of respondents rate as 'high' the risk of older building stock slipping down into energy class 'F' or worse. In many cases these buildings are so inefficient that refurbishment makes no sense. 38% of respondents said that non-ESG-compliant properties are already proving to be more difficult to finance, while 62% said this was not a problem at the moment, but they expect this to change.

57% of respondents said it was regulatory requirements putting the greatest pressure on them to avoid assets becoming 'stranded'. 36% said the main pressure was coming primarily from within their own organisation, while 7% said the main pressure was coming from their investors.

Thorsten Schnieders, a partner at PwC Germany, said the pressure for ESG compliance is growing strongly. "The need to implement ESG criteria has arrived in the industry. The possibilities for implementing ESG requirements, especially in connection with portfolio optimisation, are diverse and not standardised. The fact is that the sustainability of a building influences both its lettability and its ability to be financed and thus its overall potential."

Hannes Eckstein, founding partner of Aurelius Gruppe and board member at Aurepa, added: "Many properties are at risk of becoming stranded assets because the appropriate asset management strategy is lacking. A large part of the older building stock - regardless of the asset class - CAN be developed into an energy-efficient property. But in doing so, each property must be considered individually and it must be weighed up which refurbishment measures contribute to long-term value creation."

His fellow founding partner at Aurelius, Jan Rehbock, stressed that complete demolition should always be viewed as the absolute last resort. "In order to keep properties in the portfolio in the long term, individual manage-to-ESG strategies are essential, both at individual property and portfolio level. In this way, different energy efficiency classes and the associated CO2 value can also be balanced. But sadly, not every property, such as historic clinker brick buildings, can be developed into an ESG-ideal property by insulating and replacing the heating system.

Among the key measures respondents cited (17% each) were replacement of heating and air conditioning systems, the installation of PV systems on roofs and the use of "green" electricity. A further 12% named the use of other renewable energies, roof renovation and insulation, and façade and window replacement as necessary measures.

The role of tenants in achieving compliance is also critical. Schnieders of PwC said: "In order to save energy, the users must also be held accountable. Green leases are an effective means that is unfortunately still too little used. For the implementation of energy efficiency measures or waste separation, for example, tenants must also make their contribution."

43% of those surveyed said they had yet to conclude a green lease with a tenant, 50% had implemented them with a quarter of their tenants, and 7% had such arrangements with up to half of their users.

On the issue of price, respondents gave a mixed picture. 57% of portfolio holders expect prices to increase, 29% for prices to remain the same, and 14% expect values to fall. Of course, in the long term investment into the assets should enhance the value, but in the short term it will cost money. As Schnieders says, "Falling prices due to ESG requirements are also understandable. After all, if the investments required to achieve an energy efficiency class of at least 'E' are extensive, the current value of the property will be correspondingly lower. At the same time, there is potential for value creation and investment opportunities that should be looked at more closely."

Schnieders conceded there was still much uncertainty in the industry as to what to do. "Many portfolio owners are still unsure whether, when and how they should analyse their portfolio and develop it with regard to ESG criteria or whether it might be better to sell properties."

Aurepa's Hannes Eckstein says he expects more supply of non-ESG-compliant properties to come onto the market. "We are indeed anticipating more supply, and in our discussions we are finding that the major institutional investors are considering whether to hold their endangered properties or sell them quickly to clean up the portfolio. Due to increasingly difficult debt financing conditions, especially for less sustainable properties, the pressure to make decisions is also increasing.

"This is also confirmed by our survey: 46% of respondents plan to develop their properties in the portfolio, 25% want to sell, and around 16% plan to hold them until they have reached their useful economic life. Another 13% see demolition and redevelopment as a solution.

"Unfortunately, one thing is all too often overlooked - it is not only the so-called carbon footprint of an individual property that is important, but that of the entire portfolio. In this way, different energy efficiency classes and associated CO2 levels can also be balanced out."