Challenges in the building sector in the context of sustainability

May 13, 2022

Pēteris Celms

BluOr Bank Investment Portfolio Manager

Designed by some of the world’s best architectural minds to withstand any hurricane, the New Choluteca Bridge in the Honduras was completed in 1998, just in time to be put to the test. When Hurricane Mitch hit the Honduras later that year, much of the country’s infrastructure was considerably damaged and many bridges were destroyed, but the new bridge survived with minor damage. It had performed as well as expected. But there was one problem – the storm was so violent that the ensuing floods literally shifted the course of the river and washed away the highway that connected it, leaving the New Choluteca Bridge on the newly dry riverbed - a literal bridge to nowhere.

The takeaways from this story are many – our self-assured hubris that we can tame the environment, failure to account for every externality, etc. – but one important and simple fact is that even if something is built to last, it is its adaptability that determines how long it will.

Which brings us to European real estate.

Picturesque to all those who come visit, European cityscapes are steeped in tradition and long-lasting cultural heritage. Visit almost any European capital and you end up walking through a UNESCO world heritage site. Cities devastated by the Second World War were built back to preserve the heritage of the previous grandeur that was left over. Even today much of what is built new must fit in with the old. There is a reason why Europe is significantly lacking the skyscraper skylines that dominate the major cities of the United States, China and the fast-developing regions of the world.

At the same time, the EU Green Deal directives mean that the European building sector faces a radical change of paradigm requiring digital and physical infrastructure overhauls. These directives are extremely ambitious in their scope and will require massive adaptations of both what is already built and how we build anew to create a zero-emission building sector. Given that approximately 75% of the current EU building stock is energy inefficient and accounts for almost 40% of the EU total energy consumption and 36% of greenhouse gases, the coming changes are set to have a profound effect.

The explosion of new technologies, new and emerging needs of occupants and complex energy interactions between buildings are coming together at a time when our collective energy security is under more stress than ever. These changes are leading to a new generation of building management systems and ICT tools that render them ‘smart’ and enable new capacities and interactions between buildings, their users and with other buildings through energy grids to create a system of ‘smart’ buildings.

Thanks to this ‘smart’ evolution, there is a vision of what the future may look like. Buildings that offer an energy efficiency first approach, consuming the least amount of energy to meet the comfort required of their occupants. Buildings that generate energy on-site or nearby from renewable energy sources, some even having a positive energy balance by generating more than they consume. Buildings that enable smart interactions with the energy grid to provide flexibility via short-term energy storage, electric vehicle charge management, demand response systems and more. Buildings that empower their users by letting them access energy consumption and generation data, giving them information and control over the implications of their behavior on the energy consumed or the indoor air quality.

These technological solutions offer a utopic vision for our lived-in environments, but it is difficult to gauge how quickly they can or will be adopted.

Back in the physical world, however, there are other changes that will have a profound effect on ecological sustainability, many of which are already being implemented.

Well-insulated window systems are atop that list. High-performance windows such as double-glazed or triple-glazed windows have already become common in northern European countries, where heating systems are necessary, and the insulation performance of windows can have a significant impact on energy consumption. According to some estimates, there could be up to a 37% reduction in CO2 emissions and energy consumption by 2050 from buildings alone by using high-performance windows in all buildings in the EU. In the Baltics in particular, these changes could result in up to a 45% reduction over that same time span.

Other improvements are being made wrapping existing buildings in insulated materials. These building envelopes can drastically improve insulation and efficiency. Green envelopes (green facades or living walls) take this a step further and are an example of developing efficient energy neutral solutions. They not only can provide insulation for the buildings they envelop, but also transform the cities themselves by adding greenery to the urban environment, improving air quality, and lowering temperatures.

Changes are also happening on the structural level. Also in development and use are numerous forms of new building materials that could be see wider adoption to replace high-emission, energy-intensive materials in use today. One example is cross-laminated and glue-laminated timber, which can be used in place of steel beams in construction. One of the highest profile projects that has utilized this technology to date is the Mjøstårnet building in Brummendal, Norway. It is an 18-story, all-timber structure reaching a height of 85.4 meters. For perspective, the Latvijas Televizija building is 89 meters tall, but unlike Mjøstårnet, it does not have an attached swimming pool.

Obviously not all projects can be realized without concrete and steel, but new methods of production that can render them ‘green’ are being developed. Meaningfully shifting steel production to the direct reduced iron process is a stark example. About 5% of the world’s steel is already made through ‘direct reduced iron’ (DRI) processes that do not require coke and typically use hydrogen and CO (derived from methane or coal). If the DRI process is further improved by only using hydrogen and renewable electricity to power electric arc furnaces, CO2 emissions could be reduced to 50 kilograms or less per per ton of steel, equivalent to a 97% reduction compared to the traditional production method that dominates today. Companies in Europe, China and Australia are already piloting such plants, with several slated to open in 2025 or 2026.

This is by no means an exhaustive list and some of these solutions are far from being widely adopted, but its these kinds of changes that will contribute to us being able to increasingly occupy nearly zero-emission buildings (nZEB) in the future. It is worth pointing out that we are already on our way in Riga, with the Verde project in Skanste that is nearing completion that qualifies as the first nZEB office building in the city.

But for all the attention paid to the shiny and new, ultimately the biggest differences will be made with adapting what is already there to serve the purposes of the future. Even though 75% of the EU building stock was built before 1990, it is assumed that 80-85% of the existing building stock today will still be in use by 2050. Renovation of existing buildings will be a key priority going forward and annual renovation rates are set to grow in earnest. Currently those rates vary between 0.4% and 1.2% among individual member states but should grow to well above 2% in the next ten years to achieve renovation of almost 80% of existing buildings by 2050.

In Latvia, the goals are just as ambitious. Despite the age, quality and depreciation of existing building stock that likely means that 30% of residential buildings and 10% of non-residentials buildings will not be fit for renovation, the sheer number of buildings that will be renovated is still staggering:

Source: National long-term renovation strategy 2020, Latvia

As with any such undertaking, significant financial, social, and regulatory hurdles exist that slow down the pace of change.

From the financial perspective, both investors and financiers currently lack a comprehensive life cycle perspective. High upfront costs required for renovation, long payback time frames that disincentivize investment and the lack of funding opportunities all present challenges that slow down the number of renovation projects that actually get the funding they need.

Social barriers can be just as challenging. There is still a lack of knowledge and awareness regarding the financial and sustainable benefits of a building envelope renovation and how it affects quality perception, functionality, real estate value, etc. This is only exacerbated by the fact that much of the building stock is comprised of multi-apartment buildings with multiple owners who need to come to agreement to make these projects happen.

Regulatory barriers also play a factor. Timeframe cost and effort of obtaining the necessary building permits to renovate building envelopes has a negative impact and deters some from even trying. Architectural-related regulations that prevent alterations to historic facades or window frames greatly limit the possible building envelope renovation solutions.

But there is some light at the end of the tunnel. According to quantitative surveys, a majority of homeowners are interested in participating in an energy efficiency improvement program for apartment buildings, if co-financed by the EU.

Like in most cases, financial incentives will likely drive the adoption of these changes. Property buyers are already willing to pay more for a more energy efficient home to enjoy future cost savings and the real estate value premium. Oppositely, many existing properties will not be considered future proof and a significant discount to their value will need to be considered.

From an investor point of view, the improvements do not stop with improved efficiency and sustainability either. More accurate tools and data will make it increasingly easier for asset managers to compare properties, portfolios, and performance. Better data will attract more capital at a better cost of capital.

Investing with sustainability in mind now means lower costs in the long run. Even if it is just a few triple-glazed windows at a time.

The Latvian version of this article originally appeared in the May 2022 issue of Forbes Latvia.