The moment of modernization is on the rise, but there is a long way to go for the transition of buildings from pollution to "green" use.

What do Transition Funds Want?

Across the world, more and more real estate transition funds are emerging with the aim of transforming many older, energy-inefficient buildings into sustainable spaces.

Several major fund managers, including Ardian from France and the Switzerland-based Empira Group, have already raised or are currently raising capital. Their focus is on modernizing and renovating both commercial and residential real estate properties as the race to decarbonize buildings, which account for 40% of global carbon emissions, accelerates.

"There is clearly a growing appetite among investors for real estate transition strategies as they recognize the financial, environmental, and social benefits of making buildings more sustainable," says Nidhi Baiswar, Senior Director, Global Sustainability and Climate Leadership at JLL.

"These transition funds are successfully raising capital, but it's early days, as we wait to see exactly how and where the capital is deployed, which is mainly value-added and opportunistic."

Many markets worldwide currently face a mismatch between supply and demand for sustainable buildings. Tenants, largely motivated by their own ambitious carbon reduction goals, want spaces that support their progress and demonstrate a commitment to employees, shareholders, and customers.

Investors are increasingly taking note. According to JLL's 2024 UK Capital Markets Outlook, 50% of investors said tenant requirements are one of the biggest ESG factors behind decisions to buy or bid for an asset.

However, JLL's research across 20 major global office markets also shows that only 34% of future demand for low-carbon office space will be met in the next few years.

Looking Beyond Primes

While much of the tenant demand focuses on large spaces in prime locations, a significant portion of the action in the growing transition funds market currently focuses on smaller properties in well-connected urban areas. Non-core assets provide an opportunity to demonstrate early successes to investors before expanding to consider larger and more ambitious projects, says Baiswar.

High vacancy rates create a "blank canvas" for office refurbishments, with the sector currently undergoing significant upheaval. But other sectors also offer transition opportunities.

"The office vacancy has certainly created an opening for developers—it's quite a unique moment in that respect. But we see transition opportunities more broadly, from industrial properties, where there's often useful long-term relationships with the owner/tenant, to retail parks and multi-family rentals," says Baiswar.

"And some of the existing transition funds right now are extremely sector-agnostic—broadening their investment horizons to include multiple sectors, such as proptech and infrastructure alongside real estate."

Obstacles

But the transition, or so-called "brown to green" funds, face obstacles, including finding expertise and skills in eco-friendly construction, as well as suitable development partners.

"Matching capital with renovation expertise is a challenge," says Baiswar. "The investment opportunities are numerous, but finding experienced development partners is essential. That's why joint ventures are a credible path for some."

Australian fund manager Investa teamed up last year with developer Built to form a joint venture aimed at modernizing outdated offices in both Sydney and Melbourne's central business districts.

At the same time, inconsistencies in companies' disclosure and reporting of data add another level of complexity.

Investment Opportunities

"Many investors operate globally," explains Baiswar. "That means dealing with an alphabet soup of regulations across multiple jurisdictions. More clarity in Europe, for example, around disclosures for investors, we hope, will reduce complexity this year."

The real estate funds body INREV has called for new EU labeling to replace the current SFDR disclosure regulation subcategories 8 and 9. Article 8 refers to "light green" funds that promote environmental or social characteristics, while Article 9 "dark green" describes funds targeting sustainable investments.

Data from New Private Markets shows that only eight private real estate funds classified as Article 9 SFDR reached final close in 2018, raising $3.1 billion. In comparison, 34 real estate funds at Article 8 closed, raising $25.3 billion.

In London, Fidelity's American fund under Article 9 took on its first building refurbishment project in the City district to create a more sustainable office space.

"Regulations can help improve the performance of transition funds. The better a fund can disclose against a set of regulations, the more it can promote itself in the market and attract investors," says Baiswar.

Urgency of Modernization

Considering that 80% of today's office buildings will still be in use in 2050, the role that transition funds can play on the road to net-zero cannot be underestimated, says Baiswar.

And modernization will require significant investments. JLL's "Retrofitting to be Future-Fit" research estimates that the cost of modernizing office and shopping center stocks in 17 major countries is approaching $3 trillion.

Given that many landlords cannot or do not want to spend the necessary sums to bring their buildings up to compliance with increasingly stringent regulations, transition funds can fill the gap.