Wednesday, January 12, 2022

Ecologic Obsolescence: calculating the value at risk for stranded hotel assets

Dan Voellm, MRICS

The failure to convert hotels to become net-zero carbon emitters has a major impact on the bottom line by incurring carbon credit expenses or penalties as well as excess energy consumption levels. This article analyses current asset performance, future goals and the value at risk from foregoing necessary conversions to net-zero carbon by 2050. Failure to do so results in stranding of assets – a term the real estate industry should understand as a new form of “ecologic” obsolescence. Asset owners could face impairments (present value) from US$30,000 to US$230,000 (!) per key for an obsolete 5-star hotel– a large part of which can be mitigated while improving the bottom line.

The combined penalties and savings for a 500-room, 5-star hotel ranges from US$31 million to US$115 million or US$63,000 to US$230,000 per key.

Green House Gas emissions and reduction targets

Among a global drive to decarbonize the economy, governments across the world have signed up to drastically reduce carbon (or GHG: greenhouse gas) emissions. The United Nations Framework Convention on Climate Change (UNFCCC) with 197 countries represented, through the Paris Agreement in 2015 and the 26th Conference of Parties (COP 26) in Glasgow 2021 implemented specific measures towards mitigating climate change by restricting temperature rises to well below 2⁰C above pre-industrial levels via the reduction of GHG emissions.

Real Estate contribution to Green House emissions (EU ROADMAP 2050)

These measures are then implemented across various party geographies. For example, the EU aims to reduce total carbon emissions by at least 80% from 1990 levels by 2050. The above diagram shows the breakdown and reduction targets for seven key sectors.

While industry and agriculture have more modest reduction targets at 40% and 20%(albeit not easy to achieve), buildings are given a 95% carbon reduction target, 45% of which from within the sector via efficiency and newbuilds and 50% via a fuel shift to heat pumps. Such plans represent a significant reduction which require a rethinking for all stakeholders in the real estate industry.

At the corporate level, the science-based target initiative (SBTi - provides companies with an effective and recognized first step to work towards a specific global warming limit in the future. The specific way to lower GHG emissions can then be set within the organization. However, SBTi guidance specific to the building sector is still under development.

Aside from carbon emissions, energy use is another area targeted to reduce the ecologic foot print of humanity. The UK Green Building Council identified that for office buildings, merely decarbonizing the electricity grid will not suffice to meet net-zero carbon energy targets by 2050 given capacity constraints in zero-carbon energy. Thus, energy intensity use among buildings must be curtailed to maximize zero-carbon energy share and avoid supplementing with ‘dirty’ energy sources.

UK trajectory to a net zero economy
Source: UKGBC-Net-Zero-Carbon-Energy-Performance-Targets-for-Offices.pdf

In fact, reductions in energy use among office buildings of 60% are required to meet the net-zero carbon target by 2050. To achieve such drastic change, the real estate industry once again needs to revisit almost all and every aspects of the industry. This should become clear when one considers the scale of energy and emissions attributable to the real estate sector on a global scale. The Global Alliance for Building and Construction provides a breakdown of global emissions for different parts of the industry.

Buildings and construction’s share of global final energy and energy-related CO2 emissions, 2020

CRREM pathways

Globally, the real estate sector is responsible for 36% of total energy consumption and 37%of total GHG emissions. Naturally, residential real estate plays a large role along both dimensions. However, non-residential uses may be more challenging and costly to decarbonize. To achieve the intended goal of decarbonization by2050, the EU funded a research project named Carbon Risk Real Estate Monitor(CRREM).

CRREM aims at developing a tool that allows investors and property owners to assess the exposition of their assets to stranding risks based on energy and emission data and the analysis of regulatory requirements. By setting science-based carbon reduction pathways, CRREM faces the challenge to estimate risk and uncertainty associated to commercial real estate de-carbonization, building a methodological body and empirically quantify the different scenarios and their impact on the investor portfolios.

CRREM set regional ‘pathways’ to gradually limit and reduce GHG and energy use to achieve the targets by 2050. It is important to emphasize that both metrics vary heavily by locale based on the carbon intensity of the electricity grid today and the energy use on site due to climate conditions among other factors. Thus, each country in the EU has its own pathway for different uses (residential, office, hotel, etc) and CRREM provided pathways for a selection of international markets as well. Notably, hotels are the assets with the largest carbon footprint and energy use, similar to inefficient office buildings and only trailing industrial manufacturing properties (where the processes and machinery within can create an abundance of GHGs and consume significant energy).

The following detail illustrates decarbonization pathways (in kgCO2 equivalent/m2/year)by locale until 2050. Calculations are made on a GFA basis.

CRREM Decarbonization Pathway by Country (kgCO2 equivalent/m2/year)
Source: CRREM, AP Hospitality Advisors

Due to the heavy use of coal as an energy source and energy intensity, Hong Kong SAR has the highest pathway starting point at 370 kgCO2 equivalent/m2/year in 2021, whereas France has the lowest at 27 kgCO2 equivalent/m2/year due to the large share of nuclear energy, gradually trending lower to sub-5kgCO2 equivalent/m2/year.

In terms of energy use, a slightly different picture emerges:

CRREM Energy Reduction Pathway by Country (kWh/m2/yr)
Source: CRREM, AP Hospitality Advisors

Hong Kong SAR also ranks highest in terms of energy use pathway starting point in 2020,followed by Singapore. Most locales trend lower over time with the exception of France and to some degree the UK, where a higher share of nuclear energy provides a cleaner source of energy allowing for higher energy consumption levels.

Notably, the initial draft targets are for operating emissions and energy use only. Embodied carbon – related to the building materials used – are so far excluded and will be addressed separately. In any case, by now the reader should have realized that new development projects should also invest into limiting the embodied carbon.

Stranding risk as ecologic obsolescence

The failure of a building or infrastructure to reduce GHG emissions and energy use below the pathway target at any point in the future results in a so-called ‘stranded’ asset. This is akin to a form of obsolescence.

Next to functional (from outdated features) and economic (from changes in market conditions) obsolescence, a stranded asset could be considered to suffer from ecologic obsolescence or to be ecologically obsolete.

Ecologic obsolescence is different from economic obsolescence in that market and environmental conditions need to be recognized as two distinct domains (the environment may deteriorate while markets continue to perform well, something we have observed more frequently in the last decade). At the same time, ecologic obsolescence can be understood as a combination of functional and economic obsolescence due to the transition risk.

CRREM shows two ways to manage stranding risk or ecologic obsolescence over time as interventions are made.

Different ambitions regarding stranding risk
Source: CRREM

One major improvement in an asset’s ecologic performance is the decarbonization of the electricity grid. Carefully monitoring progress here should help an investor understand the timing of related reductions the asset would enjoy. In a market where the government is not providing supporting policies and market mechanics for decarbonising grid, there will be limited room for carbon emission trading as well and thus the price of carbon credit would remain low. The evolution of carbon credit trading may thus evolve at a different pace across the world.

All other interventions will have to be managed more hands-on and can be conducted in various ways. In the figure above, CRREM shows how multiple smaller interventions can be made over time vs a significant one early on to ‘bite the bullet’ and steer clear of standing risk while dramatically improving the asset’s ecologic performance.

Case Study: 5-star Hotel, Sydney

The point intime when ecologic obsolescence is reached is illustrated in the detail below by example of a typical Sydney 5-star hotel and the two Australian CRRREM pathways. The energy usage and carbon footprint are based on the Cornell Hotel Sustainability Benchmarking Index (CHSBI) average values for Sydney 5-star hotels.

Australian CRREM Pathways, Sydney 5-star hotel performance (CHSBI)
Source: CRREM, CHSBI, AP Hospitality Advisors

As shown in the detail, the property becomes ecologically obsolete towards the 1.5⁰C goal both in terms of decarbonisation and energy reduction pathways by 2024, assuming the asset’s performance remains stable.

For this analysis, we have assumed a hypothetical hotel starting in 2020 as follows.

Case Study: 5-star Hotel, Sydney
Source: CHSBI, ACCU,, City of New York

Decarbonization pathway for a Sydney 5-star hotel

The following detail illustrates how a stranded asset (via the decarbonization pathway)incurs additional expenses to remediate ecologic obsolescence by buying carbon credits.

Case Study: Sydney 5-Star Hotel, Decarbonization Pathway
Source: CRREM, CHSBI, AP Hospitality Advisors

Assuming a hypothetical scenario, where this hotel’s carbon footprint remains constant until 2050, carbon credits will need to be purchased annually after becoming ecologically obsolete in 2025. The chart uses the example of a hypothetical Sydney 5-star hotel of 500 hotels rooms and 50,000 sqm GFA with a carbon foot print based on the average value from the Cornell Hotel Sustainability Benchmarking Index (CHSBI). The cost for each carbon credit is based on the Australian Carbon Credit Units (ACCUs) price as of 21 December 2021 (AUD49 per metric ton increased at inflation of 3.0% annually). The detail shows how the annual carbon credit expense increases to US$689,000 by 2050 or US$291,000 deflated to 2021 dollars (cumulative US$4,626,000 through 2050 in today’s dollars). This is a significant expense impacting a hotel’s bottom line, asset values and ultimately, investor returns while carbon credit prices are assumed to be increasing at inflation while it can be expected that prices will outpace it (see chart on ACCU prices towards the end of this article). If carbon credit purchases seem like a manageable expense, look no further – there is more pain ahead.

Annual carbon credit expense increases to US$689,000 by 2050 or US$291,000 deflated to 2021 dollars (cumulative US$4,626,000 through 2050 in today’s dollars).

Energy reduction pathway for a Sydney 5-star hotel

Following the energy reduction pathway, energy expenses will be the key area where savings could be achieved. In most properties this comes from electricity and in some cases gas and fuel (mostly for backup generators). The areas of focus are from expenses due to inefficient energy usage, those attributable to building design features and specifications may be more costly to address. While power companies will shift to lower-carbon energy through rising carbon credit prices, hotels need to their part to reduce energy use intensity. For the potential of zero-carbon electricity to cost more in the future, the increases may not be tied to the fuel source alone (but carbon credits too). Minimizing energy use intensity should thus be the goal for all owners, following the CRREM pathway for energy reduction.

Case Study: Sydney 5-Star Hotel, Energy reduction Pathway
Source: CRREM, CHSBI, AP Hospitality Advisors

Similar to the decarbonisation example, this same asset becomes ecologically obsolete by energy usage in 2024. The energy consumption is based on the average 5-starvalue for hotels in Sydney according to the CHSBI. The electricity cost is based on the per kWh price for business on ofUS$0.16 (inflated at 3.0% annually). By reducing energy use below the energy reduction pathway target by 2050, the hotel could save close toUS$5,500,000 in electricity expense annually equivalent to US$2,300,000 in today’s dollars. This is an area of substantial savings too significant to ignore. Conversely, the cumulative expenses incurred (around US$35 million through 2050 in today’s dollars) could be invested into CAPEX for the asset to avoid stranding and ecologic obsolescence.

Lastly, regulation around decarbonisation remains fragmented, dynamic and keeps evolving. For example, in April 2019, New York City introduced Local Law 97 (LL97) under the Climate Mobilization Act, passed by the City Council as part of the Mayor’s New York City Green New Deal. LL97 introduced a carbon penalty for buildings’ excess carbon emissions of US$268 per metric ton. While the established limit in New York may vary from the decarbonisation pathway for Australia, the calculation can serve its purpose to understand the magnitude of such penalties. Subject to a similar carbon penalty, this Sydney hotel would incur US$5,300,000 in penalties annually in 2050 or US$2,240,000 in today’s dollars. The cumulative penalties incurred from becoming ecologically obsolete through 2050 equate to US$35 million, comparable to the savings from energy reduction. Thus, the hotel could invest around US$40 million (or as much asUS$70 million under LL97) to avoid ecologic obsolescence.

This Sydney hotel would incur US$5,300,000 in carbon penalties annually in 2050 or US$2,240,000 in today’s dollars.

The cost of ecologic obsolescence (US$)
Source: AP Hospitality Advisors

However, an asset’s economic life will not end by 2050 – assuming it can avoid ecologic obsolescence. Similar to a valuation, a terminal capitalization rate needs to be applied to reflect the potential savings in perpetuity. For the purpose of this analysis a terminal cap rate of 5.0% was selected. The calculation above shows a sum as high as US$160 million ($81M + $79M) or US$320,000 per key that could be justified for CapEX towards mitigating ecologic obsolescence.

Sums as highs as US$160 million or US$320,000 per key could be justified for CapEX towards mitigating ecologic obsolescence

Savvy investors will argue that simply deflating future expenses does not reflect their cost of capital and decision-making process. Therefore, it is required to discount the future values to the present at an appropriate discount rate. For the purpose of this analysis, we have selected a discount rate of 9.0%, the findings are shown below.

Ecologic Obsolescence – Present Values (US$)
Source: AP Hospitality Advisors

Albeit less dramatic, the present value of expenses, savings and penalties remains considerable. This analysis makes the cost of ecologic obsolescence tangible for investors and other stakeholders in the industry by quantifying it in real dollar amounts. Valuers should heed to review asset’s ecologic performance and monitor implementation of legislation mandating adherence to the two pathways. At this point, it is prudent alert readers of valuation reports towards the potential expenses, savings, penalties and resulting impairment of value attributable to stranding or ecologic obsolescence by including an analysis as shown above.

Quantifying ecologic obsolescence of 5-star hotels around the world

Adopting the above methodology, we analyzed twelve other markets around the world. All cities are based on the same hypothetical asset of 500 room with a GFA of50,000 m2. The carbon footprint and energy uses are based on the CHSBI and pathways limits on CRREM.

Ecologic Obsolescence quantified, 5-star Hotel, Major Cities
Source: CHSBI, CRREM, AP Hospitality Advisors

The range of the potential carbon credit expense and energy savings is considerable from US$15.2 million in Beijing to US$78.9 million in Tokyo.

Carbon pricing

Given that carbon credit trading is still in its infancy in many parts of the world and not mandated for real estate by law (yet), the potential savings from reducing energy use should be getting more attention. However, if Australia is any example, the cost of carbon credits is likely to increase significantly in the years to come.

Australian carbon credit units (ACCU) spot price history

As show in the figure above, the spot price for Australian carbon increased sharply at the end of 2021 from approximately AU$20.00 to close to AU$50.00. Further increases can be expected depending on which scenario of climate policies one applies.

At the end of 2021 the Australian carbon spot price increased sharply from approximately AU$20.00 to close to AU$50.00

The Network of Central Banks and Supervisors for Greening the Financial System ( explored several price development scenarios for carbon credits until 2100. The below table summarizes projections for each scenario under different models for 2020 and 2050. Five scenarios are:

·        Current Policies assumes that only currently implemented policies are preserved, leading to high physical risks.

·        Nationally Determined Contributions (NDCs) includes all pledged policies even if not yet implemented.

·        Below2 °C gradually increases the stringency of climate policies, giving a 67 % chance of limiting global warming to below 2 °C.

·        Divergent Net Zero reaches net-zero by 2050 but with higher costs due to divergent policies introduced across sectors and a quicker phase out of fossil fuels.

·        NetZero 2050 is an ambitious scenario that limits global warming to 1.5 °C through stringent climate policies and innovation, reaching net zero CO₂ emissions around 2050.

NGFS Global carbon pricing by scenario (US$/Ton)
Source: NGFS

The projections vary widely and are based on global averages – regional prices may fall above or below the range. The takeaway from this table is that bar any changes to current policies, carbon prices are set to increase. While certain countries may escape dramatic carbon price increases under the NDCs scenario, any coordinated effort would see a significant increase in prices by 2050. As a general rule, mature markets are more exposed to price increases than emerging ones.

Applying carbon penalties per LL97 (at US$268 per ton CO2 and well within the ranges outlined under the scenario analysis by NGFS) to the sample of markets, paints a more dramatic picture.

Ecologic Obsolescence quantified, 5-star Hotel, Major Cities with LL97
Source: AP Hospitality Advisors

The combined penalties and savings for a 500-room, 5-star hotel ranges from US$31 million toUS$115 million or US$63,000 to US$230,000 per key.


This analysis has shown the expenses, savings and penalties attributable to stranded asset through ecologic obsolescence. All stakeholders in the industry should work towards meeting CRREM pathway limits and reduce the industry’s carbon footprint and energy use for existing properties. For those that want to find out how this can be done, please contact the author. Embodied carbon presents another challenge for new hotel projects, which calls for more documentation and analysis.

Click to download PDF file