Circular economy ideas are leading to better real estate investments
Circular real estate is about adopting new business models to capitalize on changing spaces and delivering more flexible, adaptable and deconstructable buildings that can be better investments over time.
The built environment industry has long been identified as a wasteful consumer of natural resources. When the Ellen MacArthur Foundation began promoting the idea of a circular economy – where economic growth is decoupled from resource consumption – the built environment sector was interested, but unsure how to change. The circular economy was initially understood as a “design strategy,” focusing on managing materials and waste through the design and construction process.
Today, the argument has moved on. In a world where global trends are changing what people want from workplaces, where retail outlets are struggling, and the public is demanding an urgent response to climate change, investments in traditional real estate are getting riskier.
It turns out that those same circular principles, when applied to real estate investment strategies, lead to enduring decisions and better returns 10, 20 and 30 years down the road. It is now clear that what was missing was a clear statement of the business case for applying circular economy strategies to real estate.
The report, Realising the value of circular economy in real estate, fills this gap. This has been led by Arup and the Ellen MacArthur Foundation in partnership with 3XN Architects/GXN Innovation and with expert advice from the Royal Institution of Chartered Surveyors (RICS) and JLL.
Better returns in a world of change
If circular real estate isn’t just about materials, what else is it about?
The core idea is adopting new business models to capitalize on changing spaces. By delivering more flexible, adaptable and deconstructable buildings, investors move from making a one-time bet that’s less likely to remain profitable, to owning an asset with a dynamic operational model, one that offers new revenue streams over longer periods and greater residual value.
Circular thinking accepts that we can’t know what occupants will require or prefer in one or two decades time, but that if we design smartly and responsibly, we can adapt and stay profitable while avoiding the traditional build and demolish, boom-and-bust practices of yesterday. By designing-in flexibility at the start, you can expect better returns on investment for longer.
Circular real estate investing also helps address many of the existing concerns about real estate, (underused space, stranded assets, dwindling appeal to new tenants, costly adaptations etc.) many of which have reduced financial returns.
Three of the ideas explored in our new report include:
1. Flexible spaces
Co-working spaces are our inspiration. Like them, our model unlocks the potential of underutilised space in buildings while crucially also balancing the risks normally associated with short tenure space. When explored on a tenanted office space in Milan, the potential additional revenue was found to be equivalent to 18% of the net present lease cost over 12 years.
2. Adaptable assets
Buildings don’t stay on top of the market as long as they used to and that’s a problem for investors. By moving to a model based on adaptable assets we can produce buildings resilient to both changing market conditions and social expectations. When applied to a five floor development in Aarhus, we saw the internal rate of return increase by 3% over 50 years.
3. Performance procurement
Approximately 20-40% of building energy could be conserved, with many buildings not performing as designed. Investors could shift to paying for performance, rather than products. Scaling this approach up to whole building systems creates the concept of performance procurement, which when tested for a build-to-rent development in London delivered up to a 3% improvement in the internal rate of return over 30 years.
Ideas into action
Let’s imagine a real estate investment trust is persuaded of the benefits of the circular economy and adopts it as part of their corporate investment strategy. What do they do?
They insist on designing adaptable shell and cores, to allow tenants to select the fit out they need, ensuring it can be easily changed for future users or if requirements change. Smart building technology reveals who is using what space and when. The asset managers work with their tenants to maximize space utilization and revenue generation opportunities. Building façades and services are procured though performance-based contracts so that tenants are guaranteed better operating buildings to the specification they require. Where sites are waiting for main works to start, a pool of relocatable building operators are called upon to create productive meanwhile spaces. The trust now tracks both the market value and commodity value of its portfolio.
The point is clear: a circular investment remit leads to better sustainability outcomes and better returns.
Better business now
At every stage of investment, the circular real estate investor is more deeply engaged with what an asset might achieve, how it might perform and how it can stay valuable. Trends like rapidly developing technology, changing occupant expectations and growing demands for climate action are pulling real estate businesses in different directions. Circular real estate investment strategies align these forces, giving businesses a route to commercial success in a carbon-constrained world.