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EU efficiency standards add risk to older assets in RMBS, CMBS

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Stricter energy efficiency regulations for European residential and commercial buildings, set to take effect in 2020, will likely reduce valuations and cash flow for assets in the region's mortgage bonds, according to Moody’s Investors Service.

The impact would be concentrated in the older, noncompliant buildings that would require costly upgrades and might be less attractive to tenants seeking more energy-efficient digs, Moody’s says.

“Noncompliant properties will be at risk of lower valuations as investors and homebuyers anticipate price discounts, given the investment needed to make them energy efficient,” the rating agency said in a report published this week.

The impact will also vary across the region, as some countries, including the U.K., the Netherlands, France and Germany, have committed to more aggressive emissions reduction goals, the report states.

The new standards will go into effect in two years for a building sector that contributes to 40% of energy consumption and 36% of carbon dioxide (CO2) emissions in the euro area, according to the report.

The risks vary by property types. For commercial real estate, according to Moody’s, “the regulations will potentially increase refinancing risk” and loss severity in the event of a default." In addition, tenants and investors are increasingly seeking out green credentialed properties to occupy and buy – and relegating noncompliant properties into less-desirable “brown” portfolios.

The classifications are being made through disclosure requirements and energy-performance data, and “are resulting in higher premiums among green field sites and discounts among brown field developments.”

Moody’s cited a September 2017 investor survey by PRI/Novethic, which found that almost half of 1,200 asset managers have reduced their portfolio exposure to fossil fuel holdings (including buildings) that are “emission intensive.”

Residential properties backing mortgage bonds are likely to suffer both in terms of resale values and in recovery values in foreclosure, due to the cost of upgrades.

Complicating matters for investors and owners of noncompliant properties is the difficulty in estimating the costs of upgrades. “The costs relating to increasing energy efficiency cannot be estimated without differentiating between property types, construction years and the physical condition of the buildings,” the report stated.

Citing a study by Dutch commercial and residential management services firm JLL, Moody’s estimates the valuation differences between compliant and noncompliant properties can equal between two months and a year’s worth of rent, respectively, for a property owner.

Regulations of individual countries may also play a role in impacting mortgage bond portfolios. The U.K. already has a minimum energy efficiency standard that properties must meet to lease out residential and commercial units, while the Netherlands has legislation under discussion to force office properties to meet a minimum environmental performance certificate (EPC) rating by 2023.

Besides costs, owners face increasing vacancy risks and lower demand from tenants (such as institutional and government occupants) that are focused on renting energy efficient properties, “in line with their own sustainability strategies.”

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