By Dr Simon Radford, Associate Director, and Kevin Klowden, Chief Global Strategist, Milken Institute
The average family in England currently produces more CO2 every year just by living in their homes than by driving. So, why have we not produced a Tesla to make housing more eco-friendly?
Are you a Tesla Bull or Tesla Bear? Will legacy car manufacturers transition seamlessly into our electric future, or will new firms disrupt global leaders? And how quickly can electric charging infrastructure keep up with the demand for new electric vehicles? My guess is that you have either actively considered these questions or been proactively invited to do so by the media you consume. After all, peering into the crystal ball of the automotive sector’s future is not just a fascinating story but also part of a great social cause: navigating a path to “Net Zero”.
While we might all be hooked on tales about Tesla’s Elon Musk, the future of autonomous cars and government policies from charging to chips, the world could use similarly dramatic storylines to promote the cause of tackling a larger contributor to climate change in many countries: emissions from our own houses.
So, what is stopping a similar exciting story of green entrepreneurship in “retrofitting” houses with more energy-efficient materials, insulation and energy generation to lower emissions, reduce utility bills for hard-hit families and turn green jobs from slogans into reality? The problem at heart is that, while money pours into the race for global electric-car dominance, we have a coordination problem stalling the tackling of emissions from homes and catalysing of meaningful entrepreneurial energy. The United Kingdom provides a perfect case study on both the scale of the opportunity and the difficulties in unlocking it. And by examining this particular case study, we hope it can serve as a call to arms for the banking and finance communities to step up and break this deadlock.
All the constituent parts of a great investment opportunity seem to be in place: There is plenty of pension capital sitting on the sidelines that could be readily deployed if appropriate products were developed; large potential revenue streams from savings on household utility bills from renovated, more eco-friendly houses could provide potential index-linked returns if shared with those fronting the capital; and national and local governments are heavily incentivised with net-zero targets and constrained balance sheets to engage with private-sector solutions. And yet, for many, it is unclear whether coordinating these interests into an investable asset class and productive investment can be done or if it simply has not been tackled with enough vigor. If this coordination problem can be solved, the potential prize is massive, both financially for those willing to put capital at risk and for all of us in moving closer to international environmental commitments and more resilient infrastructure.
Tesla benefited from considerable assistance in the form of a US government loan in its early days, and it seems as if the private sector, if left alone, can’t or won’t solve this housing issue without similarly sustained government attention and catalysed investment. Tesla, too, has moved into home energy; its manufacturing of solar panels and home batteries has, however, been limited, in part demonstrating that the home-energy sphere is tough for even the biggest companies to crack on their own. Tesla’s largest impact in this space has, in fact, been the South Australian battery scheme, which was financed by a public government.
However, it is clear that the private sector isn’t tackling this due to scepticism about the market size; the scale is both significant and urgent. Research1 from the UK’s National Housing Federation (NHF) calculated that 2021 emissions from the country’s 25 million homes (which produce 58.5 million tonnes of carbon dioxide [CO2] every year) overtook emissions from the 27 million cars in use in England (responsible for 56 million tonnes of CO2 emissions annually). Gas central heating and poor insulation mean that heat easily leaks out of UK houses, especially as they have often been built long before other countries’ housing stock and therefore require even more gas to keep them at suitable temperatures. This means the average family or household in England currently produces more CO2 every year just by living in their homes than by driving.
So, it’s no surprise that “retrofitting” the UK’s houses is a priority for local governments as they look to meet local and national net-zero targets, particularly for the 4.4 million council houses (social housing) for which local councils act as landlords and manage. But those targets seem to be slipping out of reach unless there is a step change in tackling major sources of CO2. For example, the Guardian2 newspaper recently reported that the UK Government’s own analysis shows it will fail to reach its 2050 emissions targets.
If housing is the big, untackled source of emissions and retrofitting is the way to tackle it, how do we get the market to move? The housing market is large (the capital’s 3.6 million houses and apartments have a combined value of almost £1.9 trillion—equivalent to France’s entire gross domestic product [GDP]) and owned by many people. Perhaps the largest homeowner in the UK, and certainly the most willing, is the government—specifically, local councils, many of which have pledged to tackle the carbon crisis but don’t have the money or knowledge to structure financial deals.
So, what is stopping UK local governments from investing in retrofitting, starting with their own housing stocks but potentially offering services to private landlords as well? The answer is a balance-sheet constraint. Former Prime Minister Margaret Thatcher put limits on how much social landlords (councils and not-for-profit housing associations) could borrow, and any money invested in retrofitting must either come from:
- Homes that social landlords already own. The only sources of income to cover current costs and potential retrofit programmes at present are rental incomes or the central government’s grants. The bulk of rental income (often around 70 percent) comes from the central government in the form of housing benefit payments, and governments can cap the rents they are willing to use to subsidise low-income renters. They can also change that cap over time, making long-term financial planning difficult. Government grants are also hard to predict and depend on ministerial priorities.
- Homes that were built in conjunction with the private sector and often held by arms-length companies. This helps social landlords avoid some of the restrictions noted above but still relies on public organisations underwriting major investment requirements that exceed rental income. For a local council, this could mean a future choice between paying for social services or covering shortfalls in debt obligations.
In short, social landlords see the social value of retrofitting homes but cannot afford to take on the risk of paying for them, not least as funding for existing services has been cut in recent years. London local councils have seen core funding from the central government cut by 63 percent in real terms3 since 2010.
However, councils have another pool of funds: the Local Government Pension Scheme (LGPS). Take, for example, the pension fund for the London Borough of Barnet, which has approximately £1.4 billion under management. Barnet is in the process of setting a challenging net-zero target for the fund as a whole to match the council’s own commitment to be net zero by 2042. Part of the council’s pension fund’s responsible investment strategy involves following advice, such as Bridgewater Associates’ Karen Karniol-Tambour’s in a recent piece4 she wrote for the Milken Institute’s Power of Ideas series: Shift capital to companies decreasing their emissions as well as to those seeking to provide more sustainable, resilient infrastructure to power a lower-carbon future. Since declaring a climate emergency in May 2022, Barnet has also crafted a stewardship strategy to voice its values through its pension fund’s various ownership stakes and holdings. This strategy to set an ambitious net-zero target for the fund, reduce carbon intensity in existing holdings through stewardship and actively seek funds that invest in sustainable infrastructure puts Barnet ahead of most of its local-government peers. But Barnet would love to go further.
Local politicians have seen a resurgence of interest in “community wealth building”. Barnet, following Preston in northwest England, has appointed a Cabinet member to find ways to keep more of the area’s wealth in the area. And pension committees are starting to ask similar questions: How can local governments’ pension funds achieve their return objectives and fulfil their fiduciary duties while also solving important local social objectives—from tackling London’s housing crisis to launching projects that aim to reinvigorate the UK’s physical and social infrastructure? This emerging desire to see more of the local governments’ pension wealth channelled for both financial and social ends comes against a backdrop of declining allocations from UK pension funds to British-listed companies over the last few years. The New Financial think tank reported5 that UK pension funds reduced their allocations to stocks from about 73 percent in 1997 to 27 percent in 2021, cutting exposure to British equities from 53 percent to just 6 percent over the same period.
So, what is needed to unlock action when we have a large demand for capital for retrofitting and large pools of domestic supplies of funds looking for index-linked returns and social impact?
To crack open this deal, as ever, money talks. If an investor were prepared to put down a several-billion-dollar commitment to this deal based on at least index-linked returns, the other parts of it would likely fall into place. If a large foundation and/or investor could catalyse the market while bringing local governments’ pension funds in to learn from them as pioneers, it is likely that billions of pounds would follow at scale as quickly as products could be developed.
We contend that five steps need to be completed:
- First, commitments from a few local councils to allow modelling of their housing stocks to provide proofs of concept (POCs) that future utility savings can be accurately gauged if retrofitting is to take place, with estimated return expectations for investors, fund managers and householders;
- second, minimum return guarantees from climate philanthropists and/or the national government to put floors under those willing to be the first into the market as investors and pump prime a market in which these guarantees can gradually be withdrawn;
- third, a call to action for entrepreneurs and companies to establish enough retrofitting companies to deliver the needed skills and scale to provide the portfolio of opportunities to be financed;
- fourth, educating councillors on pension committees, pension managers and local pension boards, alerting them to this investment opportunity and also reassuring them that such an investment perfectly aligns with their fiduciary duties.
- The last missing piece is a call to action for the readers of this publication. We need people ready to provide the structuring skills needed to make investable pools of opportunities and put together appropriate investment vehicles that provide local pension funds with the opportunities to go beyond settling for only minimising their carbon footprints or resorting to buying carbon credits—but instead to go further and reach net zero. Only by investing in carbon-negative opportunities that meet pension funds’ fiduciary duties can funds and governments realise their ambitions.
There has been talk of Green New Deals (GNDs), environmental industrial revolutions and promises of new technology. But perhaps only by bringing together governments, allocators of capital and entrepreneurs—in which the Milken Institute specialises—can we further explore making net zero a reality. While the possibilities are tantalizing, I imagine that Elon Musk will find ways to dominate the headlines, nonetheless.
1 National Housing Federation: “England’s leaky homes are a greater threat to climate than all of its cars,” August 25, 2021.
2 The Guardian: “UK still well off track on pledge to cut methane emissions, study says,” Fiona Harvey, April 12, 2023.
3 London Councils: “A decade of austerity: Core funding reduced by 63 per cent.”
4 Milken Institute: “Investing in Climate Solutions and Climate Improvers on the Way to Net Zero,” Karen Karniol-Tambour, April 5, 2023.
5 Bloomberg: “UK Pension Funds Flee the Equity Market, Adding to London Woes,” Swetha Gopinath, March 17, 2023.