The business case of circular economy in the built environment: an exchange with Olivia Finch (Portfolio Manager at the Ellen MacArthur Foundation)

This week, Urban Chronicleshas met Olivia Finch, portfolio manager at the Ellen MacArthur Foundation. In this interview, Olivia shared with us the results of the report Realising the value of circular economy in real estate, achieved and published in February 2020 by the Foundation and the consultancy firm Arup. What is the business case of circular real estate models? What are the sources of lost value in linear models? How can circular models enable to recover this lost value in order to create financial opportunities? Discover more in this article!

More about the Ellen MacArthur Foundation
The Ellen MacArthur Foundation was launched in 2010 to accelerate the transition to a circular economy. Since its creation the charity has emerged as a global thought leader, establishing the circular economy on the agenda of decision makers across business, government, and academia.

Green Soluce :  What motivated the Ellen MacArthur Foundation (EMF) and Arup to produce the report Realising the value of circular economy in real estate? What are the key real estate actors at the center of it?

O. Finch : We partnered with Arup in 2016. Right from the outset we identified the needs to translate the principles of circular economy into practice for the built environment industry. It was a two-phase project.

The first part of that project was a research phase of assessing various different case studies and stakeholder interviews across the value chain to find out what the current barriers, opportunities and enablers were to implementing circular economy in the built environment and real estate sector. One of the key findings from that piece was that finance was viewed as a key enabler in order to kickstart a transition towards more circular practices and in the sector.
But interestingly over half of the investors and clients we talked to cited a lack of confidence and clarity in circular economy investment opportunities. They weren’t convinced of the business case for doing things in a more circular way. Because of that, we thought it was very important that we looked into this idea around a positive business case for circular economy in the built environment, that allows resource use to be decoupled from economic growth, and particularly from an investor and a construction client point of view. This is the subject of the report that we’re talking about.

GS : What are the five circular economy real estate business models the report enabled to highlight?

O. Finch : We wanted to try and show that there was a financial value involved in implementing circular economy. The starting point was to see where value was currently being lost in the system. Those five areas that we saw were:

  • Underutilized space Up to 30 to 40% of office space in Europe is unused, while their owners are still paying for it.
  • Premature demolition. A lot of buildings are built for a certain use and as market conditions change, that use is no longer fit for purpose. As a consequence, a building that was designed to last for 60 to 100 years quite often is knocked down after 30 years to build a new one. All of the value in those materials is lost.
  • Vacant lands. In many cities, large brownfield areas of land have planning permission but they’re not being developed due to several reasons: for example, because they’re waiting for planning permission or for market conditions to change to make the land more profitable.
  • Depreciated materials. Materials used to build a building are depreciated throughout its lifespan, but there’s usually no way of measuring what the value of those materials are when the building is demolished. Hence, those materials are more often than not just considered worthless.
  • The final one is very simply just underperforming components, when components in buildings and their systems don’t perform as they were designed or installed, leading to lost value especially around poor energy efficiency.

Once we had identified those areas of lost value, we developed five circular real estate business models, inspired by circular economy principles, to capture the lost value identified:

  • The “flexible spaces” business model helps to address underutilized space. It essentially uses online platforms to list existing underutilised building spaces for short term use, bringing in new revenue from sub tenants. That means that the internal space also has to be designed and constructed in a way that makes it very flexible to adapt different uses.
  • “Adaptable assets” is the model we came up with for premature demolition. It’s about making sure that buildings are designed so that their use can be adapted to alternative uses over time, with architectural features that allow for changes in floor heights for instance, or changes in extensions to be added. For example, vacant warehouses or offices can turn into residential buildings or a vacant residential into a small e-commerce logistics warehouse.
  • “Relocatable buildings” is the model we developed to respond to the lost value of vacant land. A building operator owns a portfolio of high quality, temporary and modular relocatable buildings that you can deploy quickly to these areas of vacant land. So, the value is gained well, as the owner of the land can get some temporary use out of that particular plot and the building operator can have a portfolio of relocatable buildings that can be deployed on different sites over time.
  • The “residual value” model responds to the “Depreciated materials” source of lost value. It is probably the most innovative model: it is not available in the market at the moment. It involves the creation of a new contract, similar to a commodity futures contract, which records all the materials in a building and estimates their value tied to a future point of deconstruction or refurbishment. These contracts are then traded on a centralised exchange while the building is operational and whoever owns them at the time of deconstruction becomes the owner of the materials. This means the true value of building materials is captured and recovered when they are removed from a building, thus incentivising reuse of those materials.
  • The final model is “performance procurement”. It’s essentially an extension of the product as a service model (having access to a service instead of owning it). Lighting is the classic example that people often talk about. For example, Philips procured lighting as a service in Schipol Airport. Instead of owning luminaries, Schipol pays for Philips to provide light. Hence, Philips, as a service provider, is incentivized to make the lighting as efficient and easy to maintain and repair as possible. We extended this service model to whole building level. You could also have your thermal performance, your cooling, your flooring, or your facade as a service. So, for example you’d have a subscription-based service for your HVAC systems.

GS : Can you present us some examples of profit opportunities these circular business models allow?

O. Finch : With Arup economics team, we did an extensive amount of financial analysis to evaluate the financial value of the circular business models compared to a linear equivalent. We used real commercial data from a selection of testbed projects that had already been built and assessed the financial performance of the model with sensitivity analysis on identified inputs. So, from the usual linear version that we had the data for, we applied a discounted cash flow analysis changing different parameters to compare the circular business model finance performance version to the linear model performance.

Happily, we found that in each case, the financial returns were improved with the circular version. For example, we showed an 18% reduction in net present cost over 12 years through the “flexible spaces” model. The “Residual value” model produced a 5% reduction in net present cost over 10 year. For “adaptable assets” and “performance procurement”, our modelling showed a 3% increase in the internal rate of return over 30-50 years, and “relocatable buildings” came out with an average 26% increase in internal rate of return over 11 years.

GS :The report concludes with four calls to action to stakeholders of the real estate value chain, in order to realise the opportunity presented by circular business models: can you tell us more about them?

O. Finch : We wanted to end it with a call to action because one of the overall conclusions of this project has definitely been that we need key stakeholders to take a lead on this. The hope is that if front runners in the industry embrace and start to show that there is value in adopting circular principles, then the people left behind will be forced to start thinking about it too.

  • One of the main calls to action is that we believe that real estate investors and construction clients are best placed to lead the adoption of circular principles, particularly on large commercial scale examples, by setting briefs that adopt circular principles for new projects.
  • The second call to action is that we really need the whole community of real estate professionals to be involved to make these models work: real estate agents, insurers, accountants, lawyers and other experts must be ready to overturn traditional conventions to realise the value presented in the report.
  • The third call to action is that policy makers also need to be involved. They are a really important stakeholder in the process. In the first phase of our research project, most of the policy makers we spoke to said that they can’t act without an evidence base of circular economy working in action before they can start to change policy and regulate for circularity. In that case, policy makers need to work with construction clients to develop public-private partnerships that show the value of circular economy. In other instances, existing regulatory barriers could be changed. For example, if policy makers were able to fast track temporary planning permissions needed for temporary buildings, developers would be more incentivized to go down the relocatable building route.
  • The final call to action is the fact that we need further evaluation tools to be able to really capture the lost value that we’re trying to recover. Current valuation models don’t measure the lost value and the negative externalities associated with the linear economy. We need to change that valuation process so that it makes it very clear to investors which projects make a positive contribution versus a negative contribution to those overarching natural ecosystem aspects, such as climate change and biodiversity loss, in order to create the level of systemic change that we need to really get circular economy off the ground.

GS : Do you feel like there are some countries that are more advanced than other in terms of thinking about the circular economy model?

O. Finch : Amsterdam and the Netherlands seem to be coming up again and again, in terms of examples of buildings that are being built in a circular way and partners willing to trial different approaches. I think a lot of that is to do with their regulatory environment: in Amsterdam, the municipality has introduced policies that encourage the construction industry to achieve 50% circularity by 2030. What that actually means is up for debate, but what it’s doing is encouraging the Dutch industry to really start thinking about how they need to change the ways they manage waste and the ways they design their buildings.

GS : How can circular economy help manage the Covid-19 real estate recovery?

O. Finch : I think it’s a really interesting challenge for the real estate industry. We’re probably going to see a vast amount of unused office space emerging from this crisis because companies are realizing that their employees can work from home, that they can have much more flexible working environments. So the Flexible spaces model will be more relevant than ever.

Another trend is that unfortunately some businesses won’t come out of this crisis in a strong position. That means that potentially a number of buildings are going to become unused and the real estate industry will need to adapt these buildings to new uses or die. The adaptable assets model would help cope with this, but either way there must be a focus on refurbishment and refit rather than demolition.

It would be really interesting to see if architects and designers are able to respond to that and change the way they design buildings.
Finally, if we’re in a harsh recession, people and companies presumably are going to have less disposable income, creating a cash flow issue. Products might not be bought and sold as much as they were before. So it would be great to see wider consideration of the performance procurement model (access to a service via a procurement contract instead of ownership), that would allow upfront costs to be spread out over time. Our supply chain needs a greater resilience and can be eased by the idea of a sharing and service-based economy.

Interview by Camille Raynaud

Green Soluce supports you with an approach experimented with major players in the real estate value chain who have chosen to bet on the circular economy. Contact us to discuss your needs and our solutions!

Green SoluceThe business case of circular economy in the built environment: an exchange with Olivia Finch (Portfolio Manager at the Ellen MacArthur Foundation)
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