The Challenges and Opportunities Facing Fifth Wall's Groundbreaking Carbon Impact Fund, Featuring Sustainability Expert Lindsay Baker
By Reid Carroll (MBA 2022)
$18 Trillion.
That is approximately how much money will be required to decarbonize the real estate industry, according to Brendan Wallace (CREtech, 2021). For reference, the United States national debt is about $28 Trillion (Statista, 2021).
Wallace, a managing partner at Fifth Wall, estimates that buildings can get halfway to zero carbon by implementing technologies that already exist. The other half, he says, will require R&D investments into technologies that have not yet been developed.
He also estimates that, in the last ten years, the real estate industry has only invested $100 million into R&D.
"That's like [the cost of] a sixth of a building in New York," Wallace says. "It's nothing. It's an interest payment" (CREtech, 2021).
To Wallace and Fifth Wall, who capitalized on a similar phenomenon in PropTech five years ago, this looked like an opportunity.
"There’s a lot of talk and a lot of bluster, but I don’t see anything institutional. I don’t see real dollars moving. That was the genesis of Fifth Wall back in the day" (CREtech, 2021).
And with that, Fifth Wall, the world's largest PropTech venture capital firm, announced in early 2020 that they intend to raise at least $200 million for a Carbon Impact Fund focused specifically on climate-tech for buildings.
An examination of Fifth Wall's Carbon Impact Fund makes a couple of things abundantly clear. First, the industry needs this infusion of capital in the worst way - real estate is responsible for more greenhouse gas emissions than any other industry. Second, underinvestment in climate-tech R&D is a result of numerous industry impediments. Fifth Wall's lead investors have an enormous challenge in front of them.
Sustainability in Real Estate - Where We Are Today
"As it relates to building and energy, nothing is that simple. If you think it is going to be easy to get into a huge variety of buildings, you are wrong. You're just wrong."
That's Lindsay Baker, formerly the global head of sustainability and impact at WeWork. Today, Baker is recognized as one of the leading voices in the world of real estate sustainability. She is a lecturer at the UC Berkeley Architecture School and is incubating her own nonprofit.
Her assessment of the industry is blunt: We have a massive opportunity, and we are way behind in solving it.
"I look at the numbers, the actual carbon emissions of the building sector. The numbers aren't going down."
If carbon-neutrality is the endgame, Baker estimates that we are only in the second or third inning.
Consider the following statistics from the UN Environment Program (Abergel, Dean, and Dulac, 2017):
Share of global energy-related CO2 emissions attributable to buildings: 39% (for comparison, transportation accounts for 22%)
Share of global final energy consumption attributable to buildings: 36% (transportation accounts for 28%)
You read that right. Buildings account for 75% more CO2 emissions than transportation. And yet, anybody can speak to the progress the transportation industry has made - electric vehicles, emissions regulations, micro-mobility solutions, etc. When was the last time you heard a politician or media personality discuss the ways in which we must make buildings greener?
Why, when buildings are such a big part of the problem, is there such a lack of traction in finding solutions?
Baker points to four main reasons.
Complexity
"It is pretty typical that clean-tech investors don't invest a lot in buildings," Baker says. "I had one clean-tech investor tell me that the thing that was most intimidating to them was buildings. They felt like the chances that they made a bad investment were higher, so they didn't invest in buildings."
"We are dealing with a lot more existing infrastructure, and a much more complicated set of decision makers than other clean-tech areas."
Uninformed Governance and Unfocused Legislation
Much as investors shy away from the difficult and technical building problems, policy makers rarely have the expertise to effectively advance building sustainability through legislation.
As a result of weak or nonexistent legislation, many building owners are not being forced to take responsibility for the emissions of their assets. These owners who might otherwise consume climate-technology solutions at scale are instead deflecting responsibility. Says Baker:
"A lot of owners of buildings have completely delegated the responsibility of that building to somebody else. I think that's not okay. It is making it too difficult for us to hold people accountable for their carbon footprint. Call me old fashioned, but I think if you own a building, you're responsible for its carbon footprint."
Split Incentives
Another complexity, according to Baker, lies in the misaligned incentive structures across the industry. Many design and development teams are primarily concerned with new construction costs, especially because operations (and operating costs) end up as another team's responsibility. In far too many cases, climate technologies that could quickly pay back their initial costs are omitted in the name of reducing upfront costs.
Even for fully aligned property teams, the division of responsibility between buildings and tenants presents another complication. A building cannot be totally efficient without some level of cooperation at the tenant level, which further disincentivizes landlords to take responsibility for their carbon footprints.
Insufficient R&D and Hardware Investments
Software can only take buildings so far, when many of the issues are fundamental to the properties themselves - leaky façades, inefficient windows, and ancient HVAC systems.
And while the need for hardware and physical interventions is not unique to real estate, it nevertheless has hampered investment.
"There is an unfortunate hierarchy," says Baker. "The really successful, big-name investors typically only invest in software, or in really proven hardware; SaaS in particular."
She points to prefabricated components as one physical technology that has already achieved scale, and lists cost-efficient façade technologies as being particularly high on her wish list of future innovations.
So yes, there are obstacles in the industry's path. Despite this, Baker is optimistic.
"If we are in the second or third inning, that also means that we have a team of people that have been training for their whole lives to do this work; they're in the game. We forget about all of the training that happens before you even step on to the field; we've done all that."
And, she says, the importance of the institutional money that Fifth Wall is directing into the industry cannot be overstated.
"They are bringing a frankness and urgency to the situation. They find the pace of change unacceptably slow... that's not a typical clean-tech investor thing to say."
Fifth Wall's Carbon Impact Fund
If anybody can tackle this problem, Fifth Wall is a good bet. Founded in 2016 by Brad Greiwe and Brendan Wallace, it has grown into the world's largest PropTech VC with over $1 Billion in assets under management. Some of Fifth Wall's notable investments include Opendoor, VTS, ClassPass, Allbirds, and Lime.
According to Wallace, the idea for the Carbon Impact Fund began about a year ago.
"I was gleaning that there was a gestating interest in climate-tech at these corporates, but they didn’t know what to do. And so I started to ask questions. To be totally honest, the answers rubbed me the wrong way….I was being greenwashed" (CREtech, 2021).
As Wallace discovered the shocking gap between talk from real estate corporates and their actual investment in climate-tech R&D, he came to realize that the issues holding back investment were ones that played to his firm's strengths.
"This is a problem that can be solved with enormous amounts of money. And institutionalization. And collective action. And I like to think that that's what Fifth Wall is good at" (CREtech, 2021).
Despite that optimism, Fifth Wall's actions so far indicate that they are well aware of the obstacles that Baker listed. To combat the complexity of making R&D-type venture investments in the real estate space, they brought on Greg Smithies, a veteran climate-tech investor with a long history of similarly complex R&D investments. At BMW i Ventures Smithies focused on decarbonizing manufacturing, supply chain, and transportation. He also led a number of industrial tech deals while at Battery Ventures (Fifth Wall, 2020). As for taking on the governance and split incentives issues, Fifth Wall has partnered with CREtech, a leading PropTech media organization. Together, they have created a Climate Technology Initiative that seeks to, "serve as the voice of the real estate industry's commitment to climate tech" (CREtech, 2020). This partnership is an effort to educate and organize industry on climate solutions.
Why Now?
The Fifth Wall team points to three factors that make now the right time to invest in real estate climate-tech.
1) A Triumvirate of Pressures From Regulators, Tenants, and Capital Markets
As the United States moves from the Trump administration to the Biden administration, all indications are that federal regulations will be more environmentally progressive than ever before. For landlords, this means that the scramble to get ahead of those regulations (and their stiff penalties) is officially on.
Tenants, meanwhile, are pressuring landlords like never before according to Wallace.
"The real estate industry, at the end of the day, is tenants. They pay the bills. And tenants now have their own requirements. Tenants are saying, 'We need low carbon footprint real estate, or we won’t lease from you.'" (CREtech, 2021).
Capital markets have observed both of these trends, and will be treating real estate corporates accordingly. Says Wallace:
"Capital markets are saying real estate owners have to decarbonize. That’s happening, and real estate owners are getting smart to that. If you are a real estate CEO, you are concerned about your cost of capital" (CREtech, 2021).
2) Advances in Underlying Technologies
Smithies explains:
"The price of the clean energy going into a lot of chemical processes has fallen off of a cliff….It is actually cheaper to build new solar farms than it is to simply run an existing coal power station...Chemical processes that previously you would only do because of ethics, now actually are cheaper to do if you do them in a green way" (Fifth Wall, 2020).
3) Market Size
Smithies follows three steps when when evaluating venture opportunities (Smithies, 2020):
Find a large market
Identify a factor that is forcing that market to change
Invest in the companies best positioned to capitalize on that change
There is no question that the global real estate market qualifies as a large market - Smithies estimates it to be $9 trillion annually. And real estate's role as the leading greenhouse gas contributor means significant change is coming.
The question is, will Fifth Wall succeed at finding the companies best positioned to capitalize? And if they do, will those companies be able to tap into that massive market?
What Will It Take?
For Fifth Wall to succeed, they must get a few things right.
1) Apply Scientific Rigor
Smithies has mentioned his intent to focus on "the boring stuff" that makes landlords money, like improvements in HVAC technology, or windows and cladding (Phillips, 2021). These are critical components, but it must also be noted that façades and HVAC systems represent significant capital expenditures. Any technologies in these areas will be subject to a great deal of scrutiny by engineers and architects, and investments must be vetted accordingly.
As an example, there has been a proliferation of technologies that claim to take COVID-19 particles out of the air. Few of them, though, can substantiate those claims to the satisfaction of professional engineers. Those that cannot pass technical muster will not achieve adoption at scale.
2) Focus on Measurable Impacts
How do you measure sustainability in buildings? It turns out there are a lot of answers, many of which are hard to understand and easy to manipulate. This presents a problem for climate-tech: If you can't easily measure building sustainability, you can't easily measure the impact that a new technology might have.
One standardized metric which many in the industry have advocated for (including Baker and Wallace) is carbon emissions. Carbon emissions are attractive because they are unambiguous. Either a building's carbon emissions have gone down, or they haven't.
As regulations continue to intensify, it is likely that additional metrics will rise in prominence. The important thing for Fifth Wall is that they understand which metrics matter, and they benchmark the impact of their investments accordingly.
3) Craft Compelling Narratives
Unfortunately, measurable impacts cannot tell the whole story. Even for the best metrics, such as carbon emissions, things can get murky quickly. (Should emissions measurements be on a per-square-foot basis? How do you control for the effect of tenants with abnormal energy usage? How do you control for different use cases?)
As a result, the most successful climate-tech startups will be the ones that can attach compelling narratives to their measurable impacts. Fifth Wall, with its deep industry connections, is perfectly positioned to help its portfolio companies craft the narratives that owners, tenants, and capital markets want to hear.
Wallace knows that Fifth Wall's effort to accelerate climate-tech investment will require comprehensive industry buy-in (CREtech, 2021).
“Fifth Wall is not enough. We need regulators to also see the light. We need capital markets to see the light. We need tenants to see the light. We need consumers to see the light."
"Am I optimistic that we can overcome this collective action problem when it comes to climate-tech investing? My answer is yes. My intuition is that we will."
For the Carbon Impact Fund, success may hinge on Fifth Wall's ability to accelerate this collective purpose.
The world is rooting for them.
Reid Carroll is an MBA Candidate at London Business School. Previously, Reid held engineering roles at WeWork and JB&B in New York City. He has been interested in Building Sustainability since early in his career, and has been certified as a LEED and Passive House professional. Reid received a BSE cum laude in Mechanical Engineering from Case Western Reserve University.
References
Abergel, T., Dean, B., Dulac, J. (2017) Towards a zero-emission efficient, and resilient buildings and construction sector. Global Status Report 2017. [online] UN Environment and International Energy Agency, p.16. Available at: https://www.worldgbc.org/sites/default/files/UNEP%20188_GABC_en%20%28web%29.pdf [Accessed 11 Feb. 2021].
CREtech, (2021). Exclusive One on One Conversation with Michael Beckerman and Brendan Wallace. [online] Available at: https://plus.cretech.com/sustainability-and-esg/videos/mb-brendan-webinar [Accessed 10 Feb. 2021].
Fifth Wall, (2020). Investing in Climate Tech for the Built World. [online] Available at: https://www.youtube.com/watch?v=21k4V4ONxi4&ab_channel=FifthWall [Accessed 10 Feb. 2021].
Smithies, G. (2020). Why I Believe Fifth Wall’s Consortium Might Be Key to Solving One of the Worlds Biggest Problems. [online] Fifth Wall. Available at: https://medium.com/fifth-wall-insights/why-i-believe-fifth-walls-consortium-might-be-key-to-solving-one-of-the-world-s-biggest-problems-937d2603c65f [Accessed 10 Feb. 2021].
CREtech, (2020). CREtech Announces New Climate Tech Initiative Sponsored by Fifth Wall. [online] Available at: https://www.cretech.com/directory/company/cretech/press-release/cretech-announces-new-climate-tech-initiative-sponsored-by-fifth-wall [Accessed 11 Feb. 2021].
Phillips, M. (2021). Fifth Wall Aims to Cut Real Estate’s Carbon Output by Backing The Boring Stuff That Makes Landlords Money. [online] Bisnow. Available at: https://www.bisnow.com/london/news/sustainability/fifth-wall-aims-to-cut-real-estates-carbon-output-by-backing-the-boring-stuff-that-makes-landlords-money-107657 [Accessed 11 Feb. 2021].
Statista, (2021). Public debt of the United States of America from January 2020 to January 2021, by month. [online] Available at: https://www.statista.com/statistics/273294/public-debt-of-the-united-states-by-month/ [Accessed 15 Feb. 2021]