Feb

Investing in decarbonisation solutions for the building sector

Author: S.C.

1. The Climate Challenge

The building sector generates nearly 40% of global carbon emissions (Figure 1), through operational emissions from heating, cooling, etc., as well as embodied carbon from building materials like cement. In order to achieve the Paris Climate Goals, it is essential to decarbonise the building sector, and this has to happen quickly.

Figure 1: emission contribution by economic sector. Source: UNEP (2022)

The very good news is that we already have all the necessary technical solutions to do that (Figure 2): in particular 1) lower-embodied-carbon building materials like timber [1], reducing the embodied carbon of buildings; 2) heat pumps making heating and cooling more energy-efficient and potentially entirely powered by renewable clean energy; 3) insulation reducing the energy needs of buildings for heating and cooling, making them fundamentally more energy-efficient.

Figure 2: Drivers of the climate case for timber construction, insulation and heat pumps. Source: Timber Finance.

In order to decarbonise the building sector, the world needs both 1) low-embodied-carbon construction for newbuild and 2) energy renovations, aimed at improving the energy efficiency of existing buildings – these are two related but separate avenues for growth. While the current macroeconomic environment has been challenging for the construction sector, due to the rapid and strong rise in interest rates that we have experienced starting in 2022, the secular trend of building decarbonisation remains intact and continues to offer medium- and long-term investment opportunities.

2. The Solutions

In this section, let us get deeper into the three solutions in focus, starting with low-embodied-carbon solutions like timber construction, and then looking more in detail at insulation and heat pumps.

Timber Construction and other low-embodied-carbon solutions

In order to reduce embodied carbon – the emissions produced by manufacturing building materials – the industry has to rely on either:

Existing lower-carbon solutions like, like timber structures
new processes to be developed in order to reduce the carbon content of steel and concrete

Several studies have been published, highlighting the embodied carbon advantage of timber buildings compared to traditional reinforced concrete structures. While there is no universal agreement on how to calculate lifecycle (LCA) emissions of timber buildings, due to the different ways (in some cases debatable) in which biogenic carbon is treated, research and policy point in the same direction. Among the many studies, one of the most accurate ones is the one by Skullestad et al. (2016), which compares different methodologies and estimates LCA emissions including, in one case, both biogenic emissions (from the biomass that is burned during industrial processes) and biogenic storage effects (giving trees time to regrow). One of the methodologies applied in the study can be considered fair as it does not omit the biogenic carbon emissions from the manufacturing of timber elements – which many others instead do – and at the same time includes but also discounts the effect of biogenic carbon storage. The study estimates carbon savings of at least 34% for a multi-storey building.

As net-zero pathways and embodied carbon become increasingly important and the sustainability of building materials becomes an important criterion for real estate owners and investors, the steelmaking and cement industries are investing to reduce the carbon content of their products.

With regards to steel, there are two main ways in which steel components can be decarbonised:

by increasing the recycled content – i.e. using more steel scrap – which reduces the energy required to manufacture the product [2]
by using low-carbon energy in the manufacturing process – including bio-energy [3] , as customary for the timber industry, or using green hydrogen (H2)

Kingspan, the Irish building materials group that has been recently expanding into biogenic building materials through the acquisition of a 51% stake in Steico, the wood fibre insulation specialist, invested in and partnered with Nordic low-carbon steel pioneer H2 Green Steel in order to reduce the embodied carbon content if its products. A great example of the integration of multiple decarbonisation solutions within a single company.

The cement and concrete industry has also been innovating, addressing the decarbonisation challenge from multiple angles. Major cement manufacturers like Heidelberg Materials and Holcim have started investing in carbon capture and storage (CCS): as an example, Holcim’s Kujawy project in Poland aims to capture 100% of CO2 emissions from clinker production (the most polluting part of the process) and store the CO2 underground [4]. Other approaches, like CO2-mineralisation, let the CO2 react with residues, bind permanently with those mineral residues, which will be then used as inputs to produce new building materials. Other, smaller and disruptive, players like Hoffmann Green Cement promise a reduction of carbon intensity by a factor of 1:6 by radically changing the manufacturing process into a cold and clinker-free process [5]. Biochar-concrete is another innovation gaining commercial traction [6]: by substituting part of the CO2-intensive clinker with carbon-storing biochar obtained from biomass residues, it can become a circular solution that integrates the carbon-sequestering and carbon-storing properties of plants and trees into concrete production.

Currently, the premium for green steel remains significant on a per ton basis [7] and long-term estimates – to be taken with due care – for carbon-captured cement are nearly double the current cost levels [8]. A study by Driver et al. (2024) estimates the cost and decarbonisation potential of several concrete mineralisation technologies (Figure 3): those with the largest decarbonisation potential also tend to be the most expensive ones (with the exception of cement from carbonated end-of-life cement paste).

Figure 3: price premium (x-axis) vs. carbon reduction (y-axis) for selected concrete mineralisation approaches. Source: Driver et al. (2024), CC BY. Adaptation by Timber Finance.

So, while the path towards decarbonisation has started for the steel and cement industries, too, the cost-competitiveness of such decarbonised solutions remains a challenge in the short- and medium-term vs. timber, assuming relatively stable wood raw material prices.

Insulation Materials

Insulation materials are essential to reduce the energy consumption of buildings, which as of today remains the largest driver of carbon emissions for the building sector. There are several types of insulation materials and technologies, in particular:

biogenic insulation materials, such as cellulose, wood fiber and hemp (see Steico)
fossil-based insulation materials, such as expanded or extruded polystyrene (EPS or XPS), or polyurethane (PUR) foam, in the form of either boards or spray
mineral wool, which can be made from rock or glass

Other technologies such as vacuum insulated panels and aerogels have very strong thermal performance, offset by higher costs. A more in-depth analysis on insulation, with particular attention to wood-based insulation, can be found here.

Heat Pumps

Heat pumps were invented in the 1850s, almost two centuries ago, and have become today a key component to reduce operational emissions of buildings. Heat pumps have two advantages:

they are efficient – heat pump efficiency (defined as the ratio between the heat produced and the power input used) can reach 300-400%, compared with around 100% for electric space heaters (efficient gas furnaces also approach 100%).
they can run with electricity, and if (or once) the power grid will become entirely renewable, they will enable zero-emission heating and cooling.

The physical principle on which heat pumps operate – and what makes them particularly efficient – is that they transfer (rather than produce) heat from outdoor to indoor (or viceversa) with the help of a fluid called refrigerant. Heat pumps have been very explicitly highlighted as a key solution for the decarbonisation of the building sector in both European and American regulatory frameworks (more below).

3. The Investment Case

To summarise, the investment case for companies that offer the solutions, described above, to decarbonise the building sector, relies on the following theses:

The decarbonisation of the building sector is a global necessity, to be achieved with urgency.
Existing decarbonisation solutions are economically viable and readily available.
Regulations incentivise the use of low-carbon resp. decarbonisation solutions in the building sector.
Rising demand for building decarbonisation solutions creates a tailwind for the companies offering such solutions.
The investable universe comprises companies with solid competitive positions.

On the regulatory front, there are several supportive frameworks designed to stimulate investment in building decarbonisation solutions. The European Energy Performance of Buildings Directive (EPBD) estimates that 75% of European buildings are energy-inefficient and aims to double the energy renovation rate to achieve the goal of all new buildings being zero-emission from 2030 and the entire building stock being zero-emission by 2050.

Figure 4: selected key points of the EPBD. Source: European Union. Selection by Timber Finance.

The U.S. Inflation Reduction Act (IRA) provides tax credits and rebates to install insulation, heat pumps, as well as renewable energy systems. In 2023 alone, 3.4 million American families claimed over $8bn worth of clean energy and home energy efficiency credits, with the latter worth over $2bn and used by 2.3m families [9].

Several countries in Europe (the Netherlands, France and Denmark, with more to come) have introduced LCA emissions regulations for buildings that strongly benefit timber construction by taking into consideration negative biogenic emissions. This is the case for example with the French RE2020 regulation, which grants biogenic materials like cross-laminated-timber a clear advantage: the carbon stored in the product counts as a negative emission which is offset at the end of life with a discount factor. Whether this approach is the most accurate one is open to discussion, but the point is that it creates a strong incentive to build with timber compared to steel or concrete [10].

Regulatory frameworks apart, if our societies want to address the climate risks connected with carbon emissions, it simply makes sense to deploy solutions that are readily available and effective, as per studies on payback times for heat pumps [11] or ROI for renewable electricity installations in the residential sector [12].

Cyclical factors such as interest rates (impacting cost of capital and discount rates for renovation projects), volatile energy prices, and changes in incentives such as subsidies and tax benefits can have an impact in the short- and medium-term and lead to volatility.

Indirectly linked to the decarbonisation of the building sector, as it relates to forest owners that provide an essential raw material – timber –, is another component of the investment case in this universe: the potential for natural climate solutions. There is a significant monetisation potential, partially already being exploited and partially still in the concept and permitting phase, from carbon credits for improved forest management, long-term leases for solar and wind power assets, as well as long-term leases for underground storage of CO2 (see more comments here).

4. Performance

In order to profit from the investment case and secular decarbonization trend detailed above, a strategy built around the core timber construction sector, with additional exposure to insulation materials and heat pumps has been developed. It delivered a robust total return since launch in November 2023 (Figure 5). The sharp rise in interest rates at the end of 2024, which affected the entire homebuilding sector (commented more in detail here), led to a correction in December, driven in particular by insulation manufacturers and homebuilders, which have nevertheless been among the best performers since launch and recovered again in January. Insulation manufacturers have been the leading sub-sector, followed by American Engineered Wood Products manufacturers.

Figure 5: Decarbonisation strategy model portfolio performance. Sources: Bloomberg, Timber Finance.

While several cyclical and political factors have recently led to concerns and some headwinds, such as:

The concerns with regards to Trump’s policies in the U.S., which may de-prioritise the clean energy transition, a core component of the Biden’s administration agenda.
The rise in long-term yields, especially in the U.S., also in connection with worries about Trump’s policies.
The slowdown in construction activity, extremely strong in Europe while still moderate in the U.S.
The uncertainty with regards to subsidies and incentives, both in Europe and (already mentioned above) the U.S.

The need for decarbonising solutions remains intact. With a 5-year average Return on Invested Capital (ROIC) of 19.4% and expected normalised Return on Capital Employed (ROCE) of 14.0% [13], the strategy offers a diversified portfolio of companies offering decarbonising solutions with attractive competitive positions.

Footnotes:

[1] Sustainable forest management and the minimisation of biomass burning along the value chain are essential conditions
[2] https://blog.swegon.com/uk/recycled-steel-lowers-the-carbon-footprint
[3] https://corporate.arcelormittal.com/climate-action/technology-pathways-to-net-zero-steel
[4] https://www.holcim.com/who-we-are/our-stories/ccus-decarbonizing-building
[5] https://www.ciments-hoffmann.com/industrial-process/manufacturing-process/
[6] https://www.klark.swiss/
[7] https://transitionasia.org/greensteeleconomics_es/
[8] https://www.bcg.com/publications/2024/cement-industry-carbon-footprint
[9] https://home.treasury.gov/news/featured-stories/the-inflation-reduction-act-saving-american-households-money-while-reducing-climate-change-and-air-pollution
[10] https://www.cerema.fr/system/files/documents/2022/02/acv_dynamique_re2020.pdf; https://www.construction21.org/france/articles/h/14-les-materiaux-biosources-une-realite-de-terrain-et-une-offre-qui-se-renforce-pour-repondre-a-la-re2020.html
[11] https://www.mckinsey.com/industries/electric-power-and-natural-gas/our-insights/refurbishing-europe-igniting-opportunities-in-the-built-environment
[12] https://mcsfoundation.org.uk/wp-content/uploads/2024/09/MCSF-Future-Homes-Savings-Report-FINAL.pdf
[13] Portoflio weighted-average in January 2025. ROIC based on Bloomberg, normalised ROCE based on own estimates.

5. Disclosures and Conflicts of Interest

Some or all the companies mentioned in this report may be included in the Timber Finance Forest-Based Construction Basket tracker and are part of the Timber Finance Carbon Capture & Storage Index. Timber Finance Management and/or the Timber Finance Initiative may have commercial relationships or be in discussions with some of the companies mentioned in this report. Specifically, Stora Enso is a member of the Timber Finance Initiative association.

Please note that this research is prepared for information purposes and targeted to institutional investors in Switzerland. It does not represent investment advice and does not take into consideration the individual requirements, risk tolerance and goals of an investor. Recipients who are not Swiss institutional investors should seek the advice of their independent financial advisor prior to taking any investment decision based on this report or for any necessary explanation of its contents.

The information presented in this report is obtained from several different public sources that we consider to be reliable. Nevertheless, we cannot guarantee the accuracy of the presented information. The information used may change quickly and we are not committed or obliged to modify the reports base on new information. The opinions and views expressed in this report reflect those of the author at the point in time of its compilation and may vary at any time. Valuation methods like DCF and any other analysis or expert judgement do not provide any guarantee that the target price or fair value will be reached, for example because of unforeseen changes in financial or economic conditions.

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