The Circular Economy Transition: Financial futures For Construction and Real Estate

An accelerated transition from a linear to a circular economy requires financial innovation including the creation of a futures exchange for circular assets in particular for secondary construction materials, writes Jan Raes.

Jan Raes, 3 November 2020

Bricks made from glass are seen at Laputa glass recycling plant in Tuen Mun on January 14, 2013. (Photo by Felix Wong/South China Morning Post via Getty Images)

The futures contract, as referred to in this article, is a financial product. In a financial future, the counter-parties agree to trade the underlying asset (e.g. reused construction materials) at a certain time for a certain price. This exchange traded futures contract could ensure the supply of secondary construction materials while reducing the ever-growing pace of virgin material extraction for the benefit of global construction activity.

The importance of construction and real estate

The construction sector tops the material-intensity charts compared to other sectors. According to a report by Circle Economy, the construction and housing sector’s annual consumption of resources is almost over 40 billion tonnes of material while construction waste amounts to more than 30 per cent of all global waste.

Yet, most construction waste is not recycled nor reused, instead ending up in landfills or incinerated. But, despite the efforts of many companies in the construction sector, re-inventing the world’s largest sector to operate in a circular way, is not a quick fix.

The large amounts of virgin materials and waste are linked to astronomical wealth. At the end of 2017, the value of the world’s real estate reached US$ 280.6 trillion – the highest figure that has ever been recorded and an annual increase of 6.2 per cent.

Residential real estate accounted for the largest share (US$ 220.6 trillion) with commercial real estate (US$ 33.3 trillion) and agricultural and forestry real estate (US$ 27.1 trillion) making up the rest.

Furthermore, the materials and consumed resources themselves account for a large part of the ecological footprint of real estate but only for a tiny fraction of the financial picture. If only 3 per cent of the global real estate value could be profitably recuperated from building materials, the total contribution to the economy of such a secondary building material market would equal, or even exceed, the total value of the gold market worldwide – which is currently estimated at around US$ 7 trillion by the World Gold Council.

A number of conditions are not in place for such a traded financial futures market for building materials but there are gaps that could potentially be filled by appropriate market infrastructure and the financial industry.

Circular valuation techniques for buildings

The only way to start solving the major misalignment between the cost of virgin material usage and the value of secondary materials is the change of real estate valuation methods. At the moment, mainstream building valuations do not include the second-hand value of materials and building components as a financial criterium in valuation. Indeed, these values are considered to be zero or negative.

As described by a report from Arup, the circular valuation of buildings needs to take into account the different life spans and conditions of the materials used in construction. This means that the façade, roof, interior elements, constructive concrete slabs or wooden beams, window frames, and any other buildings materials, will need to be rated and valued by a circular valuation expert at any point during the lifetime of the building.

For circular economy financing, this circular valuation should happen when the building is still on the drawing table or in the Building Information Model (BIM) phase. Building information models (BIMs) are digital files that contain detailed layers of information on a construction plan. These days, BIMs are increasingly used to exchange information digitally between all parties involved in a construction project.

BIMs exist for a wide range of built assets such as buildings, ports, roads, bridges or any type of public infrastructure. BIM models have the potential to link the decision-making during the design and the construction, operational and maintenance phases. For a BIM to be aligned with circular design principles, it should be used throughout the whole building life cycle.

Once there is a future value at stake for construction materials, a whole new array of financial services could develop around the value of secondary materials and financial futures contracts.

Types of circular economy futures contracts

There are three types of circular economy futures contracts that should be considered: the energy commodity futures, the agricultural and biotic biomass futures and the secondary materials futures.

Energy (e.g. electricity, hydrogen, syngas) commodity futuresAgricultural and biotic biomass futuresSecondary materials futures
Geographical spreadExists in various parts of the world.Exists in various parts of the world and biomass produce futures are ‘the mother of all futures markets’.Exists in various parts of the world primarily for ferrous metals, non-ferrous metals and precious metals.
Main useBetter price hedging for consumers and suppliers of green energy.Price hedging for consumers and suppliers mostly extends to energy-related biomass produce.These contracts do not get directly connected to consumption (e.g. a future on the gold in 2000 sets of mobile phones or the lithium from a battery storage or the platinum from a wind turbine).
Benefit for the producerAdditional channel to sell green electricity to the market instead of traditional one-to-one contracts towards buyers.

A mechanism to cover for shortages in supplies due to outages.

Additional channel to sell biomass to the market instead of traditional one-to-one contracts towards off takers.Demolition and/or recycling companies can change their business model towards harvesting secondary materials and developing a secondary income stream.
Benefit for the consumerA price hedging mechanism to time the buying of electricity.

Better bargaining power for consumers due to a higher transparency in the pricing mechanism of renewable power.

A price hedging mechanism to time the buying of biomass.

A mechanism to cover for shortages in biomass when material flows change due to waste volume changes.

A price hedging mechanism to time the buying of secondary materials.

A mechanism to cover for shortages in secondary materials.

Potential for construction and real estate buildingsFor the greening of the in-use phase of buildings this is a great financial instrument for intra-day trading and for reducing energy costs.If buildings operate with biomass as a heating source at a large enough scale then these types of futures might become interesting to construction and real estate buildings. The footprint of biomass however remains controversial.For building materials these future contracts have been around as a theoretical concept for a while but have never materialized in formal futures exchanges. No experiments to scale metals are known to this date

There is much that needs to be ironed out for financial futures on secondary building materials to take off and support the circular economy transition.

Future research should involve how to increase the predictability of the availability and quality of secondary materials. Indeed, this is the most critical question for the construction, real estate and financial sectors.

But one more key question remains: when do builders know that the building will be deconstructed? A signalling function on future demolition is needed to be able to time the financial futures contract. Furthermore, builders need to know what quality they can expect.

It looks as if the financial futures on secondary building materials can only work when the planned deconstruction date and the expected quality of materials are known to the market. This also raises an additional dilemma that buildings will be built with different time horizons: there will be those that are built for planned deconstruction and those that are built for ‘eternity’.

The accelerated transition from a linear to a circular economy needs financial futures contracts. These futures contracts can be traded on an official futures exchange for secondary building materials. When done well, these futures contracts could guarantee a steady flow of secondary construction materials to the construction industry. Given that the goal of the circular economy transition is to slow down the ever-growing pace of virgin material extraction, to accelerate this, a key societal transition towards the circular use of resources is needed yet a key part of the financial infrastructure is still missing for the global construction industry. While further research is needed, futures contracts constitute an important piece of the circular economy transition puzzle.