Our industry is engaged in an important dialogue to improve sustainability through ESG transparency and industry collaboration. This article is a contribution to this larger conversation and does not necessarily reflect GRESB’s position.
The global imperative to combat climate change has propelled nations across continents to reevaluate and strengthen their regulations in their drive towards net zero, particularly in the built environment. Within the built environment, building operations account for over 27% of global emissions, representing a significant portion of the worldwide share of carbon generation, underlying the importance of these regulations.
Achieving net zero in a building means that its energy consumption is equivalent to its renewable generation. At a high level, the pathway to achieving net zero at scale is primarily to increase energy efficiency; secondly, electrify, or remove any on-site fossil fuel usage; and lastly, decarbonize the grid (i.e., power the grid with renewable energy sources, using renewable energy credits and carbon offsets in the short term). The recent adoption of the revised EU Energy Performance of Buildings Directive (EPBD) targets the first two steps, signifying a significant move forward in Europe’s net-zero commitment to the built environment. This regulation joins the growing number of related policies across the globe, echoing institutional investor preferences and presenting the real estate industry with the opportunity to be part of the net-zero economy.
Globally, building regulations focused on net zero are growing, with varying approaches
- Emissions-focused enforcement: The EU’s revised EPBD rules include targets for all new buildings to have zero on-site fossil fuel emissions by 2030, and to phase out fossil fuel usage for building heating and cooling in existing buildings by 2040. This represents one of the most ambitious building-related regulations in the world to date. Other emissions-focused regulations include New York City’s Local Law 97, which sets emissions limits for buildings starting this year, with stricter limits coming in to effect in 2030 and, by 2050, requires net-zero-aligned emissions. With hefty fines for non-compliance, Local Law 97 is a large piece of the city’s plan to be carbon neutral by 2050.
- Energy-efficiency and solar mandates: Other regulations focus strictly on energy usage and may require on-site renewables. For example, California’s Building Energy Efficiency Standards include energy efficiency requirements and, for certain building types, on-site solar generation and battery storage. The state of Victoria in Australia passed a similar set of standards for energy efficiency and renewables, focused solely on new homes.
- Optional and incentive-based programs: While most headline-making laws are about requirements for energy efficiency or zero on-site emissions, some jurisdictions have used optional and incentive-based methods to reduce energy and emissions. For instance, along with its standard energy step code, British Columbia has an optional Zero Carbon Step Code that its local governments can choose to incentivize or require. In Brazil, there are energy efficiency labeling requirements for buildings that provide government financial incentives and drive the market demand for higher-performing buildings. Mexico has also rolled out a program to provide financial incentives for residential energy efficiency.
Beyond regulations, investor expectations align with the net-zero economy
In addition to regulatory compliance concerns, investors have become increasingly aware of the material risks posed by climate change and how they impact their investment decisions. In other words, climate risks are identified as financially material to investors’ decision-making. Investors have requested that real estate companies disclose environmental data, set targets, and improve performance over time to mitigate risk. For instance, some investors have made commitments to transition their investment portfolios to net zero through the Net-Zero Asset Owner Alliance and, in turn, influenced asset managers to set their own net zero targets through the Net-Zero Asset Managers Initiative.
From an investment perspective, net-zero real estate portfolios are more likely to comply with current and future climate regulations, mitigate climate-related transition risks, create long-term value, and present competitive advantages against more carbon-intensive portfolios.
High-performance buildings can reduce costs and risks while attracting ideal tenants and sources of capital
Even without regulatory fines related to environmental performance, we know that when assets optimize energy usage, their operational utility costs go down. Efficient buildings typically require less maintenance and repair, further reducing operational costs and enhancing cash flow. Electrification solutions like heat pumps are often more efficient and cost-effective than fossil fuel-based alternatives. Moreover, electrification can protect against volatile energy prices, such as those seen in 2022 following the Russian invasion of Ukraine.
Reducing a building’s energy use and emissions can translate to higher net operating incomes, enhancing a property’s profitability and long-term value.
There is a growing number of billion-dollar price-tag climate disasters occurring annually. Operationally efficient, net zero buildings can be more resilient to climate disasters, as they are better equipped to withstand extreme weather events and disruptions in energy supply. This resilience minimizes the risk of costly damage and downtime, ensuring uninterrupted operations and protecting the asset’s value.
For these reasons and more, these high-performance buildings often attract high-value tenants who may also have net zero-related targets, leading to higher occupancies and lower vacancy risks. The competitive advantages and reduced risks of these assets can also increase real estate companies’ access to capital. Institutional investors – such as pension funds, sovereign wealth funds, and asset managers – increasingly favor investments in environmentally sustainable assets. By meeting these investor expectations for enhanced environmental performance, real estate companies can tap into a broader pool of capital.
How real estate companies can prepare to comply with regulatory and investor expectations
Real estate companies must prepare to comply with evolving climate-related regulations and investor expectations. The following represent critical actions for working towards a net zero future:
- Monitor and research: Stay informed about new green building and climate-related regulations in your portfolio’s jurisdictions. While some regulations come into effect years later, some companies may require early planning and preparation to ensure they are prepared.
- Measure and assess: Assess your portfolio’s carbon footprint in alignment with recent regulatory requirements (for example, companies doing business in the U.S. and California should prepare to align with the recently passed SEC climate-disclosure rule and California’s SB253, both of which require greenhouse gas inventory reporting). Leverage data software tools like ENERGY STAR Portfolio Manager to track environmental data.
- Identify and implement: Conduct energy audits and review capital expenditure plans to determine asset-level emissions reduction. Use carbon pricing tools that consider potential regulatory fines to assess paybacks more accurately for projects like heat pump installation or rooftop solar. Explore available state and federal incentives, as well as financing options, such as those available through the U.S. Inflation Reduction Act and commercial PACE financing.
- Engage tenants: Work with your tenants to execute green leases that include data sharing and cost recovery clauses for energy-efficient improvements that benefit the tenant. In lease agreements that limit involvement in tenant spaces, develop robust tenant engagement programming that aligns on shared net zero and sustainability goals and initiatives, and provides education and materials to support the tenant’s transition to net zero.
- Report: In addition to what is typically included in an annual report through IFRS Sustainability Disclosure Standards, determine your company’s readiness to report in alignment with any regulatory requirements. Investor-favored assessments like GRESB and CDP include scoring for climate-related topics and can be an effective way to demonstrate progress to investors. Use insights gained in the reporting process to inform improvement actions for your ESG program.
As the world shifts towards a net zero economy, real estate companies must adapt to increasingly stringent climate-related regulations and investor expectations for sustainability. By taking informed action, real estate companies can reduce regulatory risks, increase portfolio value and resilience, and enhance access to capital and competitiveness.
This article was written by Nicole Nishizawa, Senior Associate, Sustainability & ESG at HXE Partners (a Morrow Sodali company).