Decarbonization

More governments start to regulate commercial building carbon emissions

The United Nations warns that world temperatures will rise above the critical 1.5-degree Celsius threshold much faster than expected within the next two decades unless significant decarbonization efforts are made. As a result, many governments are including commercial real estate among the major industry sectors requiring regulation of carbon emissions.

Building performance standards proliferate

ESG policies are an important mechanism to address climate change and will continue to gain traction in 2023. Building Performance Standards (BPS), the most widely used tools by state and local government to reduce energy consumption in existing buildings, are the primary example of ESG policies.

As of late 2022, two state and 32 local governments have established BPS to meet carbon reduction goals by 2050, with interim targets in 2030 and 2040. For example, Washington, D.C. requires owners of commercial buildings larger than 25,000 sq. ft. to benchmark their annual energy and water usage. Failure to comply results in a $100-per-day fine. Two more state and nine local governments plan to do the same by 2024.

To further strengthen BPS, the federal government launched the National Building Performance Standards Coalition, a partnership among local governments to scale programs and policies that reduce emissions in buildings. The coalition aims to achieve BPS legislation adoption by Earth Day 2024.

Figure 30: U.S. Building Performance Standards

Source: CBRE Econometric Advisors, Q4 2022.

Proposed ESG rules for U.S. investors

The Securities and Exchange Commission (SEC) recently proposed a rule regarding decarbonization and climate resilience that would require climate disclosures from SEC-registered entities. This rule provides direction, standardization and enhancements to climate-related disclosures that tie a company’s climate risk to its financial risk. In essence, the proposal shifts climate strategy to the boardroom and the C-suite, treating climate risk as a business issue.

The Carbon Risk Real Estate Monitor (CRREM) further scrutinizes carbon emissions on a geographical and sector-specific basis. Energy-intensive real estate sectors (e.g., leisure, lodging and shopping centers) have higher carbon reduction requirements than warehouses or multifamily. By geography, cities with more modern buildings like San Diego and San Francisco have lower carbon reduction requirements than those with older inventory like Boston, Chicago and Philadelphia.

For the best outcomes, companies should take a portfolio-wide approach to decarbonization, considering every building and its alignment with client environmental responsibility goals.

Figure 31: Carbon Reduction Requirements by Sector & City

Sources: CRREM, CBRE Econometric Advisors, Q4 2022.
* Calculated using unweighted average of sectors & cities.

Non-compliance will be costly

Failure to act will have two negative consequences. First, the liquidity of non-compliant buildings will dry up as investors' interest shifts to compliant buildings, resulting in price discounts. Second, tenants with environmental responsibility targets will reconsider their leases at renewal, leading to an increase in vacancies. Both will negatively impact asset value, so owners will need to proactively plan and invest in retrofits to meet regulations.