As discussions in the real estate industry around improving sustainability and increasing ESG scores have shifted to bigger ambitions, namely achieving net zero carbon, REITs are feeling a growing sense of urgency to put commitments in place to achieve this goal.
With pressure on the rise from stakeholders, including policymakers, investors, tenants, employees, and communities to reduce greenhouse gas emissions, the task at hand now is how to map out effective net zero strategies and realistic timelines.
A recent report from Green Street states that for investors, “the movement towards net zero is akin to an approaching hurricane. Its complexity and force are staggering. And progress must be closely monitored as massive uncertainty surrounds exactly where it will have an impact and how costly that will be.”
Green Street adds that the movement towards net zero appears likely to result in a drag on property prices. “As the impact will be unevenly distributed, property investors are advised to consider which sectors are best and worst-positioned.”
Meanwhile, the most recent report published by the Intergovernmental Panel on Climate Change (IPCC) in August gives REITs a strong impetus to embrace net zero. Without drastic change to reduce emissions, the report holds a dire assessment of looming climate change risk and more extreme weather events.
REITs also recognize the business case for net zero and the need to mitigate transition risk related to climate policy and regulations. Properties that are not “green enough” face the potential risk of steep fines and longer term value erosion.
For example, the first tranche of fines for New York City Local Law 97, which sets new energy efficiency and greenhouse gas emissions limits, goes into effect in 2024. “If you have a building that becomes financially obsolete because of climate reasons, there is a huge incentive to act on that and change course,” says Marta Schantz, senior vice president, ULI Greenprint Center for Building Performance. So, there is pressure from investors asking for more ESG and sustainable commitments across portfolios, and that includes net zero commitments and carbon neutral goals as a sign of that progress, she says.
For their part, REITs are striving to lower energy consumption at properties, while also reducing their use of “brown power” and instead focusing on procuring “green power” from on-site or off-site renewables.
“It’s no longer this high level ‘green is good’ type of effort, it is data driven and it requires transparency,” Schantz says. And those REITs that are taking the lead in working towards those net zero goals are pulling others forward along with them. “For those who want to remain a top tier owner and developer, they do need to have that ESG leadership in line with their peer groups,” she says.
Charting a Path
The initial and most critical steps on the path to carbon neutrality include implementing energy efficiency measures and sourcing clean energy to reduce the emissions from a building portfolio’s operations. This step may pose varying levels of challenges to real estate sectors based on building type, function, and location, according to Fulya Kocak, Nareit senior vice president for ESG issues.
For example, an office REIT may be able to leverage energy efficiency strategies more effectively with higher returns on investment while a residential REIT or a REIT with a triple net lease structure may have additional challenges to overcome to achieve similar efficiencies before reaching the next step of carbon offsetting, Kocak says. Understanding these sector specific and operational challenges assists in producing solutions that help move the real estate industry to the finish line of net zero faster, she adds.
Those solutions can involve a combination of efforts that include increasing energy efficiency, adding on-site and off-site renewable power sources, as well as procuring green power and purchasing offsets and renewable energy credits (RECs). In short, achieving net zero is a multi-faceted challenge that requires a myriad of solutions, including changes to building design, operations, and execution.
Anthony Malkin, Empire State Realty Trust, Inc. (NYSE: ESRT) chairman, president, and CEO, says that truly understanding the drive for net zero requires understanding the bigger picture, including issues surrounding electrification, life cycle analysis related to the replacement of equipment, challenges associated with the brown power supplied by local power grids, and the impacts from embodied carbon.
First and foremost, companies want to reduce energy usage and emissions at properties because that is the best business case and best course for the planet. “REITs can easily achieve net zero today just by planting a gazillion trees. The challenge is to not just get to net zero through offsets, but to get to net zero through as many steps as you can take internally on your own properties,” Malkin says.
In April, Empire State Realty Trust joined other New York State real estate leaders to kick off The Empire Building Challenge, a $50 million state initiative to accelerate progress towards the reduction of 85% of greenhouse gas emissions by 2050. The REIT also has announced a goal to achieve net zero carbon emissions across its own 10.1 million square foot portfolio by 2035. In addition, the REIT plans to target a 20% reduction of energy use intensity across its portfolio by 2024, and net zero carbon emissions for the Empire State Building by 2030.
“At its core, the principal is simple—to use less, although the work is quite complicated and intensive and technical,” says Dana Robbins Schneider, ESRT senior vice president, director of energy, sustainability & ESG. ESRT has begun to develop and execute dozens of sustainability strategies to reach those goals, including holistic decarbonization measures which include the building envelope, HVAC systems, controls, and advanced technology overlays for performance optimization.
Another important step ESRT has taken is to introduce green leases that include high performance sustainable building guidelines around energy efficiency, water efficiency, and indoor air quality.
ESRT works closely with its tenants during the design and build out of spaces to review plans and provide recommendations to make sure they are designing to those standards. They also educate tenants on the business case for investing in efficiency and assist with energy audits on operations. Generally, the payback for tenants that make sustainable investments is five years in what are typically 10 year leases. “The icing on the cake is that you also will have a more environmentally responsible, healthier, more productive space for your employees,” Schneider says.