What COP26 Means for Commercial Real Estate

Written by Carli Schoenleber, edited by Julie Jacobson

12/17/2021


Introduction


On November 12, 2021, climate scientists, activists and political and business leaders finished the 26th UNFCC Conference of the Parties (COP) in Glasgow, Scotland. As the first major climate change conference since the 2015 COP21 in Paris, COP26 was an urgent call to action for countries to ramp up their emission reduction targets in service of the Paris Agreement’s goal of limiting warming to only 1.5 degrees Celsius. While many countries did improve upon their original emission targets, otherwise known as “Nationally Determined Contributions,” and consensus was reached on curbing coal- and methane-related emissions (source), 2021 targets have been deemed inadequate and currently put the world on a higher than 2.4 degrees Celsius global warming trajectory (source). Given climate change is already negatively impacting every region on Earth, there has never been more pressure on leaders to identify rapid, scalable and innovative solutions to climate change.


When it comes to solutions that meet these criteria, sustainable real estate is an obvious solution. With the buildings sector responsible for nearly 40% of global emissions (and projected to hit 50% by 2050 (source), it’s no surprise that Roland Hunziker, the director of sustainable buildings and cities at the World Business Council for Sustainable Development (WBCSD), deemed built environment emissions as the “sleeping giant” in the battle against climate change. WBCSD was one of several organizers of the Cities, Regions, & Built Environment Day at COP26 on November 11th, the first COP day focused on commercial real estate (CRE) in UNFCC history (source). Yet, while CRE is only just emerging as a climate change priority on the international stage, in the past several years, there has been rising tide of interest and investment from the private sector to make CRE more sustainable, and not only for its emission reduction benefits.


In light of the COP26 emphasis on the built environment and private sector mobilization around sustainable real estate in recent years, this article will discuss five of the key emerging paths forward in bringing sustainable real estate to the rightful forefront of the world’s climate change strategy.


 

1) Retrofitting buildings will be key


With building-related emissions already on the rise and global building floor space expected to double by 2050 (source), decarbonizing the built environment hinges on preserving and retrofitting the world’s existing building stock. Even the greenest new buildings require carbon-intensive buildings materials (e.g., concrete, steel) and lengthy, fossil-fuel powered construction processes. Beyond mitigating emissions from new construction, retrofitting also helps reduce operational emissions by bringing old buildings up to current energy codes; tactics include tighter sealing of the building envelope, adding/replacing energy efficient lighting, electrifying heating and cooling systems, cool or green roofs, fixing gas leaks, and expanding on-site renewable energy generation. According to a 2020 report from the American Council for an Energy-Efficient Economy, the U.S. could mitigate 30% of building-related emissions by retrofitting two thirds of the country’s existing building stock (source). Through strategies like strengthening the building’s façade and increasing the capacity of stormwater management systems, retrofits also make buildings more resilient to climate change impacts that are all but guaranteed to become more frequent and intense, further extending the building’s life span.


Along with environmental benefits, retrofitting often comes with an array of financial advantages such as increased value retention and reduced operating and maintenance expenses, long-term risks and insurance premiums. An analysis from the Rocky Mountain Institute revealed the cost-saving potential of retrofitting is mostly realized through improved energy efficiency; a deep energy retrofit can reduce commercial building energy costs between 25-50% (source). Despite the long-term financial benefits, the short-term costs can make owners hesitant to invest in retrofits. To mitigate these costs, the U.S. offers several tax incentives (source) as well as Energy Saving Performance Contracts (source); discussed in the fourth point of this article, innovative private financing options have also expanded in recent years to meet the growing demand for affordable capital. Yet, in order to meet emission reduction targets, both financing options and mandatory building performance standards must expand and align, particularly for CRE (source).


 

2) Green buildings should become the new construction standard


Even assuming a retrofit of each of the world’s existing buildings, new construction will still be necessary to accommodate population and development shifts predicted throughout the next 30 years, particularly in developing markets such as Africa, China and India (source). With so much new construction predicted during a climate crisis, it is imperative that high performance energy practices become standard across the global CRE sector. Throughout the U.S., Europe and China, energy efficiency codes have already decreased the average heating and cooling demand per square meter by 40% since 2000 (source). Particularly in countries where the majority of new construction is expected, it is critical that energy codes align with the most up-to-date standards for energy efficiency; beyond efficiency, emissions from new construction can also be mitigated by recycling and upcycling old building materials, utilizing less carbon-intensive materials (e.g., wood, bamboo, recycled or fly-ash concrete), using local resources, electrifying appliances and installing more on and offsite renewable energy infrastructure.


As efficiency technologies improve, standards are quickly advancing. In 2021, President Biden set a goal for a net zero emission for the Federal building portfolio by 2045 (source). Alongside this goal, the U.S. Department of Energy (DOE) announced new building energy codes this year, predicted to reduce commercial buildings’ energy demands by 5% (source). In 2021, the International Code Council similarly launched their “Code on a Mission” campaign with a 2023 goal of covering a third of the U.S. population under the 2021 energy code update, which, based on improvements since the 2018 standard, would result in an additional 9.4% reduction in energy use and 8.7% reduction in emissions (source). Europe is further ahead, having already required all new constructed buildings to be nearly zero-energy as of 2021 (source). Advancements in material manufacturing are also making way for continued emission reductions; SteelZero and ConcreteZero, two recently launched initiatives that are gaining in popularity, require that members commit to making or producing 100% net zero steel and concrete by 2050 or earlier (source).


 

3) Smart buildings and clean power grids will proliferate


Smart buildings were among the key strategies emphasized at the COP26 Built Environment Day. Applicable to both new and retrofitted construction, smart building technologies interconnect building operational systems, serving to optimize both resource efficiency and occupancy comfort. Internet of Things (IoT) sensors, for example, can sense variables like lighting, temperature and oxygen levels throughout the entire building at once, allowing building operators to view and control all building operations remotely. With artificial intelligence, modern IoT sensors have the ability to automatically regulate lighting, heating and cooling systems based on occupancy to minimize energy consumption and greenhouse gas emissions (source). Open Energi, Measurabl, HqO, Aquicore and BrainBox Ai are examples of startups that are attempting to meet the growing demand for integrating smart building technologies (source).


Working in concert with IoT sensors, demand response/flexibility is a quickly advancing smart building strategy that works to maximize use of clean energy from the electricity grid and minimize energy use during times of high demand or cost. The more clean energy that is flowing through the grid, the more effectively demand response technologies can mitigate greenhouse gas emissions. To serve the goal of achieving a 100% clean power grid by 2035, the Biden Administration announced a plan in 2021 to update the U.S. electricity grid to accommodate the growing influx of clean energy infrastructure. Biden’s plan involves installing long-distance, high-voltage transmission lines that incorporate smart grid technologies and increase transmission capacity, grid connectivity and access to clean energy sources (source). The bipartisan infrastructure deal, passed in November, allocates $65 billion toward these goals (source).


 

4) Green financing will expand


Perhaps the biggest impediment to rapidly decarbonizing the CRE sector is lack of affordable and accessible financing (source), particularly in emerging markets. Indeed, one of the major shortfalls of COP26 was failure to meet 2020 financing goals for developing countries to fight climate change (source). Fortunately, the landscape of green financing is quickly evolving with investors and financial institutions increasingly recognizing the systemic risk climate change presents; likewise, both clean tech mobilization (source) and green financing instruments (source) were discussed by leaders at COP26. Green financing describes a category of financial instruments (e.g., bonds, debt mechanisms, loans, and investments) that aim to benefit the environment (source). Among these instruments, sustainable bonds (includes green, social and sustainability bonds) in particular have risen in popularity as a strategy to finance emission reduction projects, including green buildings. Between 2020 and 2021 alone, the sustainable bond market grew by 32%, reaching $650 billion in 2021 (source). Green bonds in particular are growing so quickly that they are predicted to reach $1 trillion in annual issuance by 2023 (source). Just prior to COP26 in Glassow, the European Union issued the largest green bond deal of all time, topping $14 billion (source).


Though green buildings are generally more valuable and less costly than conventional buildings in the long-term, financing is often required to meet short-term construction or retrofitting costs. As prioritization of climate risk increases across the financial sector, investors’ environmental social governance (ESG) standards for CRE portfolios have increased in tandem. Green financing instruments are often issued with an array of requirements for the borrower that, when achieved, can result in a paying a lower rate back to the bank; for CRE, this can mean requirements around energy efficiency and emission reductions, both of which can also offer additional financial benefits for the owner and/or tenants (source). In addition to ESG generally, the CRE sector should take notice that net zero plans are similarly rising in priority among investors when allocating capital. One initiative that emerged from COP26 was the Glasgow Financial Alliance for Net Zero (GFANZ) representing a commitment from 450 financial organizations to allocate US$130 trillion into investments aligned with net zero emissions by 2050 (source).


 

5) CRE requirements will shift due to increasing ESG disclosure standards


Dovetailing with investors’ accelerating expectations to reduce emissions and improve efficiency in CRE are heightened standards for detailed, accurate and comprehensive ESG disclosures. Much like financial disclosures were regulated in the U.S. following the great financial crash of 1929, investors are realizing climate risk and other material ESG factors demand a similarly rigorous and standardized level of reporting. Motivated by both investors and an Executive Order from President Biden (source), the U.S. Security Exchange Commission (SEC) announced this year they are currently developing climate-related disclosure rules for public U.S. companies (source). As of 2021, the EU already implemented climate-related disclosure rules across Europe via the Sustainable Finance Disclosure Regulation (SFDR), which requires banks, investment firms and insurance companies to disclose sustainability risks, including those from climate change (source). Likewise, the UK announced in 2020 they will require economy-wide climate-risk disclosures by 2025 (source). At the global level, the International Financial Reporting Standards Foundation (IFRS), the central global financial accounting standard setting organization, moved in 2021 to create the International Sustainability Standards Board (ISSB), an organization that will establish a global sustainability accounting standard (source).


For the CRE sector, improved ESG accounting standards will provide increased transparency to investors on how companies plan to decarbonize their portfolios and minimize climate change risks, thereby leading to more informed investment decisions and strategic capital allocation across the CRE marketplace. To hedge against legal, competitive and market valuation risks, CRE companies would be prudent to get ahead of the regulatory curve and implement more sophisticated ESG data tracking and disclosure protocols today. This means ensuring reporting encompasses Scope 1, 2 and 3 emissions across a building’s entire lifespan, aligning with credible and widely-used ESG reporting frameworks (e.g., GRI, SASB, GRESB), and remaining adaptable to improved industry standards around Science-Based targets, net zero goals and expanded social and biodiversity metrics (source).

 

Conclusion


Hypothetically setting aside the urgent imperative to decarbonize the built environment to help mitigate climate change, building green is still a smart investment. Sustainable buildings use fewer natural resources, help improve occupants’ health and wellbeing, and have financial advantages including reduced operational expenses, strengthened NOI, decreased risk, improved value retention, enhanced occupant productivity and a measured resilience strategy. Given the direct relationship between sustainability and performance, it's no wonder the world is finally witnessing the alignment between COP initiatives, the growing importance of ESG and expanding green innovation and financing. The broader implication of this alignment is that change is coming fast; the more CRE companies can self-regulate and innovate today, the better positioned the sector will be to maximize both emission reductions and value creation into the future.

 

About The Authors

Carli Schoenleber

Carli currently serves as a writer for Verdani Partners and the Verdani Institute for the Built Environment, where she is leading efforts on VIBE’s sustainable real estate textbook series. Carli has a decade of experience in the sustainability field, working across diverse roles in wetland science, environmental education, land use planning and conservation psychology research. She holds a B.S. degree in Environmental Science, Policy, and Management and a M.S. degree in Forest Ecosystems and Society.


Julie Jacobson

Julie currently serves as an ESG Manager for Verdani Partners and is the Interim Executive Director of VIBE. Julie brings over a decade of experience in commercial real estate (including roles as diverse as leasing, sales and acquisitions), and sustainability including green home advisor for Redfin, commercial solar development, education (including leadership with USGBC-LA) and ESG. She holds B.A. in Sociology with a minor in Urban Studies from UCBerkeley, and an MBA with a concentration in Real Estate Finance from USC.