Commercial Real Estate Climate Strategies: Exploring Opportunities

In many ways, the timing could not be better for North American commercial real estate owners and developers to make climate change strategies a business priority. There is a window of opportunity to take advantage of federal, regional and municipal incentives designed to support energy efficiency and efforts to reduce carbon pollution.

Taking advantage of these incentives could position industry participants to support the net-zero transition while also cutting expenses over time. Indeed, when U.S. and Canadian real estate professionals were asked in a global survey what are the top business benefits of green building activity, the most frequently cited answer was lower operating costs.¹

This two-part series explores the evolving regulatory response to climate change. In this article, we examine the opportunities for the commercial real estate industry, including:

• Taking advantage of a temporary cascade of federal, regional, municipal, and private-sector financing opportunities to accelerate deep energy retrofits.

• Considering the full range of benefits from retrofits with a lifecycle analysis rather than a simple payback analysis.

• Being attuned to investors’ and tenants’ sustainability goals and staying ahead of increasing emissions disclosure rules.

Part two considers the risks the industry will have to manage.

Taking advantage of government financing opportunities

Canada and the U.S. have set ambitious targets to reduce emissions across their economies. Targets specific to the building sector have also emerged at the federal level in Canada and the state level in the U.S., led by California, Massachusetts, New York, and Minnesota.²

Governments in Canada and the U.S. are also looking to building retrofits as a key component of the energy transition. Canada has committed CA$150 million to develop the Canada Green Buildings Strategy to “reduce [greenhouse gas] emissions, create more climate-resilient buildings, increase skilled jobs, and increase investment” in the sector.³

The U.S. federal government has committed funding from the Inflation Reduction Act of 2022 to reduce emissions from the sector, including US$1 billion to adopt zero-energy building codes and a tax credit increase from US$1.80 per square foot to between US$2.50 and US$5 per square foot for energy efficiency improvements.⁴

Business implications:

There are more incentives than ever to support climate-aligned deep retrofits⁵ as federal governments seek to drive private capital toward retrofit markets. For example, the Canada Infrastructure Bank’s CA$2 billion commitment to support large-scale building retrofits provides a foundation to attract private capital.

As lenders are beginning to respond and create new lending products off the back of public-sector funding, building owners, operators and managers can take advantage of this fleeting opportunity to align the cost of capital with their sustainability goals.

The business case for climate action

In 2022, commercial buildings accounted for 9% of emissions annually in Canada⁶, and in the U.S. they accounted for 15% of annual emissions.⁷  While emissions from the building sector have remained relatively stable over the past decade, absolute emissions are not yet declining at the rate required to meet government climate targets. Doing so will require the pace and scale of deep retrofits to accelerate from less than 1% today to about 5% of total commercial building stock per year.⁸

Fortunately, there is a solid business case to be made. A 2021 survey of real estate professionals showed building retrofits to improve energy efficiency in Canada yielded:

• A 10% reduction in operating costs over the 12 months following implementation, and a 15% reduction after five years.⁹

In the U.S., survey respondents cited:

• A 13.5% cost reduction after one year, and nearly 18% after five years. 

Furthermore, in North America, the average rental premium was 7% higher for green-certified office real estate across eight major Canadian and U.S. markets.¹⁰

The example of Avenue Living

Avenue Living Asset Management, a real estate investment trust, recently partnered with BMO to revitalize a mixed-use multi-family residential and commercial building in Edmonton, Alberta. The nearly CA$28 million retrofit project aims to reduce the building’s greenhouse gas emissions by up to 64%.

The project, which includes a vertical solar panel array that doubles as an art installation, leverages BMO’s short-term retrofit financing program, providing Avenue Living with the ability to access impact capital from both BMO and the Canada Infrastructure Bank (CIB).

The retrofits will seek to align with CIB’s Environmental Consumption Measures, potentially enabling Avenue Living to take part in the Canada Mortgage and Housing Corporation’s multi-unit loan insurance project, MLI Select, which offers insurance incentives.

Business implications:

The business case for deep retrofits will be different for every building, and yesterday’s cost-benefit analysis can quickly become outdated against the backdrop of shifting energy prices, evolving government incentives, and private financing products. Property owners can benefit from regularly evaluating the evolving landscape of influencing factors including:

• Building type and age within a portfolio

• Available incentives

• The cost of capital and the ability to align this with the decarbonization goals, energy costs, the carbon intensity of electricity in your jurisdiction

• The price of carbon over the building’s lifetime

• The timeframe for Building Performance Standard implementation, which could render capital equipment functionally obsolete before end of life

• The number of buildings that can be retrofitted simultaneously to achieve economies of scale

The economics of retaining traditional energy systems might look attractive today on a simple payback basis, but a full life cycle cost analysis that incorporates all the costs and benefits associated with a particular investment decision can offer a more robust indication of value.

Why climate reporting transparency pays off

Evolving disclosure requirements from Canadian and U.S. regulators will require more climate reporting from owners and tenants, likely influencing demand for low-carbon buildings. The trend toward increased reporting and disclosure will only grow in importance. Three-quarters of Fortune Global 500 companies are reporting annual emissions and two-thirds have made climate commitments.¹¹

Additionally, the U.S. Green Building Council recently reported that 60% of the largest real estate investment trusts “publicly report a GHG reduction goal or energy reduction goal,” signaling the market trend toward increasing emissions transparency across the real estate sector.¹²

Real estate markets  in North America have seen a response to evolving consumer demand as well as the evolving policy and regulatory environment, with green building certifications increasing 19% following the pandemic.

Business implications:

Staying attuned to the sustainability ambitions of your stakeholders and proactively meeting investors’ and tenants’ net-zero expectations present an opportunity for green real estate.

Governments, lenders and major corporate lease holders are setting targets and making commitments to reduce their emissions, and they’re seeking greener buildings to help them achieve their goals. This translates to a growing market for climate-aligned commercial real estate, despite a backdrop of post-pandemic headwinds for the sector.

Keeping pace with an evolving landscape

The full scope of this market opportunity will depend on the continued evolution of climate policy at the municipal, provincial/state, and federal levels, as well as the continued resolve from corporate tenants for square footage aligned with their decarbonization goals.