Commercial Real Estate’s Impact on Climate Change
Climate risk manifests itself in commercial real estate in numerous ways, according to a recent report from CBRE. Per CBRE, 35% of all global REIT properties are exposed to climate hazards related to extreme weather events like flooding and hurricanes.
At the same time, nearly $60 billion of commercial real estate bonds are backed by mortgages vulnerable to natural disasters. And the impact goes both ways: with the built environment responsible for much of the world’s carbon emissions, it is undeniable that commercial real estate impacts climate change. As the Quadrennial Technology Review from the Department of Energy reveals, the buildings sector accounts for about 76% of U.S. electrical use and 40% of associated greenhouse gas emissions.
This article examines commercial real estate’s impact on climate change, how climate-related factors affect CRE asset values and ways property owners can make commercial properties more energy-efficient and sustainable.
Environmental Impact of Commercial Real Estate
The Deloitte Center for Financial Services concurs that commercial real estate buildings significantly impact the environment. Nearly every property asset class — including medical centers, warehouses, timberland, self-storage facilities, hospitality, office, and retail — impacts the industry’s carbon footprint. This is driven mainly by the high cost of extracting water, fossil fuels, and other natural resources to support construction and operations.
According to Jonathan Watts in a 2019 article for The Guardian, “extractive industries are responsible for half of the world’s carbon emissions.” They are also to blame for “more than 80% of biodiversity loss.” Over the last fifty years, the rate of resource extraction has exploded. “This was a huge boost to the global economy [for the first thirty years].” However, in the last twenty, “there has been a diminishing rate of return” as costs increase and “the environmental costs become harder to ignore.”
Some of commercial real estate’s impacts on climate include greenhouse gases, water abstraction, and air pollutants. In the context of Watts’ article, it makes sense that these three items account for almost 90% of CRE’s total environmental impact costs. Environmental impact costs have begun to outpace commercial real estate investments revenue growth, which could affect future property values.
Below, we consider the environmental impact of several asset classes in the commercial real estate industry. From hospitals and data centers to office buildings and shopping malls, commercial properties and their operations significantly impact the natural environment.
Hospitals and Health Care Centers
Due to single-use products and energy-intensive machines, hospitals and health centers are responsible for 8% of total energy consumed by commercial buildings. They are also responsible for a large share of emissions produced by commercial buildings. According to the Health Care Climate Council, the average hospital uses “2.5 times more energy per square foot than an office building.”
In just ten years, the rate of greenhouse gas emissions produced by our healthcare industry “increased 30%.” Today, our healthcare system in the United States “contributes 10% of the nation’s carbon emissions and 9% of harmful non-greenhouse air pollutants.”
Warehouses and Storage Units
Storage — especially that which requires climate control and other technology — can be incredibly energy-intensive. The Verge writer Justine Calma notes that “warehouses and storage units have become the most common commercial buildings in the country” due partially to the pandemic-era online shopping boom. With new warehouses popping up all over the country, climate scientists and CRE industry experts have expressed concern over their environmental impact.
Overall, warehouses and storage units consume less energy than office buildings, but they also consume energy less efficiently by using outdated technologies. As we build more warehouses and storage units, their use of natural gas alone could escalate emissions substantially.
Of course, operational energy usage is not the only source of emissions in this space. Calma writes that “building materials and construction are responsible for about 10 percent of global greenhouse gas emissions.” Building new warehouses – especially in areas subjected to extreme weather – could substantially increase emissions from day-to-day construction operations. Adopting new technologies as we build more warehouses could reduce their impact on the environment.
Data centers can be even more energy-intensive than other storage facilities due to the servers they house and the climate control those servers require.
Asaf Ezra explains in his article “Renewable Energy Alone Can’t Address Data Centers’ Adverse Environmental Impact” for Forbes that “data centers consume approximately 200 terawatt-hours (TWh) of electricity or nearly 1% of global electricity demand.” Data centers are responsible for “0.3% of all global CO2 emissions.”
Though this might sound minimal, data centers consume more energy than Iran and several other countries worldwide. Data center consumption could also skyrocket as needs increase — just like warehouses and other storage facilities. According to Nicola Jones in an article for Nature, “electricity use by ICT could exceed 20% of the global total” in the coming decades. Data centers alone would use “more than one-third of that.”
Office Buildings, Retail Stores, and Shopping Malls
Together, office and retail buildings account for nearly one-third of all energy consumed by commercial buildings in the United States.
According to the U.S. EIA, buildings utilized by mercantile and service industries represent “15% of total energy consumed by commercial buildings.” This includes malls, supermarkets, retail stores, car dealerships, and gas stations.
Office buildings alone are responsible for 14% of total energy. In an article for Inc, Jeff Pochepan explains that the impact of office buildings on our environment extends far past energy usage. Pochepan notes that “office buildings are responsible for 41% of the world’s average energy use,” referencing the Green Building Council data.
Resorts and Hotels
As one might imagine, the hospitality industry — home to commercial buildings like restaurants, resorts, hotels, and spas — contributes heavily to climate change. Harvard Business School notes that “tourism accounts for about 5% of global CO2 emissions – a fifth of which is generated by the hospitality industry.” Building and operating resorts and hotels are responsible for a large chunk of CRE’s energy consumption and emissions. According to the EIA, the sector accounts for 6% of total energy consumed by commercial buildings in the U.S.
How Climate Change Threatens the Commercial Real Estate Industry
Commercial real estate contributes to climate change through emissions related to construction, maintenance, and operations. In turn, climate change impacts the commercial real estate industry. Rising sea levels, natural disasters, and extreme weather events pose physical risks to commercial real estate.
In a paper for Columbia Law School’s Sabin Center for Climate Change Law, Jessica Wentz notes that “climate-related phenomena such as flooding and heatwaves can directly impair the performance and longevity of buildings and infrastructure.”Climate-related impacts “can also alter the nature and magnitude of environmental impacts associated with a particular project,” making commercial buildings more vulnerable and less safe for consumers and users.
Unfortunately, climate change’s impact “on temperature, precipitation, storm patterns, rising sea-levels, and other environmental processes” is expected to worsen in coming years. If more sustainable practices do not curtail emissions, impacts could be catastrophic.
Relationship Between CRE Valuations and Environmental Measures
Utility costs affect the profitability of commercial real estate investments. It makes good business sense for stakeholders to embrace environmentally friendly green building measures. Specific updates are inexpensive and straightforward to install. Others are more expensive but offer incredible returns.
Lower Operating Costs & Higher Returns
Property managers, developers, and investors who choose to make commercial buildings more energy-efficient can see huge cost savings.
According to Karen Ho in her October 2021 article for Business Insider, “sustainable buildings…consume 29 to 50% less energy” than typical buildings. They also consume “40% less water and produce 33 to 39% less carbon-dioxide emissions and 50 to 70% less solid waste.” Green buildings consume less energy “because of installing features like smart LED lighting and energy-efficient heating, ventilation, and air-conditioning systems.” Building green buildings or retrofitting older, less efficient buildings “also means fewer utility expenses and other financial benefits for building operators and tenants.”
Recent evidence suggests that buildings with green features also depreciate less quickly. Not only do sustainable buildings retain property values over time, they are also more likely to meet the growing demand of discerning tenants and investors.
In today’s world, many investors are increasingly concerned with sustainability and climate change risks. The result is higher occupancy rates, with rents and sale prices potentially higher above-market than non-green properties. The benefits of retrofitting energy-intensive buildings to more efficient spaces often far outweigh financial transition risks.
How sustainability factors affect NOI
Revenues and the cost of owning and operating a commercial property are affected by sustainability factors in different ways. Those with the weightiest impact on net operating income (NOI) include:
- Occupancy levels
- Rental growth
- Service charges
- Business rates
- Premium on yield
- Debt availability/liquidity
- Refurbishment costs
- Energy, waste, and water expenses
How Climate Risk Affects CRE Investment Decisions
A recent report from the Urban Land Institute analyzed the relationship between climate risk and real estate. It also examined how climate changes will drive future commercial real estate investment decisions. We summarize the results of the Urban Land Institute study below.
- Physical environmental risks such as hurricanes or localized flooding.
- Investments will focus on resilient infrastructure, the current protection offered, and an asset’s anticipated ability to perform under future climate scenarios.
- Local government capacity to adopt, fund, and implement resilience policies to protect the safety of both businesses and residents.
- Financing available for resiliency investments and the anticipated longevity and impact on investment prospects.
- Risk sentiments held by stakeholders such as insurers, lenders, key employees, and residents can help anticipate ripple effects on investor and lender views.
Making Commercial Buildings More Energy Efficient
Making a commercial property more energy efficient isn’t always capital intensive. A resource from Energy Star lists a wide array of low-cost measures and cost-effective investments that can help reduce energy waste:
- Turn off lights when not in use or when occupants can use natural light.
- Set back thermostats at times when the building is unoccupied.
- Improve operations and maintenance practices by routinely checking and maintaining equipment.
- Optimize start-up time, power-down time, and equipment sequencing to reduce energy loads.
- Revise janitorial procedures to minimize the hours that lights operate each day.
- Educate tenants and employees about how their behavior affects energy use and operating costs.
Cost-Effective Investments That Improve Energy Efficiency
- Work with an energy services provider to manage and improve energy usage.
- Install energy-efficient lighting such as compact fluorescent lights (CFLs), light-emitting diode (LED) exit signs, and occupancy sensors.
- Install window films and add insulation or reflective roof coating to reduce energy consumption.
- Upgrade or install new HVAC equipment to meet reduced loads and benefit from today’s energy-efficient technologies.
- Use a vendor performance contract to ensure energy savings from any upgrades made.
- Engage in energy audits and retro-commissioning to identify areas of energy inefficiency.
Tax Benefits and Other Government Incentives
- 179D Energy-Efficient Commercial Building Tax Deduction
- Energy Investment Tax Credits
- Better Buildings Initiative and L-Prize® from the DOE
- Accelerated Recovery Period for Depreciation of Smart Meters and Smart Grid Systems
Consumers and Investors Demand Environmental Responsibility from CRE Industry and Others
In “The Rise Of Climate-Conscious Consumers” for Forbes, Ron Shevlin writes nearly “one in four Americans considers climate change” the most critical social issue. Many consumers are willing to pay more for sustainable products and go out of their way to work with climate-conscious companies.
Potential profits for businesses that “go green” are huge. According to BusinessWire, 85% of people globally “have shifted their purchase behavior towards being more sustainable in the past five years.” 34% of consumers are willing to pay more for green goods and services, while 25% are willing to pay a premium.
Consumers and users are not the only groups committed to environmental responsibility. Michelle Bachir and Meadow Hackett explain in their post “Decarbonization of Real Estate: End-to-End Business Transformation” for Deloitte’s Risk Advisory blog. They note that investors have already begun to apply pressure, and are starting to align “their portfolios with the Paris Agreement.” Hundreds of investors are now “[making] ESG, particularly climate change, central to their investment strategies.”
Positioning CRE for Future Success
The impact of commercial real estate on climate change is significant, as are the effects of climate change on CRE. However, commercial real estate investors and building owners who are proactive could gain a competitive advantage.
As rising sea levels, extreme heat, wildfires, and other physical risks threaten usability, improving efficiency could make an enormous difference. Asset managers, property owners, and other investors would do well to consider the impacts of climate change on commercial real estate and limit emissions as more tenants, investors, users, and consumers prioritize sustainability and environmental responsibility.