Office REITs map out tangible strategies to achieve ambitious goals to reduce carbon emissions.
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.
“Tenants have a lot of interest in sponsoring their own corporate social responsibility commitments, and they are much more active participants and willing contributors to energy efficiency.”
As part of its Vision 2030 plan, Vornado Realty Trust (NYSE: VNO) has set a goal of reaching net zero by 2030 through a combination of emissions reduction strategies from its buildings. The first pillar of that commitment is energy efficiency with a 50% reduction goal starting from a base year of 2009. The company has already made significant strides in improving energy efficiency, reducing its energy consumption by 24% between 2009 and 2019.
“The path forward is more sophisticated than the low-hanging fruit that has already been completed, but we have a few things in our favor,” says Daniel Egan, senior vice president, sustainability & utilities at Vornado. One is technology advancements, such as artificial intelligence, building automation, and leveraging building data and analytics to better understand a building’s relationship with energy and identify more opportunities to reduce consumption.
A second key piece is that building tenants now have a seat at the table, Egan says. “Tenants have a lot of interest in sponsoring their own corporate social responsibility commitments, and they are much more active participants and willing contributors to energy efficiency,” he adds.
Vornado has been meeting with tenants on an annual basis for many years to show them best practices and behaviors they can manage within their spaces to be more efficient. In addition, Vornado gives them data to help them understand their consumption. The company also converts that energy consumption into carbon emissions data so that tenants have a clear view of the relationship between things like sub-metered electricity and carbon emissions.
“As we advance our tenant spaces…new spaces are becoming more efficient from day one,” Egan says. Regulation and compliance also will play a role in opportunities for efficiencies in both landlord and tenant spaces. For example, New York’s Local Law 97 and California’s Title 24 contain energy or carbon requirements that will result in lower energy consumption in future tenant spaces.
Buildings located in dense urban markets have limited opportunities for on-site renewables, leading many property owners to consider alternatives. Vornado has sourced its electricity supply in the New York City market from hydroelectric and wind resources upstate, resulting in a zero carbon electricity supply. Vornado is also phasing out its few remaining oil-fired boilers by 2030. “All of these components together—energy reduction and products to source our energy renewably—that will get us to net zero carbon,” Egan says.
Reducing Scope 3 Emissions
Setting realistic timelines depends to an extent on how a company is defining net zero, and whether a REIT is counting Scope 1, Scope 2, or Scope 3 emissions.
Scope 1 refers to emissions that occur directly due to a company or property’s activities, while Scope 2 emissions occur indirectly from its use of energy. All other greenhouse gas emissions that occur, which a property owner has no direct ownership or control over, are known as Scope 3 emissions.
Some REITs are taking the next step to push for a reduction of Scope 3 emissions. Kilroy Realty Corp. (NYSE: KRC) is one company that has announced a goal to reduce its Scope 3 emissions 70% by 2050. The REIT made a commitment in 2018 to achieve carbon neutral operations in Scope 1 and Scope 2 emissions and achieved that goal at the end of 2020. Kilroy is in the process of identifying exactly which Scope 3 emissions it measures or needs to start measuring to better quantify that progress, notes Vaishali Sampat, director, sustainability and corporate social responsibility at Kilroy.
For example, Kilroy started benchmarking the embodied carbon in its development projects in 2019, which it aims to reduce in current and future developments. The company also is looking at reductions related to its onsite waste generation, as well as working with tenants to help them reduce their emissions.
In 2020, Hudson Pacific Properties Inc. (HPP) achieved 100% net zero carbon across all operations through a combination of energy efficiency, on-site renewables, off-site renewables, and carbon offsets.
Hudson Pacific Properties is committed to maintaining its net zero carbon status, while expanding its carbon reduction further into Scope 3. The REIT also is working to reduce its reliance on financial instruments by implementing more lengthy, capital-intensive projects such as on-site renewables and increased energy efficiency initiatives. Specifically, the company is continuing to invest in capital projects around electrification, efficiency, and on-site renewables.
“We hope to reduce our reliance on those financial instruments over time as we make bigger strides around reducing our absolute footprint and bringing more renewables to the grid,” says Natalie Teear, senior vice president, innovation, sustainability, and social impact at Hudson Pacific Properties.
“We hope to reduce our reliance on those financial instruments over time as we make bigger strides around reducing our absolute footprint and bringing more renewables to the grid.”
REITs are battling a number of challenges when it comes to achieving and maintaining net zero carbon. One of the biggest is that net zero carbon is unachievable without the use of offsets, because the power grids they rely on are supplying brown power.
For example, when Indian Point’s two nuclear reactors were shut down in New York State, it increased the carbon content of the grid by 30%. “So, as a landlord who receives power in New York City, the carbon generation of my operation went up by 30% simply because they shut down the Indian Point nuclear reactors,” Malkin says. The power that replaced those reactors is all carbon generated, primarily natural gas. So, increasing clean energy in the grid is critical, he adds.
Vornado’s Egan says the REIT’s biggest challenge is that it has stakeholders that have “different nuances in their definition of carbon neutrality, and those stakeholders include our federal and local policy makers.”
In New York City and San Francisco, for example, there is new climate policy that is regulating buildings to ultimately become carbon neutral, “but in a certain way that may or may not be applicable to all building types,” he says. REITs such as Vornado have been proactive in setting their own carbon neutral commitments.
“Our policy makers are advancing their own carbon neutrality plans that may or may not align perfectly with an end user, such as a REIT’s plan to do so at the same time,” Egan adds. Internationally recognized carbon emissions reduction plans, such as the Science Based Target Initiative (SBTi), provide REITs an opportunity for third-party validation of their reduction goals. Vornado earned this distinction with their carbon neutrality commitment this year.
Adding on-site renewable power generation also is difficult for many REITs. “One of the things that we struggle with is the ability to scale up our on-site renewables,” says Kilroy’s Sampat. Last year, the REIT generated about 6,800 MW of annual electricity from on-site solar at 12 of its buildings, which represents about 3% of its power consumption. Oftentimes there is not enough of a footprint or enough available space on a roof, or it may not be a good location for solar.
One alternative to on-site power that Kilroy is looking at is utility provided green power or Community Choice Aggregations (CCAs). Currently, 23% of the REIT’s power comes from those renewable sources, which it is continuing to look at increasing. The first strategy is always to continue to reduce on-site consumption.
“As technology evolves, such as more AI technology and building IoT, we can further finetune our building operations to improve its efficiency and reduce on-site consumption,” she adds.
Another hurdle for REITs is understanding the cost. RECs and carbon offsets are much more affordable than they have ever been before, and it is very doable if a company is willing to pay.
“People think it is prohibitively expensive, and that is just not the case anymore,” Schantz says. However, companies do have to conduct that cost analysis, get estimates, and be willing to make that investment. Oftentimes, it is easiest for owners to make an investment when they can pass that cost through to tenants. When it comes to the incremental cost of renewables and investing in green power, it’s not that simple, she adds.