How Much Will Complying With Emissions Standards Hurt Commercial Real Estate?

What commercial real estate sectors will pay the most to comply with greenhouse gas emissions rules globally, and what CRE sectors will be least affected? Answers: offices will pay the most and warehouses the least.

That assessment was part of a recent webinar conducted by Green Street, the real estate analytics firm. The session covered the cost of compliance aimed at reducing climate change globally. Daniel Ismail, Green Street’s co-head of strategic research, described how companies’ rising capital expenditures to control GHG and other such outlays, such as insurance, will affect profitability.

In 2024, Ismail said, these expenditures are relatively small. Trouble is, the costs will mount over time, he pointed out. Eventually, if current trends continue, more commercial properties will be totally electrified via renewable sources, leaving their oil or natural gas-fed furnaces a memory, which likely would be cheaper. But that could take a while.

Ismail cautioned that climate costs should hardly be the deciding factor for investors in choosing what kind of real estate to put money into. Long-term growth expectations and other factors will be more important, he noted.

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Example of a CRE climate cost: New York City enacted a new fine on buildings that exceed emissions limits, starting in 2025. Ismail said most landlords will opt for the fine ($268 annually per ton of carbon dioxide over 2024 levels) rather than pay the far weightier costs of retrofitting their properties to comply. It is unclear, at this stage, what the average fine would be, but information from the city states 11% of buildings required to comply with the law exceeded emissions limits for the first compliance period, 2024 to 2029.

Offices and shopping centers will shoulder the biggest outlays complying with climate regs, both in the U.S. and around the world, according to Green Street. Over the next five years at a minimum, office building owners will need to boost their capital expenditures by 3.5% of net operating income and shopping centers by 2.1%. The costs for self-storage sites (1%) and industrials (0.9%), mainly warehouses and factories, will be lighter.

Some sectors, though, will be able to pass along their new costs to customers, particularly self-storage and industrials, Ismail said. Offices and malls will find that much more difficult.

The pandemic and high interest rates have punished CRE economically, most notably in the office sector. In this year’s first quarter, the U.S. vacancies for offices hit 19.8%, a new record, from 17% at the end of 2019 (right before the pandemic), data from Moody’s Investors Service shows. Meanwhile, for industrial properties, vacancies are less of a problem, around only 5%, only slightly higher than 2019’s final quarter (3%), data from commercial real estate services and investment firm CBRE indicate. The industrial sector has expanded to meet pandemic remote-buying demand, but new construction is tapering off.

Investors in real estate investment trusts have suffered in general, but offices were down the most last year, losing 23.7%, per data from NAREIT, the trade association for real estate trusts.