The US commercial real estate market is less than 10 years away from achieving a 50 percent reduction in building emissions by 2032 – its first key milestone as it aims to achieve net-zero by 2045. But the necessary regulatory framework or push from within the industry to effect significant change does not yet exist.
Cities including New York, Los Angeles, Portland, Seattle, Pittsburgh and Washington, DC, have adopted strategies that will move them toward a carbon-neutral future. Additionally, a March 2022 proposal from the Securities and Exchange Commission that would require SEC registered companies to include climate-related disclosures. But implementing these strategies is proving to be difficult, market participants tell Real Estate Capital USA.
“One of the issues is that it is very difficult to steer the ship of a large asset management company encumbered by existing assets within successful fund franchises that do not contemplate carbon reductions with embedded assets that are in the encumbrance of funds,” says Joseph Sumberg, managing partner and head of real estate at Galvanize Climate Solutions, a climate-focused global investment firm.
Sumberg says the firm has been pleasantly surprised to have had conversations with lenders that want to effect change.
“In the equity space, our goal is to own these assets and make authentic, tangible changes to their carbon footprint from an [emissions] perspective and improve profits,” Sumberg says. “We are only going to buy assets that allow us to achieve our financial and sustainability goals, we are not going to wait for lenders to roll out green lending programs or depend on peripheral pricing from a lender to do this.”
While there is a sense that equity investors are waiting for regulation to occur or carbon reduction efforts to become more economically feasible through government incentives or credit structures, Sumberg believes increasing that resiliency boosts an asset’s value and creditworthiness. “I think equity investors are waiting for a more material advantage from a lender to be able to effectuate a more comprehensive ESG strategy and, frankly, that is unlikely to come.”
The number of near-term city and state mandates around efficiency upgrades is leading more sponsors to consider Commercial Property Assessed Clean Energy, or C-PACE, financing for energy efficiency or resiliency upgrades. C-PACE financing, which allows owners access to low-cost, long-term, fixed rate loans that are secured by a tax lien, is enabled by state legislation and administered on a local level.
According to data from Sacramento-based consultancy PACE Nation, C-PACE financing has increased in usage steadily since 2009, when there was about $40 million of issuance, to $4.2 billion through the end of the third quarter of 2022.
The potential for PACE is real, but sponsors and lenders have not historically widely adopted it as a strategy, says Lara Rapaport, founder and chief executive of North Bridge, a New York-based C-PACE lender. The firm, which focused on institutional sponsors and lenders, is active in 18 states that allow PACE financing and focuses on institutional sponsors and lenders.
While the firm is fielding a substantial number of in-bound inquiries, North Bridge believes more education is needed among sponsors, lenders and lawyers. “We are happy to help educate the market and hold people’s hands,” Rapaport says. Part of this education, she adds, is letting people know that PACE financing can be applied to new loans and refinancings. It can also be applied retroactively to give sponsors credit for work that has already been done.
Rapaport launched the firm after a career that started in the leasing market and included a long tenure in Lehman Brothers’ CMBS group and Tishman Speyer’s acquisition and development platform. She also spent nine years at L&L, where she worked on projects that included the redevelopment of 425 Park Avenue in New York. During her time at Lehman, Rapaport worked on some of the earliest European commercial mortgage-backed securities deals.
“There are a lot of similarities to where the C-PACE market is today and where the CMBS market was in Europe in the early 2000s,” Rapaport says. “We have sat in every seat so that when we look at PACE, we start with a blank sheet of paper and figure out the optimal structure for all. We know how to apply it to a myriad of situations because we understand what the other side or sides are thinking.”
There is a growing sense that the commercial real estate market presents an opportunity to create the right rules and guidelines for moving forward.
“While the EU taxonomy has provided a clear direction, the US has an opportunity to be more innovative when the principles are set,” says Breana Wheeler, US director of operations for BREEAM, part of the BRE Group, a London-based consultancy that administers third-party voluntary certification around sustainability.
“A principle-led approach, driven by business and innovations will achieve very different outcomes than an approach that is driven by the fear of fines and penalties.”
Avrio Real Estate Credit, a newly launched commercial real estate lender, opened its doors with sustainability as a main theme, says Lee Hodgkinson, head of sustainability. The firm’s investment thesis is that lending that measures ESG factors on commercial and housing-related assets is part of a larger shift that needs to happen.
“We are not going to wait for lenders to roll out green lending programs or depend on peripheral pricing from a lender to do this”
Galvanize Climate Solutions
There is also a larger story around ESG that Hodgkinson believes can be missed – risk mitigation.
“ESG gives us the ability to incorporate more risk and more non-financial data into our investment process, which we think leads to better investments overall. In many ways, that is how ESG started – it was about identifying risk and incorporating that risk into investment decisions. It wasn’t about just quantifying the good you were doing, which is what I think it gets conflated with these days.”
Jani Nokkanen, partner and chief investment officer of Copenhagen-based real estate investment manager NREP, says implementing ESG principles is easier for US market participants than it may seems.
“It is very clear at this point that ESG makes sense from a monetary perspective. It is more about attitude and knowledge, and it is not complex,” Nokkanen says. “As a real estate owner, there are four or five things to do and there is a whole chain of consultants, engineers and suppliers. It is all about the attitude.”
‘Drive the change’
There is a growing sense that a main driver will be from local forces rather than a federal program, market participants tell Real Estate Capital USA.
“The regulatory aspect of things is coming on a local level, but it is not likely to be comprehensive on a federal level anytime soon,” Sumberg says.
But there is a silver lining, Sumberg believes: “What we do know is that capitalism scales, and if we’re looking to the government to fix this problem, if we’re looking to lenders and mortgage providers to fix this problem, we will be waiting for a long time. If we focus on what is profitable and use that to drive the change by showing people, then capitalism will do what it does best, which is to spawn ripple effects that others will follow to make money and profit. Once the market sees this, it will replicate it.”