Owners and operators of assets in New York City are increasingly concerned about one of the nation’s most comprehensive—and consequential—ordinances targeting energy efficiency. Local Law 97 mandates that buildings in the nation’s largest commercial real estate market reduce greenhouse gas emissions by 2024 or face financial penalties.
As the deadline for making improvements gets closer, with compliance requiring extensive renovations that take time and money, some in the industry worry that the requirements could further complicate recovery. Offices remain largely empty and Manhattan apartment occupancy and rents have plummeted. The prospect of fines is yet another potential blow to the city’s competitiveness.
The Real Estate Board of New York (REBNY), an influential advocacy and educational organization, recently detailed its concerns to the New York City Council’s Committees on Environmental Protection and Capital Budget.
“REBNY agrees with the Council’s intention of decarbonizing New York’s building stock, but the approach it adopted is deeply flawed and needs to be amended, if we have any hope of achieving a carbon-free New York City on the timetable suggested,” the organization stated in written testimony.
That said, conformity to the law might not be as financially onerous as feared, a new analysis by Moody’s Investors Service suggests. The report, released May 5, says that fewer than 20 percent of New York City properties studied are on track to exceed emissions limits that would trigger fines in 2024. Only a fraction of those properties would trigger fines that exceed 2 percent of 2019 net operating income.
“The overall point is that it is a relatively small measure but may be just enough to be an effective incentive,” said Kevin Fagan, a vice president & senior credit officer in Moody’s CMBS group. “It’s a nudge rather than a cudgel.”
Around the country, property owners are increasingly acting on climate risk. A survey of investment managers conducted last week by the National Association of Real Estate Investment Managers found that one-third of respondents have developed climate risk analysis on at least 75 percent of properties.
Yet managers surveyed agreed that climate risk data and modeling wasn’t ready to integrate fully into underwriting due to challenges related to consistency and methodology, and the difficulty of balancing long-term climate forecasts with 10-year investment time horizons.
Enacted in 2019, the law represents an ambitious attempt to reduce greenhouse gas emissions in New York City. It sets thresholds for carbon emissions for buildings of 25,000 square feet or more, an initial standard that takes effect in 2024 and a steeper limit required by 2030. The law imposes a fine of $268 per ton of emissions on owners whose buildings do not reach the prescribed level.
While there is practically unanimous agreement that LL97 is well-intentioned and that reducing the city’s carbon footprint is critical, many in the real estate industry contend that the law goes about it the wrong way. For example, REBNY notes that the law applies only to larger buildings, which represent about 5 percent of the city’s commercial properties. Although those buildings represent a significant share of total commercial space, the law regulates only half of emissions in the city.
Another objection is that LL97 categorizes buildings by property type, rather than by energy use. Sparsely occupied buildings are subject to the same standards as buildings that are heavy consumers, such as properties with a trading floor. A better solution, REBNY argues, would be to set a baseline standard and require every building to reduce emissions by a certain percentage.
“(T)wo buildings with similarly efficient systems can perform wildly (differently) against their carbon caps because of the varying energy needs of their tenants,” REBNY noted in its written testimony. “As a result, building owners that made commitments to the environment and invested in sustainable and efficient systems long before any regulatory inducements still face up to millions of dollars a year in fines.”
Critics also say that the city has dragged its feet on reducing emissions in city-operated buildings, and that the city needs to update its outdated electric grid, which is sourced almost entirely from fossil fuels.
REBNY calls the law misguided because it “uses a flawed metric that penalizes buildings for emissions per square foot, not how efficiently the building uses energy, penalizing densely occupied buildings. As many building owners simply don’t have reliable access to renewable power, they will not be able to reach these emissions targets. The next Mayor and City Council will need to do better to reach our shared goals.”
Penalties, But Less Than Onerous
Moody’s studied the emissions of New York City properties that serve as collateral for $99 billion of loans in CMBS pools. The study assumes that buildings would emit a constant 2019 level of greenhouse gases, even though emissions have declined since 2019 due to COVID-19 and many properties are implementing energy-saving measures.
The purpose of the study was to determine whether fines could impact the ability of property owners to make mortgage payments and potentially create defaults in CMBS pools. Moody’s concluded that very few properties would face a major hit to the bottom line, even assuming no improvements in energy efficiency and no growth in net operating income.
“If owners take no action to decrease energy usage to comply with the New York City greenhouse gas emissions standards, resultant fines will pose a limited degree of cash flow risk for properties backing CMBS,” Moody’s states. “Therefore, even though about 80% of … underlying CMBS loan volume is on track to exceed emissions limits by 2030, such fines are unlikely to overburden borrowers and heighten credit risk for most CMBS deals.”
As property owners continue to retrofit buildings to improve energy efficiency, the potential for fines will decrease. Moody’s notes that some improvements can create financial strain on owners, though at the same time such capital expenditures will reduce energy bills.
More Action Coming
New York City’s law is one of the first and most comprehensive to require commercial property owners to reduce greenhouse gas emissions and align with the Paris Climate Agreement, but it won’t be the last. Municipal leaders across the country have pledged action to reduce energy consumption and use of fossil fuels. California, Washington, D.C., and Texas are among the major jurisdictions to pass energy consumption laws that directly impact commercial property owners.
Determining the most efficient way to reduce energy consumption remains in the beginning stages, so it is likely that jurisdictions will try various approaches. New York City relies on a “stick” approach, punishing owners for non-compliance, but other strategies might involve a “carrot” method that rewards businesses for improvements. Another important component to solving the equation is developing alternative sources of clean energy, which will likely be more available by the time properties are due to meet the 2030 requirements of LL97.