For executives in the commercial real estate sector striving to stay ahead of climate obligations amid economic headwinds, innovation and collaboration have become key.iStockPhoto / Getty Images
International and domestic commercial real estate owners have made considerable progress on the path to decarbonization and in tracking emissions but faced with the twin COVID-19 legacies of low office occupancy and high borrowing costs, net-zero compliance has become more challenging, say experts.
While half of the companies in the S&P/TSX Capped REIT Index have linked executive compensation to climate change goals, Deloitte’s recent 2024 commercial real estate outlook, called Finding Terra Firma, found that 60 per cent of commercial REITs surveyed this year lack the data, processes and internal controls needed to meet emissions reporting requirements.
The report shows revenue expectations among the REITs with assets under management of at least US$50-million dropped to their lowest level since the survey began in 2018, with about half expecting the cost of capital and capital availability to worsen through 2024.
Forty per cent of the respondents to the survey of 750 CFOs at multipurpose commercial REITS across jurisdictions, including Canada, said they plan to further reduce expenses in 2024, with almost 50 per cent reporting that staffing and office space would be the primary areas for cost cutting. (Last year, 6 per cent said they’d be making cuts.)
Against this backdrop, smaller office REITs may be forced to delay climate-related measures even as the clock ticks on efforts to limit global warming, says Nura Taef, co-lead, ESG reporting advisory for Deloitte Canada.
“Some may be adopting more of a compliance mindset as opposed to being at the leading edge,” she says. “If it weren’t for this cost-cutting market, more of them would be reporting prior to the regulations, but in the face of this, they’ll do it when they absolutely have to.”
For office REITs, especially those with lower-tier assets, there are two schools of thought, says Michael Brooks, chief executive officer of the Real Property Association of Canada, a trade group that represents the larger players in the country’s commercial real estate industry.
“One school says: ‘Gee, our revenues are way down because our office buildings are becoming under occupied, maybe we can just kick this down the road,’ ” he explains. “The other says, ‘Maybe someday we are going to want to sell or recapitalize and buyers and investors are going to want to see our green credentials.’ ”
A failure to act, adds Mr. Brooks, could depress property values and impact the ability to sell.
Office real estate investment trusts have been hard hit by remote work and high borrowing costs, trading at their lowest level since 2009 with the S&P Composite 1500 Office REITs Sub-index, which makes up about 6 per cent of the broader Equity All REITs Index, down more than 23 per cent over the past year.
REITs are also dealing with the complexity of emissions reporting under a variety of standards, in addition to the heavy lifting of green building and retrofitting to meet net-zero targets, says Yingzhi Tang, research associate at Queen’s University’s Institute for Sustainable Finance.
A lot of building owners are discouraged by these high upfront costs and the administrative burden associated with climate compliance.
— Yingzhi Tang, research associate, Institute for Sustainable Finance at Queen’s University
Mandatory annual greenhouse gas emissions reporting is in place in more than 40 countries and jurisdictions, including California, but it is not yet federal law in Canada or the U.S.
The Securities and Exchange Commission (SEC) is finalizing climate-related risk disclosure rules that are to include GHG emissions, and in Canada, the Office of the Superintendent of Financial Institutions (OSFI) has published draft regulations for reporting GHG emissions for financial institutions and their borrowers, to be implemented for the fiscal years beginning after October, 2024.
ISO 14064, International Standard for GHG Emissions Inventories and Verification is being introduced to gauge emissions during each stage of the lifespan of a product or building, while regulators in North America have signalled that the SEC and OSFI rules will encompass scope 3 emissions reporting for REITs – requiring landlords to track, record and report not only their own direct emissions and waste disposal energy use but also the consumption of tenants and other occupants.
“A lot of building owners are discouraged by these high upfront costs and the administrative burden associated with climate compliance,” Ms. Tang says.
She suggests that smaller REITS might not be required to report until after larger competitors have done so and that elements of scope 3 could be phased in. In any case, she says, for those REITs that haven’t gotten a head start, “reporting may not be top of mind in this very challenging interest rate environment.”
For executives in the commercial real estate sector striving to stay ahead of climate obligations amid economic headwinds, innovation and collaboration have become key.
“When we think of decarbonization broadly we have to be creative,” says Marlee Kohn, vice-president, ESG at Toronto-based real estate and asset management company Starlight Investments. “We have to tap into what available government incentives exist, what sort of incentives our lenders have so that we can actually move these decarbonization efforts forward, and that includes tracking and reporting,”
She says lenders have their own net zero objectives as well. “They want to be involved and are motivated to accommodate some sustainable finance options … getting better rates or in whatever form, provided we have verified targets and data.” It has been an ongoing conversation for the last couple of years, Ms. Kohn adds. “We don’t feel that we are alone.”