Targeted Investment: Untangling the Building and the Grid

The industry now understands that net-zero carbon encompasses both operational and embodied carbon, with operational carbon further divided into site energy use and energy production/transmission factors.

This shift has led to more specific sustainability goals and metrics. Investors now consider whether they want to invest in already green assets or transform brown ones, and whether they prioritize greenhouse gas (GHG) emissions or building-level efficiency. The choice of primary sustainability metric significantly impacts tactics and effectiveness. Importantly, metrics and targets must align with overall investment strategies to be both achievable and profitable.

KEY LEVERS: BUILDING ENERGY USE AND GRID ENERGY SOURCES

The GHG emissions impact of operational real estate can be broken down into (1) energy use and (2) energy sources. 

Building Energy Use:

Ranked in descending order of impact on energy use in real estate – property type comes first, followed by building efficiency and then climate zone.

• Property type is the most important single determinant of a property’s total energy use. For example, low energy intensity property types such as non-refrigerated warehouses may use around 50% of the energy of high intensity property types such as high-rise multifamily. Property type also impacts investors’ ability to obtain data and implement improvements. A forward-looking sustainability strategy could prioritize the property types with greater control and ability to electrify—such as low-rise office and multifamily—over more challenging property types, such as high-rise office and multifamily, hotels, shopping centers, and life science.

• Building energy efficiency is the second most impactful factor on energy use. The best multifamily buildings use 15-35% less than the median building, and the best warehouse building uses 40-75% less than the median building. Therefore, selecting efficient assets or increasing the efficiency of assets can significantly reduce overall energy use and GHG emissions.

• Climate zone is also a driver of overall energy use. For example, the median industrial building in mixed mild versus cold climates differs by about 25%, and the median multifamily building differs by 15%. Climate zone also has an impact on the ability for properties to electrify, as gas heating is used more in colder climates, where the technical and economic feasibility for heat pumps is also more challenging.

Grid Energy Sources:

Differences in building-level energy efficiency are multiplied by transmission losses and grid energy mix in determining variation in GHG emissions. Utility regulation and supply have always been under state—rather than federal—control. There are twenty-two main grid regions in the US with different power generation sources, with variations down to the local utility even within regions.[i]  

Energy sources and building energy efficiency are almost equally powerful levers influencing GHG emissions. The same building on a relatively clean grid such as California, versus a dirty grid such as Colorado, has a difference in GHG performance of about 45%.

WHAT SHOULD INVESTORS PRIORITIZE: BUILDINGS OR THE GRID?

It is not possible for a building to get all the way to net zero without addressing energy supply – buildings will always require energy to operate. But it is possible for a building to get to net zero only through electrification and supply, without addressing efficiency.

The best sustainability strategy should depend on an investor’s goals. At a high level, they should seek to articulate their objectives in two main areas:

• Key Metric: either directly contribute climate change mitigation by targeting GHG emissions, or prioritize ensuring that the property uses resources efficiently by targeting site EUI, defined as the amount of energy used per square foot per year (which is one factor in reducing GHG emissions) 
• Type of Strategy: Either purchase and hold buildings that are already high performers or drive reduction over time through “brown to green” efficiency improvements.

Selecting GHG emissions as the primary metric enables a pure focus on carbon-science based Net Zero Carbon (NZC) goals and the macro change towards a low carbon economy. A focus on GHG and electricity grids also helps create market signals for green power generation and electrification of buildings. This means that areas where utilities are not acting strategically to clean up their generation and distribution may see less institutional investment over time.

Energy efficiency remains the primary focus for many US real estate owners and investors. EUI has the greatest alignment with fiduciary and financial goals. Investing in efficient equipment and operations can decrease costs, future proof the building, and make it more marketable to tenants and investors. In addition, whether a building is a relatively high or low energy user can indicate its relative risk exposure to energy price changes and local regulations (e.g., Building Performance Standards).

Energy supply is outside the scope of levers that can generate returns or protect against risk at the property. In fact, paying a premium for green power can be dilutive to returns. Moreover, building owners cannot directly control the efficiency of the electric grid, and recent presidential administrations have taken drastically different stances on energy policy, leading to diverging projections regarding the future energy supply and its carbon intensity.

Looking at total GHG emissions ties to NZC but is agnostic to how that performance is achieved. In other words, an efficient building on a dirty grid and an inefficient building on a clean grid could have the same GHG performance. Looking at EUI helps ensure that buildings are “doing their part” independent of the grid, in addition to identifying building-specific risks and benefits.

WHAT ARE THE BEST INVESTMENT TACTICS TO REACH DIFFERENT SUSTAINABILITY GOALS?

Achieving each of these objectives entails different investment tactics: 

The choice of properties to acquire depends on the specific goals and approach of the investor. For those prioritizing strong GHG performance, the focus may be on ENERGY STAR–certified, all-electric buildings in cleaner grid areas like California—supplemented by green power purchases to achieve zero emissions.

Investors aiming for relative GHG improvement could target median-performing buildings in dirtier grid markets like Colorado, then implement electrification measures, install on-site solar where feasible, and potentially purchase green power. In this scenario, improving property efficiency might be optional if green power proves more cost-effective than capital investments in efficiency upgrades.

For those focused on high EUI performance, ENERGY STAR certified buildings in any market would be the primary targets. A strategy centered on relative EUI improvement would involve acquiring median-performing buildings across various markets and enhancing their energy efficiency and ENERGY STAR score, without necessarily pursuing full electrification.

WHAT ARE THE BEST METRICS TO MEASURE PROGRESS TOWARDS GOALS?

There are several options to measure progress towards each type of goal: 

GHG Emission Metrics

For GHG emissions, totals and reduction over time are the most straightforward metrics.  Reductions over time can be evaluated annually, over hold period, since vehicle inception, and/or since base year. 

Investors can also track on-site solar installations as a GHG metric. On-site solar is one of the main ways that owners can directly impact GHG in a financially accretive manner.

Many investors are also using the CRREM Pathways, which provide descending annual targets for GHG intensity, broken out by property type, climate zone and grid. The targets are based on the remaining carbon budget allocated to that market segment under a 1.5-degree scenario.[ii] These investors are often evaluating “stranding year” or the year when the property’s GHG exceeds the remaining carbon budget. While this can be a useful high-level metric, it is important to note that most properties exceed the CRREM carbon budget by the early 2030s. Market-based green power procurement is therefore essential to meeting the CRREM GHG pathways.

Energy Use Metrics

For evaluating energy use, Energy Use Intensity (EUI) is a widely accepted metric globally, and should be examined on a property type basis to control for the variations discussed previously.

Moreover, ENERGY STAR Portfolio Manager is an exceptional resource for sustainable investing in the US, because it is the industry standard tool for tracking, evaluating and reporting energy performance.  The tool tracks utility usage, normalizes for weather and occupancy, and generates key metrics as well as a 1-100 score representing the property’s performance relative to the building stock. Investors can examine the ENERGY STAR score of individual buildings, the average score for the portfolio and/or the portion of properties achieving ENERGY STAR certification for performance above the seventy-fifth percentile. 

As a public tool that provides benchmarks based on measured performance, ENERGY STAR is perhaps only comparable to NABERS in Australia, since European EPCs are based on physical conditions and modeled data.[iii]  In general, actual energy performance is usually worse than modeled energy performance, meaning ENERGY STAR is more accurate and stringent than modeled approaches.  

WHAT TYPE OF SUSTAINABILITY TARGET IS BEST FOR DIFFERENT TYPES OF VEHICLES?

Investors in real estate must carefully consider their goals when developing sustainability targets, as different objectives can lead to varying approaches.

While some may focus strictly on GHG emissions, this approach often requires investors to allocate capital based on power grids or invest in items that may not have a strong financial business case, such as electrification and green power. For those pursuing carbon budget-based GHG targets in the US, it’s crucial to be transparent about their willingness to pay for these items and to consider handling them separately from typical investment return calculations. Alternatively, many investors may find it more appropriate to view NZC as a long-term goal and emphasize GHG emissions reduction progress.

Energy efficiency measures often rival or surpass grid location choices and green energy initiatives in their impact on reducing greenhouse gas emissions. Site energy use is a robust metric for performance evaluation. Real estate owners have greater influence over a property’s energy use than its energy sources, and energy use aligns more closely with value generation. Prioritizing energy-efficient buildings can lead to lower operational expenses, enhanced market appeal, and reduced vulnerability to energy price volatility and emerging regulations such as building performance standards.

Investors have options when it comes to building a sustainable portfolio using either metric. They can either acquire properties that are already low-carbon or energy efficient or improve properties through a “brown to green” strategy. The former approach can benefit from tenant and investor premiums associated with best-in-class properties, and the latter approach can drive returns by decreasing OPEX and increasing marketability to tenants and buyers. Either strategy can potentially achieve sustainability goals while also addressing risks and opportunities that can impact financial performance.

SUMMIT #18

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