Dive Brief:

• New York City, San Francisco, Washington D.C., Boston and St. Louis are preparing to fine building owners who fail to comply with newly enacted or updated local regulations that in most cases limit large buildings’ greenhouse gas emissions and/or curb energy usage, according to a Nov. 16 Moody’s Investors Service report.
• The fines — the earliest of which will go into effect next month in San Francisco — come as a total of 30 U.S. municipalities are phasing in higher standards for commercial real estate emission reductions and energy consumption, according to the report. The cities moving forward with stricter environmentally-friendly standards span nearly every region and include Atlanta, Denver, Chicago, Los Angeles, Miami and Houston.
• While regulations vary, the costs could be a significant new line expense that would be borne by owners and possibly even tenants of all types of properties including data centers, offices, mixed-use and hotels, Darrell Wheeler, vice president and senior credit officer at Moody’s, said in an interview. “If you have a net lease any new fines may qualify as billable expenses which could create an interesting discussion about whether that can be charged back to tenants,” Wheeler said. 

Dive Insight:

The growing patchwork of new local environmental regulations comes amid increased federal scrutiny of businesses’ climate impact and as investors have been investing in companies that adopt environmental, social and governance best practices. The Securities and Exchange Commission is expected to soon publish a rule requiring publicly traded companies to provide detailed disclosures on carbon emissions and climate risk. 

In light of the new local regulations, Wheeler advised CFOs to review the emissions of the buildings they occupy or own. If they are renters, companies should ask if their lease permits landlords to pass through the costs of fines. 

For now, meeting new standards will be costly. Wheeler said that the cost for retrofitting properties with new zero-emission HVAC systems will vary with the situation but could be up to $60 per square foot or about $6 million for a one million square-foot building. 

“Even if you got a new HVAC system over the last four years, it is not likely zero carbon,” Wheeler said, noting that buildings will essentially need to be converted to use electric heating and cooling systems. “The standard of zero emissions requires you to consider other technologies that are available but expensive. This means your previous equipment is suddenly obsolete,” he said. 

Hopefully the availability and the cost of the technology will improve as the upgrades become more common, he said. 

San Francisco, with a goal of zero GHG emissions from large buildings by 2035, will be the first of the five cities to implement fines, according to the report. Beginning in December, properties that don’t comply with new requirements will be fined $100 a day for a maximum of 25 days in a 12-month period. 

The fines in New York and Washington D.C. are among the most onerous although those in Washington can be reduced if certain compliance plans are undertaken, Wheeler said.

New York passed the Climate Mobilization Act in April of 2019, which placed GHG emission limits on commercial buildings larger than 25,000 gross square feet, according to the report. Properties that exceed the limits will face fines of $268 per metric ton over the limit starting in 2024 with stricter standards starting in 2030. 

In contrast, Washington D.C. will require privately-owned buildings larger than 50,000 square feet to meet new emission and energy consumption standards by the end of 2026 or incur a penalty of $10 per square foot, not to exceed $7.5 million, according to the report.

The cost of the fines could pose cash flow risks for weaker properties. For example, the Moody’s report estimates that by 2030 almost 3.3% of the $139 billion in debt contained in commercial mortgage-backed securities, or CMBS, backed by New York commercial properties will face emission fines that will be greater than 10% of the collateral’s 2021 reported net operating income.

The rules, “meant to encourage owners to invest in HVAC systems’ early replacement and make other improvements, will challenge...certain CMBS collateral,” the report states. “Owners of properties struggling with already lean financial resources will be hard pressed to afford certain capital improvements.”