Building a Sustainable Future: The Cost of Developing and Operating Net Zero Real Estate
INTRODUCTION
Real estate portfolios are increasingly negatively impacted by heat waves, droughts, wildfires and subsequent soaring insurance costs. Risk-proofing properties in the face of climate change is no easy task. Scientific targets suggest that to avoid greater economic disaster and climate risks to portfolios, emissions must decline over 45%[1] by 2030. With buildings responsible for ~40% of global carbon emissions and 34%[2] of energy demand, real estate plays a significant role in the climate transition. At the same time, we can resiliently power and manage homes at scale due to technology and scientific breakthroughs. Biophilic designs, embodied carbon, LED lights and smart appliances are accessible tools to reduce energy use and emissions. Simultaneously, war and geopolitics ignited the most recent oil and gas crisis, reminding stakeholders that clean energy independence is a matter of economic and national security. With this global backdrop, U.S. and global commitments to net zero continue to grow, and asset managers are pledging $16 trillion of assets by 2050.
We would like to thank Chris Pyke, the Chief Innovation Officer at GRESB, for his contributions to this blog, given his expertise in the ESG space.
THE COST OF NET ZERO CONSTRUCTION
For many, questions remain on how to price climate risk into models. What is the cost of net zero retrofits and new builds? How are costs recovered or reduced? Net zero innovations may require additional capital outlay but, in most cases, enhance investment returns. The potential additive costs associated with net zero construction can be mitigated through the increasing affordability of green materials, sustainability rebates, tax benefits, green premiums and operational efficiencies. Partnerships with private and public stakeholders can also reduce capex and diversify revenue streams. Furthermore, according to ULI, studies suggest 3.5% rental and 13% sale premiums exist for highly efficient buildings, as well as up to 7% higher occupancy rates from better tenant attraction and retention.
As we consider the cost drivers, let’s first review the components of net zero buildings:
Energy-efficient design and construction: trees and native gardens, natural light, LED lights, high insulation glass, efficient HVAC, smart appliances and efficient heat water pumps
Renewable energy sources: solar panels and microgrids
Energy storage and management systems: batteries and/or EVs (Vehicle-2-Grid)
Sustainable materials and construction practices: green cements, recycled materials, carbon sequestered building-products and modular homes
In 2018, Rocky Mountain Institute suggested the cost of net zero construction is close to price parity with traditional builds within a cost range of +1-8%. However, this differs by state, energy costs and available incentives. In 2022, Schnedier’s European IntenCity project demonstrated that technology to reach net zero operational emissions is around 2% of the total cost of investment in state-of-the-art development. During our recent discussion with Chris Pyke, he highlighted that the perceived costs are vastly overestimated in most cases. “The real challenges and opportunities lie in organizational procurement practices. Advanced procurement practices enable organizations to design and build a wide range of high-performance facilities at prevailing market rates. This contrasts with traditional procurement strategies which are likely to incur higher costs and contribute to the perception of significant cost premiums,” Chris shared. On the other hand, if you are a speculative Investor, planning to hold the asset for a few months, accessing expensive capital, then achieving cost parity will be more challenging. The location can also impact net zero costs. For example, a 2021 California Energy Commission study found that optimally designed single-family and multifamily homes result in lower customer lifecycle costs for all-electric and mixed-fuel cases in all climate zones studied, but generally with higher initial costs.
Despite logistics and trade war challenges, key energy transition components are getting cheaper, and a trained workforce of service providers is now ready to install. Solar panel costs have declined over 90% since 2009. Post-Covid logistics challenges coupled with tariffs placed on Chinese solar panel producers during President Trump's office temporarily caused solar panel prices to rise. President Biden has since temporarily lifted the panel tariffs, while also incentivizing local productions in the U.S., and trade volumes have restored. It is expected that electric vehicles (EVs) and batteries will decline in cost by 50-70% by 2025 and will increase in market share and availability. Meanwhile, there is a need for many more chargers to meet the growing demand for where people work, live and play.
REDUCING COSTS
Government incentives, tax credits and grants are reducing the cost of net zero development and retrofits. Some of these include the Inflation Reduction Act (IRA), Department of Energy (DOE) grants and green affordable housing subsidies. This July, the Biden administration announced applications opened for the Community Energy Program providing grants with special savings for low-income households to increase home efficiencies and reduce energy costs. Another government program funds entrepreneurs who are converting sequestered carbon into new building materials. Utilities in many states also provide rebates to retrofit and install chargers, for example. A list of state-by-state rebate and incentive opportunities is available on DOE’s Alternative Fuels Data Center.
Creating agile new partnerships with supply chain providers can also reduce costs. For example, the Department of Energy led the novel procurement, acquisition and contract process of several large-scale replicable net zero energy office buildings and provided the blueprint for others to do the same within typical construction budgets. Requests for Proposals (RFPs) were leveraged to source from a broad range of partners. The study concluded that to achieve cost goals, owners must incentivize innovative design and construction teams through contractual requirements to meet specific demand side energy and LEED goals. Additionally, they established a voluntary incentive program - a financial incentive based on how well the owner feels the design-build team is meeting the RFP goals. See the complete “How To Guide” here.
In another example of innovative procurement, foam glass gravel made from recycled glass can be used in sub-slab insulation systems, and as lightweight fill for soft soil applications and green roof fill installations. However, a large developer may find it increasingly difficult to obtain such products from suppliers in the U.S. In fact, only a handful operate, and most production facilities are currently in scale mode. One such company, Glavel, is a B Corporation that prices competitively against traditional materials. Sourcing Glavel’s product may require stepping outside traditional suppliers or retraining to build new green partnerships for downstream suppliers. Finding ways to source innovatively and with agility, and invest in the scalability of these innovations, remains critical to cost reduction in long-term.
Building coalitions among partners can also reduce investment and payback periods. The Energy Coalition (TEC) helps public stakeholders to become energy-producing networks where clean energy is affordable and accessible. One of TEC’s projects includes Hermosa Schools in California. Funded by a municipal bond, SVA Architects designed the Hermosa School as net zero. Using microgrids and selling energy back to the grid, among other benefits, the investment in net zero development boasts a payback period of 4 years.
Accessing a lower cost of capital for net zero investments is another mechanism to improve ROI. Green discounts on financing, blended finance and sustainability commitments reveal that climate investments are resilient despite decreases in investment risk appetite globally.
Other alternatives include leveraging private companies to own, operate and manage energy and charging on-site. Renewables, EV charging and electric mobility as service models exist where capex is reduced, and services are professionally managed. MN8 Energy, for example, owns and operates over 3GW of renewable power distributed across the nation on commercial property rooftops. The company installs solar panels on commercial real estate and sells energy back to the grid. Other similar examples include:
Shell’s Sonnen owns and manages community power walls
OBE Power’s EV Charging for urban mixed-use
Envoy’s condo EV offering
Pearl X’s virtual power plants
Partnering with the above-mentioned companies can also reduce operating risk. Many property managers are not comfortable managing energy and charging - the new onsite utility and gas station. Smart products may be better managed remotely by dedicated teams to ensure reliability.
Continued investments in R&D and agility towards adaptation in the race to net zero carbon emissions in construction and property management also presents an opportunity. Fifth Wall suggested on a recent podcast that it is critical to invest in sustainable prop tech for real estate as well as actual deployments to get ahead of the wave, rather than waiting for the net zero tech to mature independently. R&D investment needs to pick up today to get products to scale. Their conclusion - better than just avoiding headline risk, turn a crisis into an opportunity.
MOVING FORWARD
Evidence also points to the most significant cost of all: inaction. Long-term real estate portfolio risk is highly exposed to climate change, and sustaining as a business requires adaptation. Achieving scientific targets to lower carbon emission levels requires investment across stakeholders of $1.8 trillion per year. However, starting in 2030, this investment would generate a return of $2.8 trillion per year, according to the Coalition for Urban Transitions, increasing to $7.0 trillion per year in 2050. This translates to an economic return of $23.9 trillion on a net present value basis over the next 30 years, supporting 87 million jobs annually by 2030. Today’s investments will pay off in reduced risk and new markets of opportunity.
ABOUT ALLIANCE GLOBAL ADVISORS
Alliance Global Advisors is a women-owned consulting firm focused on empowering the institutional investment community to elevate best practices. Advising clients with over $520 billion in assets under management, Alliance partners with organizations to provide an independent perspective and innovative approach to critical strategic initiatives. Our partnerships allow senior management teams to focus on what matters most: diligently managing client capital, creating value and delivering exceptional returns in a performance-driven market.
ABOUT LEBEC CONSULTING PARTNERSHIP
In 2022, Alliance formed an exclusive partnership with Lebec Consulting. Lebec Consulting is a women-owned and women-led firm that advises corporations, foundations, high-net-worth individuals, financial institutions and entrepreneurs on how to amplify their impact through philanthropy, impact investing and ESG investing. Lebec’s partnership with Alliance Global Advisors led to the expansion of a dedicated and experienced real assets ESG Team within the firm. All engagements related to real assets are exclusively conducted alongside Alliance Global Advisors, providing Alliance clients with a clear advantage. The ESG Team for Alliance Global Advisors has over 55 years of combined ESG/DEI experience. Since inception, the Alliance ESG Team produced and reviewed over 60 ESG/DEI policies, established ESG data collection practices, crafted tailored ESG/DEI implementation plans, facilitated reporting to UN PRI and GRESB and advised on pathways to net zero for leading institutional fund managers.
Disclaimer: This blog was originally published in August 2023 and will be updated periodically to reflect changes in the industry. The content may contain or cite personal and/or professional opinions that differ from the views of Alliance Global Advisors.
[1] https://www.un.org/en/climatechange/net-zero-coalition
[2] https://www.unep.org/news-and-stories/press-release/co2-emissions-buildings-and-construction-hit-new-high-leaving-sector