Carbon Neutrality in Real Estate: Strategies for Success
As communities across the world continue to grapple with the effects of climate change, climate action is surfacing as a priority topic of concern for the real estate industry. A growing consensus from many large and small companies is spurring an unprecedented wave of carbon neutrality pledges.
In our previous report, we provided an introduction to carbon neutrality, including industry terms, frameworks, and the implications for the real estate industry. We highlighted the recent uptick in carbon neutrality pledges made by companies and covered the implications of these pledges on the real estate sector. This report will expand from that premise to examine how real estate investors are working to achieve carbon neutrality through goals, pledges, and the importance of defining comprehensive scopes and timelines. After this report, the third report in the series will focus on emerging domestic and international legislation and regulations in relation to carbon neutrality. The fourth report, in early 2022, will focus on a review of, and response to, the COP 26 summit in Glasgow.
Defining the boundaries (or scope) of the program
Measuring the emissions associated with the established scope
Setting goals to reduce emissions
Implementing programs that reduce emissions
Communicating the goals and results to relevant stakeholders
As the journey toward carbon neutrality progresses, these steps are repeated multiple times over the years to continually monitor, assess, and adjust carbon reduction initiatives and strategies to try and maximize results.
From the investor perspective, pledging to go carbon neutral may provide landlords with a competitive advantage through sustainability leadership and alignment with carbon neutrality pledges from tenants. It can additionally save money on operational costs while helping protect from current or potential legislation pertaining to carbon—such as the Sustainable Finance Disclosure Regulation (SFDR) in Europe and municipal regulations limiting buildings’ carbon emissions in a growing number of U.S. cities. Perhaps most importantly, it can help insulate assets from future devaluation while increasing the portfolio’s resiliency to an uncertain future. The next paper in this series will focus more on the risks associated with the changing regulations and laws associated with an asset’s carbon footprint, and how this may affect cash flows through potential fines or penalties.
Setting the Boundaries – Establishing the scope
Strategy 2: Determine Scope
The first step in embarking on a carbon neutrality journey is to identify what types of carbon emissions will be measured and included in reduction plans. For the real estate industry, carbon emissions are primarily either operational or embodied. Operational emissions are attributed to the sources and processes required to operate the property on a daily basis. Embodied carbon, which was discussed in the first report, consists of all the emissions associated with building construction, including those that arise from extracting, transporting, manufacturing, and installing building materials on site, as well as the end-of-life emissions associated with disposing of the materials when the building is demolished.
In addition, the Greenhouse Gas (GHG) Protocol, a widely accepted and internationally recognized emissions reporting and accounting standard, categorizes greenhouse gas emissions from any company into three groups or ‘Scopes’:
Scope 1 represents direct emissions that are emitted onsite from the landlord, such as from a natural gas furnace, etc.
Scope 2 covers indirect emissions from the generation of purchased electricity, steam, heating and cooling, which is generated off site, yet consumed by the reporting entity.
Scope 3 includes all other indirect emissions that occur in the value chain.
Figure 1 illustrates the types of scopes with examples of each and how they relate to the reporting company’s business activities.
WRI/WBCSD Corporate Value Chain (Scope 3) Accounting and Reporting Standard
Once a reporting entity considers its carbon impacts and has a better understanding of their scopes, boundaries can be established to achieve impactful targets, such as carbon neutrality. Some real estate investors only include operational emissions in their carbon targets, which would include Scope 1 and Scope 2. A second option would also include tenant emissions (Scope 3) from tenants operating in the building. Note that both these options are representative of only operational emissions. A sophisticated and even more aggressive approach would include also accounting for embodied carbon. Embodied carbon cannot be reduced after construction, so to eliminate these emissions relies on carbon removal mechanisms, such as the purchase of carbon offsets. Real estate developers can reduce embodied carbon, but that first requires accounting for them during the planning process.
Downstream Leased Assets”. Gathering emissions data from tenant-controlled areas is not always as easy as one might think, and it often requires green leasing clauses, cooperation from local utilities, and tailored operating agreements that can be put in place to aid in obtaining tenant data. Figure 2 gives an example of potential established boundaries a landlord could select when formulating the carbon reduction plan.ENERGY STAR® Portfolio Manager® to measure, track, and compare their own energy and water use. The ENERGY STAR Tenant Space recognition is a program provided by the U.S. Environmental Protection Agency (EPA) that can be used to demonstrate that a tenant space has met energy-efficient design criteria. It also offers free resources for office tenants, residential tenants, and others for reducing their energy and carbon emissions. Commercial tenants using ENERGY STAR Portfolio Manager are also able to easily share their energy and water data with their landlord, facilitating the emissions data collection process for the real estate investor.
MetLife Investment Management’s Journey
Strategy 3: Develop a Plan
MetLife Investment Management’s (MIM) Real Estate Group’s own response to the intensifying call for climate action was the implementation of the MetZero™ program, a customized approach that was developed to reduce carbon in equity real estate portfolios. As Figure 3 illustrates, MetZero™ utilizes the “Carbon Cascade” approach of tackling operational emission reduction, first and foremost. Reducing energy use in real estate portfolios saves money and reduces operational emissions. The next tranches of renewable energy through solar panels and power purchase agreements can further reduce operational emissions and lower exposure to utility price spikes.
Offsetting Remaining Emissions
When all on-site modes of carbon emission reductions have been exhausted, Renewable Energy Credits (RECs) and carbon offsets are alternatives to balance unavoidable emissions.7 Both RECs and carbon offsets help an organization reduce their carbon footprint, but they have different uses in supporting claims of carbon neutrality.
RECs seek to reduce emissions associated with purchased electricity (scope 2) by funding an existing renewable energy source and ultimately shifting more supply to renewable sources. Each REC represents the attributes of one megawatt-hour (MWh) of renewable energy and allows the purchaser to claim to use renewable energy. Some RECs are independently verified, such as those with Green-e® certification. The price of RECs tends to fluctuate cyclically each year, generally increasing during the first quarter of the year, through March—the deadline for building owners to purchase Green-e® RECs to offset their previous year’s consumption. Bundled RECs can be purchased locally for the property through Power Purchase Agreements (PPAs), where available, while unbundled RECs can be purchased at a national portfolio level for all properties in the U.S. When the owner of a REC makes a claim about renewable energy based on it, that REC is “retired”—which means that building owners cannot sell the same REC to another party once they’ve claimed credit for it.8 Currently, RECs have been responding to increased demand, and REC pricing has escalated higher, with 2021 being the most volatile year on record. MIM believes that REC pricing will continue to increase, due to more owners adopting carbon neutral goals.
Carbon offsets are utilized to ‘balance’ carbon emissions (primarily scope 1 or 3) using a specific activity that will remove, reduce, or sequester emissions in another location. An offset represents a metric ton of emissions avoided. Carbon offsets can be purchased from a voluntary market and help to finance a project such as installing a new, renewable energy power plant somewhere in the world. Other examples of carbon offsets are solar cookstoves and hot water heaters for families or municipalities. Because offsets don’t reduce carbon emissions at the source, offsets have sometimes been criticized for allowing companies to continue emitting carbon (and thus in some cases polluting the air) near their facilities.
One of the primary concerns with carbon offsets involves the concept of additionality, i.e., would buying the specific offset lead to a reduction in emissions that would not have happened otherwise? It’s important to question whether the purchase actually resulted in additional carbon being sequestered versus a project that was taking place and would have sequestered the same amount of emissions whether or not your offset had been purchased. An additional concern includes the permanence of offsets purchased. To achieve true carbon neutrality, the emissions must be kept out of our atmosphere permanently. For example, utilizing carbon offsets from a tree planting project that will then be cleared decades later negates some of the effectiveness of the offset. Additionally, carbon leakage is a concept that is associated with the notion that offset projects can drive others to emit in different locations. For example, a carbon offset project that preserves forest areas could drive locals in the area to simply clear forests in another location. This results in emissions ‘leaking’ as a result of the offset project. Other concerns with offsets include double-counting and verification methods as the offset market gains traction on a global scale. To help mitigate these concerns, it is important to work with a respected offset provider and only purchase carbon offsets that meet reputable and approved third-party standards.
RECs and Offsets can be an important strategy for reaching carbon neutrality after making on-site reductions such as deceasing energy usage, installing on-site renewables, and buying renewable energy, with the goal to reduce net emissions and need fewer RECs and offsets for the same set of properties, year over year. Some assets may be able to completely eliminate their operational emissions, such as a single-story industrial or retail building, with the installation of a large rooftop solar array; while other assets, like mid-rise multi-family communities and high-rise office buildings, may only be able to cover a small percentage of their operational emissions through on-site renewables and will depend more heavily on RECs and offsets. Portfolio owners must take these differences into account and work to reduce carbon emissions both at the asset level and across the portfolio.
MIM’s MetZero™ approach, as highlighted above, purposely employs the Carbon Cascade approach that seeks to reduce energy demand as much as possible, then moves to the use of renewable energy, and finally employs the use of carbon offsets or RECs to reach carbon neutrality in select portfolios. MIM sees this approach as an effective way to take climate action and achieve attainable carbon neutrality goals, while strategically establishing resilience to the portfolio. More details on this approach can be found in this recent paper, “Investors Expect and Demand Meaningful Environmental Goals and Progress”.
The Future Journey to Carbon Neutrality
MIM believes the real estate industry must transition away from, and disrupt, ‘business as usual’ investing. Our ecological (and economic) systems are stressed and overburdened by anthropogenic activities, and real estate has a major role to play in response. Investors committing to carbon neutrality and utilizing the strategies outlined in this paper are important first steps. While many investors are making commitments to achieve carbon neutrality by 2050, or in a similarly distant future, it is important that the industry focus on short-term progress and incremental goals.
In our next report in this series, we will delve into current and future legislation related to carbon neutrality, and how regulatory changes may affect real estate investing.
This material is intended solely for Institutional Investors, Qualified Investors and Professional Investors. This analysis is not intended for distribution with Retail Investors. This document has been prepared by MetLife Investment Management (“MIM”)1 solely for informational purposes and does not constitute a recommendation regarding any investments or the provision of any investment advice, or constitute or form part of any advertisement of, offer for sale or subscription of, solicitation or invitation of any offer or recommendation to purchase or subscribe for any securities or investment advisory services. The views expressed herein are solely those of MIM and do not necessarily reflect, nor are they necessarily consistent with, the views held by, or the forecasts utilized by, the entities within the MetLife enterprise that provide insurance products, annuities and employee benefit programs. The information and opinions presented or contained in this document are provided as the date it was written. It should be understood that subsequent developments may materially affect the information contained in this document, which none of MIM, its affiliates, advisors or representatives are under an obligation to update, revise or affirm. It is not MIM’s intention to provide, and you may not rely on this document as providing, a recommendation with respect to any particular investment strategy or investment. Affiliates of MIM may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives) of any company mentioned herein. This document may contain forward-looking statements, as well as predictions, projections and forecasts of the economy or economic trends of the markets, which are not necessarily indicative of the future. Any or all forward-looking statements, as well as those included in any other material discussed at the presentation, may turn out to be wrong.
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