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Last Updated, May 7, 2021, 11:03 AM
A Bill Is Coming Due for Greener Offices


Cutting carbon emissions is about reducing energy leakage from buildings as much as photogenic new technologies like wind turbines and electric cars. Property owners are understandably nervous about who foots the bill.

The U.S., the European Union and the U.K. all have plans to at least halve their carbon output by the end of the decade. Property, which generates nearly 40% of global emissions, will face stricter regulation. Although commercial real estate is less of a problem than residential, it will likely be targeted earlier as its ownership is less fragmented and less politically sensitive.

For developers, that points to higher construction costs. A net-zero office is up to 17% more expensive to construct, according to the U.K.’s Green Building Council. A green building is cheaper to run, but for now, most of the benefits go to the tenant. The evidence that property owners can charge higher rents in exchange for lower utility bills is mixed.

One report from real estate advisers JLL found that central London offices certified as sustainable get a 6% to 11% “green” rent premium. Skeptics say this probably reflects the higher rent a brand-new building would fetch anyway. Still, there is convincing data to show that green offices are leased more quickly. A clearer green premium may also emerge as corporate tenants pay more attention to their own emissions.

To reduce the sector’s environmental footprint, the most urgent priority is to overhaul existing properties. In the Netherlands, it will be illegal from 2023 to lease buildings that score below an energy grade C on the EU scale. Big listed office landlords, such as London-focused Great Portland Estates and New York-based

SL Green Realty,

will plow more money into their portfolios in the coming years to keep up with standards.

Landlords that delay overhauls risk having a “brown discount” applied to the value of less sustainable properties. Independent experts who value the portfolios of listed real-estate investment trusts aren’t using one yet. But they are trying to understand how to model the risk of higher capital spending and potentially lower exit values for older buildings.

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The discount also might become a reality due to new regulations for asset managers. Since March, the EU’s Sustainable Finance Disclosure Regulation has forced money managers to disclose the climate impact of investments. In the U.K., large pension funds will have to do something similar from October. If a building hasn’t been “greened,” it will probably face a smaller pool of buyers and lower sales value. Real estate consulting firm Green Street estimates that purchasers will want 50 basis points of extra yield to compensate for regulatory risks.

For some, this may present an opportunity. If institutional investors begin to unload “dirty” buildings cheaply, there will be a market to overhaul them and resell at a premium. German real-estate investment trust alstria buys buildings at around €3,000 a square foot, equivalent to roughly $3,620, and sells them for up to double that amount after investing in a green refurbishment.

The problem for commercial landlords is the number of refits needed, particularly in Europe, which has a larger stock of heritage buildings than the U.S. In London, just 9% of offices are certified as sustainable—half the proportion in Manhattan, data from Green Street shows.

On top of potentially weak demand for office space caused by a shift to remote working, real-estate investors need to start worrying about climate risks too.

Plexiglass dividers and floor decals might not be permanent, but the pandemic will bring lasting change to offices. Experts from the architecture and real-estate industries share how they are getting back to work and what offices will look like in the future. Photo: Cesare Salerno for The Wall Street Journal

Write to Carol Ryan at carol.ryan@wsj.com

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