• State and local governments around the world are turning to Building Performance Standards (BPS) - which mandate specific building-level energy use and emissions reductions - as key policies to meeting their climate targets. As of early 2024, these policies cover about 25% of all buildings in the U.S.¹

• The limits set by BPS become increasingly stringent over time and typically include hefty fines for non-compliance. Across three leading BPS jurisdictions, 14% of buildings are estimated to be subject to penalties in the first round of limits, while 62% of buildings will face fines come the second round.²

• For building owners, investing in a future-ready capital planning approach that aligns with long-term energy and emissions performance goals not only ensures compliance with BPS but also presents an opportunity to enhance asset value and mitigate risks.

Every major city around the world has embarked on the journey to reduce emissions, many setting net zero targets by 2050 or earlier. Globally, buildings account for 40% of total emissions, but within cities, they are typically responsible for over 60%.³ So, while national policies are aiming to use tax schemes and corporate disclosure requirements to incentivize decarbonization, city governments looking to turn commitments into action are directly targeting emissions from real estate. 

Within most buildings, emissions generated during operation, as opposed to construction, represent a greater share of whole life-cycle emissions.⁴ To tackle existing buildings and their operational emissions, an increasing number of local governments are implementing Building Performance Standards (BPS) that set emissions or energy use limits, usually by property type, for the buildings within their boundaries. These limits become increasingly stringent over time and typically include hefty fines for non-compliance.

Adapted from the IMT

Focusing on three leading BPS jurisdictions - New York City’s Local Law 97 (LL97) which took effect this year, Boston’s emissions standards under its Building Emissions Reduction and Disclosure Ordinance (BERDO) that will take effect in 2025, and Seattle’s Building Emissions Performance Standard (BEPS), adopted in December 2023 and taking effect in 2031 - their approach to BPS and penalties differ greatly.

• Buildings that fail to comply with New York’s LL97 emission limits will face financial penalties of US$268 per ton of emissions that are in excess of the specified cap in a given year.

• Under Boston’s BERDO, buildings greater than 35,000 s.f. that do not meet emissions standards face a penalty of US$1,000 per day beginning in 2025, while smaller buildings (20,000 s.f. – 34,999 s.f.) will face a US$300 per day penalty for non-compliance starting in 2030.

• Failure to meet annual building emissions targets under Seattle’s BEPS includes a non-compliance penalty of US$2.50 per s.f. for low-income housing/low-rent multifamily buildings, US$7.50 per s.f. for other multifamily sites and US$10.00 per s.f. for non-residential buildings.

For New York and Boston, non-compliance rates are relatively lower in the first round of limits but quickly ratchet up come the second round and steadily increase thereafter. Across these three leading BPS, total fines faced by buildings given current emissions performance estimates will increase by an average of 82% between their respective first and second round of limits.

Note: Non-compliance and average penalties are calculated based on 2022 electricity/fuel usage and the city’s official emissions coefficients. Source JLL Research; NYC Dept. of Buildings, City of Boston, Seattle’s Office of Sustainability & Environment.

In terms of scale and the number of non-compliant buildings, the multifamily sector is typically the most exposed to penalties under BPS today. Across these three jurisdictions, there are nine times as many multifamily buildings that will be subject to fines by 2030/31 than the second most exposed sector, office. Many BPS authorities aim to avoid placing excessive financial pressures on low-income households and organizations that provide affordable housing. To do so, they often offer alternative compliance pathways that are less demanding. For example, while buildings that include affordable and rent-regulated housing are not exempt from requirements under LL97, they may be treated differently and be able to access more favorable options to avoid fines. It is important for building owners to get ahead of these nuances and ensure they are well set up to leverage these distinctions where applicable.

It is important to acknowledge that energy savings are often challenged by the ‘split incentive problem.’ A split incentive is when one party, usually the owner, incurs the cost of a capital spend on a building improvement while another, usually the tenant, incurs the benefit – typically in the form of operational savings. When this happens, we can expect owners to directly raise existing rents up to an amount equivalent to the total energy savings, but there are limitations.

Full-service lease structures can help mitigate this problem as owners would be responsible for utilities. Today, however, there are many cases where owners with triple net leases are finding creative solutions to reach a fairer distribution of costs and benefits. These include cost-sharing arrangements between the landlord and tenant, often using the tenant’s estimated savings in utility costs to finance the capital spend of the retrofit. Tenants and landlords will need to work together and find collaborative, ‘win-win’ agreements to ensure the capex needed for the building improvements required to comply with BPS makes financial sense across both parties.

Financial instruments, including energy-as-a-service (EaaS) and Commercial Property Assessed Clean Energy (C-PACE), coupled with incentives from the New York State Energy Research and Development Authority (NYSERDA) and local utilities, as well as tax credits like those available through the U.S.’s Inflation Reduction Act, can all help overcome the split incentive problem. With C-PACE or tax credits, cheaper, lower risk and longer-term sources of capital are available to pay for retrofits improving building performance while reducing or eliminating exposure to future penalties.

To reduce a building’s emissions, owners should seek improvements in energy efficiency, electrification – or the removal of onsite fossil fuel systems – and clean energy procurement. Improvements in energy efficiency should always be prioritized as most utility grids are not yet ready to supply 100% clean electricity. Moreover, energy efficiency improvements come with a range of added benefits. These can significantly reduce operational utility spend, mitigate challenges from energy price volatility and help streamline the broader transition to a decarbonized grid by reducing energy demand, especially during peak times.

When attempting to undergo a cost-benefit analysis to retrofit a building, relying solely on penalty avoidance to justify the capital spend is not always viable. Owners and investors must consider a broader ecosystem of factors.

To provide an example, JLL experts undertook a cost-benefit analysis for a prime office building in New York City – a 500,000 s.f. Class A office powered by natural gas and electricity. JLL mapped out possible decarbonization pathways, as shown above, and determined that a maximum Net Zero Carbon (NZC) retrofit would cost the owner nearly US$15 million and allow them to avoid over US$2.5 million in penalties, while also cutting energy costs by about 35%.

Although these two factors have a clear positive impact on the asset’s Net Operating Income (NOI), the short-term outcome is likely that the owner assumes the cost of penalties. Whether the cost to retrofit is justified solely by the avoidance of penalties will differ on a case-by-case basis, which is why it is important to consider a broader perspective as improving a building’s energy performance could yield a wider set of financial benefits.

Conducting the necessary works to comply with BPS will not only improve the property’s NOI but can also have a number of indirect value impacts. Compliance with BPS can enhance property value, both directly and indirectly, as this means the property is advancing towards net zero and, in doing so, is able to meet the increasing demand for sustainable, low carbon workspaces. This has the potential to drive higher occupancy rates and rents and gives properties a competitive advantage in a market where tenants are already favoring higher-quality spaces and, at the same time, having to show material progress towards incoming carbon reduction targets of their own.

JLL Research shows that an estimated 65% of demand for low carbon workspaces in New York City will not be met by 2030, given the current stock and low carbon construction. As building owners execute retrofits to become compliant with LL97, they become more appealing to both investors and tenants, and longer, more secure leases can be signed with investment grade tenants. This reduces a building’s overall risk, attracting global capital from both investors and lenders seeking to prioritize risk-adjusted investments. Assets will then become more liquid and investors holding such properties could expect to see higher exit prices and improved returns.

“Not only are non-compliant properties exposed to escalating fines, but they also face additional increasing risks associated with the fact that they are not low carbon properties. These assets could face indirect liquidity issues, for example, as they may prove more challenging to sell, leading to significant value erosion over time,” says Jaime del Alamo