ESG Presents Commercial Real Estate With New Challenges in 2024

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“Twelve months ago, I don’t think people were saying we are going to hit 1.5 [degrees Celsius] warming,” said Joanna Frank, CEO of the Center for Active Design, referencing the internationally agreed-upon upper limit of temperature increase for the planet. “Whereas I now really see that as somewhat of an inevitability.”

Disaster after disaster struck both the built and natural environments, impacting cities, states and regions previously unaccustomed to and ill-prepared for severe events. Over the summer, New York City was blanketed by smoke from Canadian wildfires; the June haze created an air pollution problem that called ventilation systems and air quality into question. Meanwhile, California — long known for wildfires as well as droughts — endured severe flooding, while rainstorms pummeled parts of the Northeast. 

The National Centers for Environmental Information reported that, as of Dec. 8, the United States had seen 25 weather and climate disaster events in 2023 where losses surpassed $1 billion. These disasters predominantly included severe storms, with one-off instances of a drought, a tropical cyclone, a wildfire and a winter storm, as well as two floods. 

“The shift in frequency of these extreme events has really shifted the dialogue,” Ariane Laxo, sustainability director at design firm HGA, said of resiliency and the built environment. 

Last year’s environmental extremities therefore encapsulates each aspect of ESG, intersecting with both social and legislative goals. “Every time we see an extreme climate-
related event — whether it’s a wildfire, whether it’s flooding, whether it’s drought — we see it borne out on the impact on people,” said Frank.

Yet, while the perception of climate change’s effects on commercial real estate has changed, the industry’s efforts still have a ways to go. Adaptation and mitigation investments, varying levels of regulation, financial incentives and projection data collectively elucidate the current state of ESG — and elucidate where opportunities lie in 2024. 

ESG principles widely adopted

For evidence of how far commercial real estate — not to mention the United States — has come, consider the overarching sentiment toward ESG. 

“I think the industry has really educated itself about ESG and how to respond to the risk that ESG is quantifying,” Frank said. “What [ESG means] is: How do I understand the full risk profile of an asset? And how do I mitigate, how do I quantify, that risk?” 

Over the past year, corporate public reports frequently referenced ESG, while net-zero has likewise gained more recognition than in years prior, said Laxo. 

Given the all-encompassing nature of last year’s climate events, ESG has blurred the boundaries between its three components. In 2022, Frank classified the “S” of ESG as an underused set of metrics, thanks in large part to a lack of quantification. In 2023, however, the perception of health and wellness shifted; they’re no longer seen exclusively in reference to combating diseases. Rather, ESG’s social elements also refer to the creation of environments where people can thrive. So, strategies for climate resilience double as strategies for social benefits. 

Yet despite its headway last year, the term “ESG” is not set in stone. Frank noted that the evolution of the name will be interesting to track. She doesn’t know how the expression will evolve, though she believes its fundamentals will endure. They’re that entrenched now. 

“Three years ago we were going into a room of real estate professionals and asking if anyone had heard of ESG,” said Frank. “Last year, we were still opening with that question and getting a good show of hands in the industry. … This year, we’re not even asking the question.” 

Business priorities expose challenges 

Although ESG has been folded into real estate’s discourse, 2023’s climate emergencies highlighted the urgency of adaptation and mitigation efforts — and exposed real estate’s wavering priorities. Commercial real estate experts generally believe sustainability should be the bottom line, but its value has yet to be fully understood and embraced.

HGA’s clients, for example, have struggled to balance priorities, as budgets have been set in years prior to the current climate and prices have continued to fluctuate post-pandemic. At the end of 2022, HGA conducted a survey with the University of Minnesota Climate Adaptation Partnership that found about 60 percent of fellow architecture and engineering firms offer services related to sustainability.

“That should be at 100 [percent],” said Laxo, who’s based in Minneapolis. “We should see every single architecture and engineering firm saying that sustainability and decarbonization is an integral part of their practice — and we’re not there yet.”

Beyond sustainability services, outcomes have likewise fallen short of goals, and not just in commercial real estate. According to Siemens research, roughly 40 percent of surveyed global senior executives believe it “likely” or “very likely” that their companies will meet their decarbonization goals for 2024. “The majority of executives will need to prioritize the bottom line,” Stefan Schwab, CEO of proptech company Enlighted, owned by Siemens, said in an email to Commercial Observer. 

Schwab referred to the situation as a “great divide” that indicates a lack of uniform progress across companies and countries. Executives have yet to widely accept that sustainability is not a trade-off that works against business; rather, it increases value and can be a financial driver, leading to cost reductions and better business. 

“If we could work towards a place where impact on planet and impact on people were of equal importance as the dollar, we would start seeing really creative and innovative solutions,” said Laxo. 

Mitigation efforts add value

Investments in sustainability threaded the year together. Adaptation and mitigation endeavors come with costs made up for in added value. Such financial benefits highlight an opportunity for commercial real estate in 2024.

Eco-friendly, energy-efficient infrastructure will both attract and retain tenants who prioritize sustainability, Jonathan Kaufman Iger, CEO of owner Sage Realty, said in an email. These installments have proved wide-ranging and include solar panels, green roofs and more efficient heating and cooling systems. Similarly, the push toward electrification charged 2023’s mitigation efforts in the United States and across continents. 

“The most sought-after sustainable features include EV chargers in every building as a response to the surging demand for EVs amongst prospective homebuyers,” David West, founding partner at NYC-based Hill West Architects, said in an email. 

West also highlighted electric induction cooktops and HEPA air filtration, the latter of which addresses air quality issues like those incited by this year’s wildfires. 

In line with decarbonization, growing public pressures may spur more limited project resources. A small percentage of companies and individuals bear responsibility for most emissions, and if the Securities and Exchange Commission (SEC) continues with its proposal to make carbon emissions transparent, public companies in particular could face more pressure, said Laxo. She believes we’re about to hit a tipping point. 

“Hopefully, [changing public pressure] leads to a transformation in practice, even if we don’t see the regulatory commitments follow through,” she said.

Adaptation efforts skyrocketed

In 2023, climate responses shifted to a more cynical — but necessary — sentiment: the need to prepare for a warming world of ongoing natural disasters. Adaptation methods span all stages of real estate, from design and construction to later maintenance and operations. 

“Now, we’ve reached the point statistically where we see that it is no longer possible to limit some extent of warming and that we do need to also look at doing more than limiting,” Laxo said. “Now, we also have to start to adapt to that change.”

Many resilience techniques are place-specific. Real estate in coastal cities, for example, widely utilizes stormwater management systems and flood precautions. 

Soaring insurance spurs investments

Climate wasn’t the only risk factor of 2023. Additionally, risks of a recession characterized the year, which opened with questions of economic uncertainty. While that recession never arrived, real estate endured a slew of financial setbacks, including rising construction costs and skyrocketing insurance rates. 

The cost of insurance, in particular, had some of the biggest impacts on real estate this year, said Frank — a trend she didn’t expect. These included a steep increase in insurance premiums across the sectors of affordable and student housing. “The first half of the year we’re all talking about interest rates, and the second half of the year we’ve all been talking about insurance rates,” she said. 

Rising insurance rates directly connect to resilience measures, propelling asset owners to better mitigate risk. Owners want to prove to their insurance companies that, even if an asset exists within a flood or a fire-prone zone, infrastructural strategies can counteract the risk of potential disaster.

In Louisiana, for example, state law actually requires insurance companies to dole out discounts for buildings that install fortified roofs, said Peter Waggonner, public policy director for economic development nonprofit Greater New Orleans Inc. Fortified roofs are less inclined to come off during hurricanes, thanks to different nails, protections and coverings, Waggonner said. The state also has a grant program that financially supports homeowners who install fortified roofs. 

“This cumulative effort in Louisiana makes us more attractive to insurance carriers who now say Louisiana is a safer place,” said Waggonner, who sees such policies as a trend for 2024. “People are really investing in their resilience.” 

Many local jurisdictions have similar regulation in incentive programs in place to help homeowners and landlords prepare for disaster.

Regulation holds the power

Both new and ongoing regulations impacted climate efforts in 2023. The White House allocated $6 billion toward climate resilience in November, while the Inflation Reduction Act continued to dole out incentives for greener energy. 

“[The Inflation Reduction Act] will continue to facilitate emissions reductions through tax credits and deductions for energy efficiency, renewable energy and cleaner manufacturing; investment in green workforce development; and electrification rebates,” Amanda Kaminsky, Lendlease Americas’ director of sustainable construction, said in a statement to CO. 

For commercial real estate, however, the power also lies in place-specific policies. Local regulations, from citywide carbon-cutting initiatives such as New York City’s Local Law 97 to statewide resilience endeavors, contributed to the acceleration of decarbonization and climate adaptation. 

These laws may also set the precedent for 2024, especially if they harness those all-too-important financial incentives. 

“If more states adopt a zero-energy code, we actually could see a blanket change across the country and the dollars available,” Laxo said.  “Tax incentives, through the Inflation Reduction Act, for example, are really helping.”

Many states have led by example. Parts of Massachusetts adopted an updated stretch code that requires solar on more roofs, while the city of Fort Worth, Texas, has focused on heat, scaling overarching climate problems to a more local, tangible level.

“We won’t get anywhere on these issues as complex as climate change without partnership,”  Fort Worth Mayor Mattie Parker told Commercial Observer in September, highlighting the city’s focus on natural land and waterways. Specifically, Fort Worth works with the Regional Integration of Sustainability Efforts Coalition to tackle climate challenges. 

Data can design the way 

Preparing real estate for an uncertain future in 2024 and beyond is no straightforward feat. Just as there’s risk in not planning or preparing for environmental emergencies, there is likewise risk in designing for something that doesn’t happen. By the time construction on a building finishes, the state of the climate may be drastically different. 

An owner could therefore invest money into, say, enlarging a stormwater management system, only for the rain not to come, said Laxo.

To make more informed decisions, reputable climate projection data — like that from the National Climate Assessment or Intergovernmental Panel on Climate Change  — will become particularly useful. Data, as a scenario-planning device, can help alleviate some uncertainties in 2024 and beyond so the industry can better evaluate possible outcomes of a building’s design.  

For the most informed investments, however, commercial real estate best benefits from a downscaled level of data: information closer to a project site, rather than at the county or regional level. 

Minnesota, for instance, has invested in a set of downscaled climate projection data to examine valid, reliable climate projections. “We’re not only considering how we can optimize energy use reduction for right now and design for net-zero, we also are looking well into the future,” said Laxo. 

Just as data’s place of origin matters, so does its time of collection. Given the changing trends, historic data is not necessarily an accurate indicator of the world’s direction. The abnormal atmospheric river events in California, for example, don’t align with the state’s previous patterns of droughts and wildfires. Such “global weirding” — as climate scientist Katherine Hayhoe categorizes the unpredictable, extreme climate — underscores the importance of making as informed a decision as possible. 

“We’re not living in dull times,” said Frank.