Jon Douglas of Menkes Shares How Real Estate ESG Drivers Have Changed in Canada in the Past Decade
I remember being asked 10 years ago when 25 York Street became the first building in the City of Toronto to achieve LEED Platinum certification; why did the property strive to achieve this? My answer to that question was the motivations of the tenants. At that time, the building was trying to attract discerning tenants to the property: Those who were demanding third-party sustainability certifications. Fast forward a decade, and asked the same question today, my answer has less to do with tenants.
When 25 York Street was being constructed, it was part of a group of four new office towers being developed in downtown Toronto to expand commercial real estate. These developments were constructed in response to the early real estate boom the City of Toronto experienced over the past decade. The addition of over two million square feet of office space was something the City had not experienced in a long time. At the time, all four towers were pursuing the relatively new sustainability certification, Leadership in Energy & Environmental Design (LEED), which set these developments apart from others. This certification aimed to incentivize organizations to change locations, away from their current space, into a more sustainable one. This marketing point was critical in a time when the industry was starting to experience impacts from the Great Recession due to the financial market crisis.
During this time, landlords observed that tenants wanted to be exclusively in LEED buildings. Some major institutional tenants even stated publicly that they would only move into LEED-certified buildings. Canadian financial institutions were some of the early organizations putting these sustainable policies in place for their corporate offices. It’s a common saying in the real estate industry “where the banks go, so does the industry.” Because of the size, influence, and desirability of these institutions, landlords started to respond. More and more properties were looking at green certifications to both attract and retain tenants.
I have never been a believer that LEED-certified buildings could demand or achieve a “green premium” for their sustainability certifications, but I advocate for there being a “brown discount.” Buildings that did not have LEED certification or could not obtain it, would not be able to achieve their full lease rate potential. Having to compete with the shiny new towers and their sustainability certifications was seen as a large risk to existing assets. This has led us to today where, for a AAA commercial space in downtown Toronto, LEED certification at the gold level is table stakes.
Ten years after the original four towers were completed, there have been many new commercial office towers added to the Toronto skyline. The City has seen millions of square feet of office space achieve sustainability certifications. Naturally, we would think that tenants had continued to demand increased performance for sustainability over the past decade. Though that is somewhat true, the real pressure to push sustainability performance is now from investors. Over the past ten years, investors have started to see more regulations applied to them for emissions and their climate exposure risk. They have seen the popularity of programs like the Global Real Estate Sustainability Benchmark that guides the portfolio of assets for their sustainability performance, and can also increase and create competition among investors.
More and more investors are committing to reducing their emissions to comply with the Paris Accord , which is driving buildings to figure out ways to reduce energy consumption on a larger scale. The idea of fuel switching or pursuing a new HVAC system a decade ago would have been unheard of; today, these conversations are starting to happen as a result of conscious investors who are looking for ways to reduce emissions to meet their corporate commitments.
Why does this change matter, and why is it a good thing? Investors being the driving force, rather than tenants, is beneficial to us as a society to meet the climate emergency challenge. Investors make financial decisions that have a huge influence on the quantity of emissions we produce. When we look at the major sources of emissions, there are a couple of big culprits: steel production, agriculture, cement production and electricity generation. While individual consumers do have some influence on our choices (a good example is buying an electric vehicle), the largest culprits of greenhouse gas emissions are generally out of an individual’s control. As Bill Gates says in his new book, How to Avoid a Climate Disaster, “people don’t buy steel, corporations do.” If we want to change and innovate how steel is made along with other large sources of emissions then corporations need to be held accountable. In the next ten years, buildings are going to see a lot of pressure to find ways to cut emissions to meet our climate change goals, which will be particularly challenging for older buildings.
These days I worry more about our investors’ climate change commitments and what they mean for our buildings versus what our tenants will request. The next ten years will present a lot of challenges. However, those challenges will push us to exceed the industry benchmarks of today, to meet the increased investor demands, and embrace innovation at a new level.