Climate Change: Risks &
Opportunities in the
Canadian Commercial
Real Estate Market
KPMG LLP
Climate Change:
                                                                                                          ...
Although buildings use a lot of energy, the   emissions reduction. This is due partly to   from practically zero 20 years ...
Perhaps the main reason for slow              regulate GHG emissions, and it is working    reporting. Currently the US doe...
• Improvements in the energy efficiency     It is anticipated that EPA will accept all of   satisfying specific “green”bui...
Managing Risks
                                                                                                         Gi...
One of the questions the CDP asks each year is: How are financial risks related
to GHG liabilities and assets being manage...
Canadian Signatories 2009                                            Hospitals of Ontario Pension Plan (HOOPP)

          ...
a well-constructed GHG information      The resulting baseline of GHG emissions
management plan. Elements of such a     al...
Enhancing Opportunities
                                                                                                  ...
In Canada, the market for Green Power        expedite a permit, or sign a lease with         Summary
Certificates is volun...
kpmg.ca




The information contained herein is of a general nature       KPMG and the KPMG logo are registered trademarks...
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Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market

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A report by KPMG taking a look at the impact of sustainability on the commercial real estate market in Canada.

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Transcript of "Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market"

  1. 1. Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market KPMG LLP
  2. 2. Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market The Challenge Climate change has been called the greatest challenge of the 21st century. Its social, environmental, and financial impacts cross all segments of society. Commercial real estate will now be bought and sold within the constraints of a new “low-carbon” economy. The challenge will be to align incentives such that owner/operators, investors, and tenants all benefit from improved environmental performance— independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. © 2009 KPMG LLP a Canadian limited liability partnership and a member firm of the KPMG network of especially improved energy efficiency. Contributing to the Problem Commercial buildings are a major source of both direct and indirect greenhouse gas (GHG) emissions. Direct GHG emissions come from the on-site combustion of fuels for heating and cooling, as well as the on-site use of refrigerants, which are powerful greenhouse gases. Indirect emissions come primarily from the GHGs released from fuel combustion related to producing construction materials and electricity used in the buildings. In 2005, the International Energy Agency estimated that buildings account for 20 to 40 percent of the world’s energy use, a number that varies greatly depending on a country’s climate and economy.1 In Europe, for example, buildings use about 40 to 45 percent of the total energy consumed. A recent estimate for North America is 46 percent, from which 8 percent can be attributed to the embedded energy of the materials used in construction. The commercial building sector in Canada is estimated to account for 13 percent of Canada’s carbon emissions and , 14 percent of end-use energy consumption.2 2 Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market
  3. 3. Although buildings use a lot of energy, the emissions reduction. This is due partly to from practically zero 20 years ago, to over potential for drastic reductions in energy the fact that most measures aimed at 1.2 percent of total US energy consumption is significant. With proven reducing GHG emissions from buildings consumption.4 and commercially available technologies, also result in reduced energy costs over the energy consumption in both new and a building’s life cycle, which eventually Slow Adoption of Energy old buildings can be cut by an estimated offsets any incremental investment cost. Efficiencies 30 to 50 percent while producing a Indeed, energy reductions in buildings favourable return on the initial may evolve as a financial asset—a Although the potential to improve investments. Instead of contributing to carbon offset to be traded (an building energy efficiencies to reduce the problem, financial leaders in the opportunity described later in this GHG emissions is significant, the independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. © 2009 KPMG LLP a Canadian limited liability partnership and a member firm of the KPMG network of commercial real estate sector have found paper). As the carbon market goes industry has been slow to act. For ways to be part of the solution. global and the cost of carbon increases, example, Canadian buildings constructed GHG emissions threaten to become a between 2000 and 2004 use on average significant business liability. “Clean” only 7 percent less energy than those Untapped Potential constructed prior to 1920. businesses’ low exposure to climate risk Canada has more than 440,000 could represent a valuable asset. commercial and institutional buildings Despite years of government and utility- representing floor space of over The energy performance of commercial sponsored grants and incentive programs, 670,000,000 m2 and consuming over buildings is affected by several factors. as well as energy audits indicating 1,036,000,000 GJ of energy (or For large commercial buildings, favourable returns on investments, there 287,800,000,000 kWh)3 annually. (In geographic location is much less has been little progress in wide-scale comparison, the amount of energy important than building use for adoption of energy-efficiency required to supply the Montreal Metro determining energy performance. For improvements, especially retrofits to each year is approximately a million GJ). example, food services facilities use existing buildings. Historically, energy has approximately four times more energy per been inexpensive and viewed as a minor The Intergovernmental Panel on Climate square foot than wholesale and or uncontrollable cost of business to be Change (IPCC) stated in its fourth warehouses, and just under double those simply passed on to customers. In assessment report that not only does the of office buildings. Another example of addition, there is confusion regarding the building sector have the largest potential energy-intensive commercial real estate is costs, risks, and payback of current for significantly reducing GHG emissions, computer data centres. According to a US energy-efficiency technologies. , but also that this potential is relatively Department of Energy report, the energy independent of the cost of GHG consumption by data centres has gone Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market 3
  4. 4. Perhaps the main reason for slow regulate GHG emissions, and it is working reporting. Currently the US doesn’t have adoption is that incentives are not aligned toward a protocol for both new and federal climate regulations, but most among commercial real estate existing commercial buildings that the believe that will change as early as 2010. stakeholders. For example, the short-term federal government could adopt. British Proposed legislation may make up to 1.5 financial benefit of lower energy bills Columbia has taken Alberta’s lead as the billion tonnes of international offsets resulting from investments by building first province to make a commitment to available to US federal cap and trade owners typically accrues to the tenant. a carbon-neutral public sector by 2010. markets. With the price of these Likewise, the long-term benefit of energy- By 2011, through the Pacific Carbon regulatory carbon credits to trade from efficiency investments by tenants typically Trust provincial Crown Corporation, BC USD$5 to USD$15 per tonne, the total accrues to the building owner as a capital expects to purchase between 700,000 market value becomes compelling. The improvement. Keeping energy costs low and 1,000,000 tonnes of CO2-equivalent price for carbon offsets in Canada may be is not a common motivator for building offsets each year. KPMG Performance even higher. The current structured operations and maintenance (O&M) Registrar Inc. has been active in the purchase price of BC carbon offsets by independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. © 2009 KPMG LLP a Canadian limited liability partnership and a member firm of the KPMG network of contractors. Nor is it common for verification of these high-quality the BC government is CAD$25 per architects to budget more for design carbon offsets. tonne.5 improvements that exceed building codes or historic expectations. In the US, both the Environmental Another GHG emission regulator program Protection Agency (EPA) and the Western that may affect Canadian commercial real Because of the potentially catastrophic Climate Initiative (WCI) (a partnership estate is the Regional Greenhouse Gas impacts of keeping the status quo, between seven US states, British Initiative (RGGI). This regional effort governments, industry organizations, Columbia, Manitoba, Ontario, and involves 10 Northeastern and Mid-Atlantic and investors are stepping up to Quebec) each include commercial states and has Quebec, New Brunswick, create change. buildings in the scope of proposed and Ontario as official observers. regulated entities. Under the EPA’s Although the RGGI currently caps only mandatory reporting rule, only facilities GHG emissions from electric utilities, it North American Regulations (related grouping of buildings) with more allows for the sale of both emission While the Canadian commercial buildings than 25,000 tonnes of CO2-equivalent allocations (permits) as well as carbon sector is currently not covered directly by emissions annually are required to report offsets. These offsets can come from a any GHG emissions regulations, there are emissions. From a practical standpoint, variety of emission reduction projects, developments both in Canada and the US only the largest warehouses, office and/or including commercial buildings that have that could change that. Alberta was the entertainment complexes, shopping implemented one or more of the first jurisdiction in North America to malls, hospitals, and universities will be following energy conservation methods: , 4 Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market
  5. 5. • Improvements in the energy efficiency It is anticipated that EPA will accept all of satisfying specific “green”building criteria. of combustion equipment that RGGI’s offset protocols, including those Projects earn credits in categories, provides space heating and hot water, for energy-efficient buildings. In addition, including: including a reduction in fossil fuel proposed US and Canadian federal consumption through the use of solar legislation gives “early action” credits to • Sustainable Sites and geothermal energy those carbon offset owners (foreign or • Water Efficiency domestic) that have already implemented • Materials & Resources • Improvements in the efficiency of international standards, such as ISO • Energy & Atmosphere heating distribution systems, including 14064-3, and been verified as doing so. • Indoor Environmental Quality. proper sizing and commissioning of heating systems EPA, WCI, and RGGI are considered The average LEED-certified building is bellwether regulatory regimes strongly designed to use 32 percent less • Installation or improvement of energy influencing federally legislated language in electricity and results in 350 tonnes less independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. © 2009 KPMG LLP a Canadian limited liability partnership and a member firm of the KPMG network of management systems Canada. It seems inconceivable that of carbon dioxide emissions annually.6 Canadian commercial buildings will not be However, additional analysis shows very • Improvement in the efficiency of hot affected either directly or indirectly (e.g., little correlation between the awarding of water distribution systems and through potential offsets) by North LEED energy-efficiency points and actual reduction in demand for hot water American climate change regulations energy savings. In some studies, 28 to 35 within the next two years. percent of the LEED-certified buildings • Measures that improve the thermal performed worse from an energy-savings performance of the building envelope standpoint than their conventional Leadership in Energy and and/or reduce building envelope air counterparts.7 This has prompted the Environmental Design (LEED) leakage organizations of the Green Building In 2000, the US Green Building Council Council to develop several new versions • Measures that improve the passive launched the Leadership in Energy and of the LEED rating system, which have solar performance of buildings and Environmental Design (LEED®) Green been released over the past few months. application of active heating systems Building Rating System as a tool to help These new versions are based more on using renewable energy build energy-efficient, resource-friendly, performance verification, similar to the and healthier structures. In Canada, the US EPA Energy Star program, than on • Switching to a less carbon-intensive program is administered by the Canadian design modelling. However, verification fuel for combustion systems, Green Building Council (CaGBC). The and disclosure of site-specific including the use of liquid or gaseous LEED Green Building Rating System is a performance information can raise a eligible biomass, provided that point-based system in which building number of unexpected business risks. projects earn points or credits for , conversions to electricity are not eligible under the RGGI regulation Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market 5
  6. 6. Managing Risks Given that regulations and industry standards are quickly evolving, ignoring the resulting regulatory, reputational, and financial risks or missing the potential opportunities could be a serious strategic mistake. Regulatory Non-compliance with emerging regulations is of the most concern. As previously independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. © 2009 KPMG LLP a Canadian limited liability partnership and a member firm of the KPMG network of mentioned, the Canadian commercial buildings sector is currently not covered directly by any GHG emissions regulations. However, assuming the Canadian federal government follows the US and regional initiatives, this could change. Initial regulations will most likely focus on only the largest facilities, including office, shopping, and entertainment complexes (e.g., those with over 25,000 tonnes of CO2-equivalent emissions). This doesn’t mean that real estate investors and managers won’t be affected. On the contrary, anchor tenants from regulated industries or those who have committed to voluntary emission reductions will be (if they are not already) demanding energy and refrigerant-use information. Expect this demand to be formalized in amendments to standard lease agreements. Be proactive and understand this request while protecting the confidential and competitive use of energy performance data. Because of the uncertainty associated with evolving GHG emissions regulations, regulators are often unable to provide specific guidance. When it comes to zoning variances and permit requests, municipal officials are under public pressure to include climate considerations. Commercial real estate developers and investors who are unprepared to address climate considerations risk unfavourable treatment, , delays, and additional fees. 6 Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market
  7. 7. One of the questions the CDP asks each year is: How are financial risks related to GHG liabilities and assets being managed? Being able to confidently answer this question reflects on the reputation of a commercial real estate entity. Reputational to take action to prevent climate change. potential financial exposures. For Today, over 475 institutional investors are example, are future liabilities related to An important component of conducting CDP signatories, with assets under poor energy efficiencies, negative tenant commercial real estate transactions is independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. © 2009 KPMG LLP a Canadian limited liability partnership and a member firm of the KPMG network of management of over USD$55 trillion. In reactions, or unfavourable zoning and each party’s reputation. Being “out of addition, some 60 purchasing permitting being properly valued? Have touch” with social, economic, and organizations, such as Walmart, PepsiCo, ownership rights related to accrued environmental issues such as climate and Cadbury, have joined in 2009 as part energy efficiencies, Green Power (or change can lead to delays and mistrust. of CDP’s new supply chain disclosure renewable energy) Certificates, and/or Who wants to do a deal with, or invest in, initiative. With this kind of global GHG emission reduction offsets been someone who doesn’t understand the full coverage, it is likely almost every major addressed in commercial leases or other risks as well as the full potential of any commercial real estate project is or will legal agreements? How do environmental given project? This can lead to a decrease be affected. In Canada, 40 major factors affect purchase/selling price, taxes, in seeing the best deals, restricted access investment groups participated in 2008. insurance, and other potential financial to favourable capital, and even more Many of these investors have vast responsibilities? delays. Managing this risk involves commercial real estate holdings. strategic disclosure of key reputational Having a clear carbon management indicators starting with the investment strategy should be part of any large community. Financial commercial real estate holding. This Commercial real estate entities need to strategy starts with assessing the GHG The Carbon Disclosure Project (CDP) was understand and account for current and emissions related to the entire portfolio started in 2000 by a handful of future carbon liabilities and assets as an (know your carbon footprint). Because you institutional investors to collect and important part of comprehensive Merger can’t manage what you don’t measure, distribute high-quality information to and Acquisition (M&A) due diligence. New gathering GHG information should follow motivate corporations and governments checklists are being developed to assess , Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market 7
  8. 8. Canadian Signatories 2009 Hospitals of Ontario Pension Plan (HOOPP) Acuity Funds Inhance Investment Management Inc. Addenda Capital Inc. Jarislowsky Fraser Limited AGF Management Limited McLean Budden Alberta Investment Management Corporation (AIMCo) Meritas Mutual Funds Alberta Teachers Retirement Fund Natcan Investment Management Beutel Goodman and Co. Ltd. National Bank of Canada Blue Marble Capital Management Limited Northwest and Ethical Investments LP BMO Financial Group OMERS Administration Corporation British Columbia Investment Management Corporation Ontario Teachers Pension Plan independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. © 2009 KPMG LLP a Canadian limited liability partnership and a member firm of the KPMG network of CAAT Pension Plan Phillips, Hager & North Investment Management Ltd. Caisse de dépôt et placement du Québec PSP Investments Canada Pension Plan Investment Board Royal Bank of Canada Canadian Friends Service Committee (Quakers) Scotiabank Catherine Donnelly Foundation Sprucegrove Investment Management Ltd. CI Mutual Funds’ Signature Advisors Sun Life Financial Inc. CIBC TD Asset Management Inc. Comité syndical national de retraite Bâtirente The Co-operators Group Ltd. Evangelical Lutheran Church in Canada Pension Plan for Clergy The Daly Foundation and Lay Workers The Presbyterian Church in Canada Fondaction CSN The United Church of Canada – General Council Front Street Capital Toronto Atmospheric Fund Genus Capital Management Vancity Group of Companies Groupe Investissement Responsable Inc. York University Pension Fund GrowthWorks Capital Ltd. Youville Provident Fund Inc. , Guardian Ethical Management Inc. 8 Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market
  9. 9. a well-constructed GHG information The resulting baseline of GHG emissions management plan. Elements of such a allows for tracking improvements, plan include: certifying reductions for carbon offsets, and creditable reporting to key influencers • Organizational and Operational within the commercial real estate market. Boundary Conditions These influencers include investors, regulators, and anchor tenants. Increased • GHG Quantification Process, pressure from these influencers on Procedures, and Methods commercial real estate entities will result in more “green” buildings. • Data Quality Control and Management Although the regulatory, reputational, and independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. • Ongoing Roles and Responsibilities financial risks are quite real, perhaps the © 2009 KPMG LLP a Canadian limited liability partnership and a member firm of the KPMG network of greatest risk involves missing the • Auditing and Verification opportunities related to drastic changes in regulations and public perceptions. } } Investors Commercial Regulators Real Estate “Green” Buildings Holdings Anchor Tenants , Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market 9
  10. 10. Enhancing Opportunities In their newly updated book, Green to Gold: How Smart Companies Use Environmental Strategy to Innovate, Create Value, and Build Competitive Advantage, Yale University authors Daniel Esty and Andrew Winston make the case that sustainability should be a core strategic business element of any business. They focus on addressing social and environmental concerns as a way of turbo-charging economic returns. Commercial real estate is no exception. The benefits can be significant if the right strategies are implemented. Turning “Green” Real Estate into Gold As presented, energy savings from LEED buildings can be quite variable, especially independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. © 2009 KPMG LLP a Canadian limited liability partnership and a member firm of the KPMG network of under earlier versions of LEED scoring. Nonetheless, the public perception of “green” value is quite real. The CoStar Group, an information company that tracks 44 billion square feet of US commercial space, reports that LEED buildings generate rent premiums of USD$12.25 per square foot over other buildings, enjoy a 4.1 percent higher occupancy rate, and sell for USD$184 more per square foot. Nevertheless, LEED buildings incur no more than a 2.5 percent cost premium upfront to design and build. Commercial real estate groups should realize that the economics are becoming even more compelling, particularly since a Canadian national market for carbon offsets related to building efficiency is on the horizon. It is important to track developments in regulatory carbon markets internationally, especially those involving energy efficiency and related carbon credits (offsets). Before this happens, forward-thinking companies will have long-term real estate agreements in place addressing development, ownership, and sale of all environmental attributes accrued from their commercial property. Don’t assume the environmental benefits accrue to you because you own the property. Unlike energy-efficiency projects, the production and purchase of Green Power Certificates are a very hot topic. Commercial building owners with large rooftops , or those found in windy areas are finding opportunities to generate and sell renewable or “green” power. Not only does the electricity have value—more than the market rate—but also, more importantly, the resulting Green Power Certificates have a value that is growing by the day. 10 Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market
  11. 11. In Canada, the market for Green Power expedite a permit, or sign a lease with Summary Certificates is voluntary. However, 29 someone who is perceived as being as The “greening” of commercial real estate US states and the District of Columbia “out of touch” with current trends? is not a fad, but rather a fundamental have Renewable Energy Portfolio change. Real estate groups that want to Standards, meaning that, by a given Energy savings, carbon offsets, Green attract the best deals, strategic investors, date, a certain percentage of the state’s Power Certificates, or premium rentals for and marquee anchor tenants should energy production must be from “green” space are all examples of very realize this change. Leaders in renewable energy. Pending US federal real opportunities. Leaders in commercial commercial real estate need their climate and energy legislation has a real estate will address these advisers to help them reduce these mandatory federal target, thus a national considerations in their buying strategies, strategic risks while enhancing business Renewable Energy Portfolio Standard. operations, and sales. It will be an integral opportunities in this new low-carbon Assuming integration between US and part of the way they do business. economy. Canadian environmental markets, the opportunity could be quite large for Yes, there are risks, but risks can be independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. © 2009 KPMG LLP a Canadian limited liability partnership and a member firm of the KPMG network of Canadian commercial building owners. managed. Leaders are proactive in KPMG Contact Even if commercial real estate groups designing their lease agreements to Diane Jeffreys don’t want to get into the power address potential financial exposures. National Industry Leader generation business, there is a fast- They work with regulators, tax advisers, Building, Real Estate and Construction growing number of alternative-energy and insurance companies that are KPMG LLP project owner/operators that could focused on “green” issues to achieve 416-777-8411 handle project development. These facility zoning/permitting, reduce tax djeffreys@kpmg.ca kinds of subleasing arrangements are burdens, and potentially lower insurance yet another mechanism to enhance total premiums. This results in a competitive 1 Natural Resources Canada, Natural Energy Use real estate development value. advantage to those who have stepped Data Base, 2005. forward. 2 National Round Table on the Environment and Economy (NTREE) & Sustainable Technology Leadership Can Pay Off Development Canada, “Geared for Change: It has been said that clean technology and Energy Efficiency in Canada’s Commercial Building Sector, 2008. www.nrtee- ” In a widely run television ad for Ford, alternative energy driven by climate trnee.com/eng/publications/commercial- Mike Rowe makes the point: “If you buildings/commercial-buildings-report-eng.pdf issues will be the “next big thing”— haven’t heard—this fuel [energy]- similar to the Internet in the 1990s. Today, 3 Natural Resources Canada, Commercial and efficiency thing is a pretty big thing. ” Institutional Consumption of Energy Survey, who would buy commercial real estate June 2007 . “Green branding, particularly if it is ” that wasn’t plugged into the current 4 Lawrence Berkeley National Laboratory, 2007. perceived to save money and the information super highway? Those who environment, sells. It speaks to your 5 Vancouver Sun, October 23, 2009. take a leadership position can help reduce , stakeholders who matter the most: their risks while enhancing their 6 Turner and Frankel, Energy Performance of LEED of New Construction Buildings, 2008. investors, regulators, and anchor tenants. opportunities. Who wants to do a deal, lend money, 7 National Research Council Canada—Institute for Research in Construction, “Do LEED-certified buildings save energy—Yes, but ... August ” 2009. Climate Change: Risks & Opportunities in the Canadian Commercial Real Estate Market 11
  12. 12. kpmg.ca The information contained herein is of a general nature KPMG and the KPMG logo are registered trademarks of KPMG and is not intended to address the circumstances of any International, a Swiss cooperative. particular individual or entity. Although we endeavor to © 2009 KPMG LLP a Canadian limited liability partnership and a , provide accurate and timely information, there can be no member firm of the KPMG network of independent member guarantee that such information is accurate as of the firms affiliated with KPMG International, a Swiss cooperative. All date it is received or that it will continue to be accurate rights reserved. Printed in Canada on recycled paper. in the future. No one should act on such information 2439_09_MM without appropriate professional advice after a thorough examination of the particular situation.

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