Climate Change Risks and Opportunities in Canadian Commercial Real Estate

Climate Change: Risks &
Opportunities in the
Canadian Commercial
Real Estate Market
KPMG LLP

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

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

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

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

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:
,


• 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

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


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

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.


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

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
,


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

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.


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

• Ongoing Roles and Responsibilities financial risks are quite real, perhaps the

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
,


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

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.


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

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.


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.

Climate Change Risks and Opportunities in Canadian Commercial Real Estate

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