The green tipping point

The past four years have fundamentally reshaped real estate markets, economies and cities worldwide. Commercial real estate activity has slowed and many core business centers face record-high office vacancy amid the rise of hybrid working. Today, rightsizing and ‘flight to quality’ are driving leasing decisions. At the same time, the concept of 'flight to quality' is evolving to encompass energy performance and sustainability credentials as increasingly discerning occupiers seek spaces that align with their carbon commitments – and reduce operational spend.

More companies are rapidly committing to carbon reduction goals, many through the Science Based Targets initiative (SBTi) which has over 7,600 corporate signatories. Over 80% of signatories have joined in the past two years alone. As the buildings they occupy typically fall under their scope 1 and scope 2 emissions, these commitments have direct implications for how businesses operate and lease spaces. Moreover, aligning offices with carbon commitments clearly demonstrates environmental stewardship, allowing corporates to meet employees’ rising expectations.

Supply of low carbon offices will struggle to keep pace

Demand for sustainable, low carbon space is growing; however, our research shows that, without increased levels of retrofitting, supply will struggle to keep pace. Across top global office occupiers, an overwhelming share of future requirements¹ for space will be tied to carbon commitments. In 21 cities globally, 30% of projected demand for low carbon space will not be met by 2025, leading to a potential gap exceeding 70% by 2030, given the current quality of existing stock and the development pipeline.

Note – Numbers have been updated since our 2023 report with the inclusion of more markets and for the adjusted timeframe, 2024-2030.

The level of expected supply-demand imbalance differs markedly between cities, given varying levels of commitment and regulatory environments:
 

• London: One of the most calibrated markets in terms of progressiveness among both occupiers and landlords, low carbon demand is expected to exceed supply by 35% by 2030. Currently, low carbon demands are impacting prime office space most acutely, but this is expected to scale rapidly.
   

• Paris: Demand will outstrip supply by 54% by 2030, with momentum driven by regulation. France’s Décret Tertiaire mandates building owners to provide the central regulatory authority with energy consumption data. It imposes financial penalties if parties fail to meet publicly stated targets, and also publicizes their failure, creating a huge reputational driver. Data sharing is now standard practice, and owners and occupiers must cooperate to reduce energy consumption in their buildings.
   

• New York: Similarly, regulation is quickly becoming the driving force, and an estimated 65% of demand will not be met by 2030. In January 2024, Local Law 97 (LL97) came into effect, placing emissions limits based on property type on most buildings over 25,000 square feet (~2,300 square meters) – with annual penalties of US$268 for every excess ton of emissions. While 86% of premium office buildings will comply with the 2024 emissions limit, only 4% will comply with the 2030 limit at current performance levels. Owners will look to pass the burden of the hefty fines or of compliance to tenants, forcing tenants to consider building performance in leasing decisions.
   

• Sydney: Market demand and regulation are focused on energy-efficient, electrified stock. The National Australian Built Environment Rating System (NABERS), a performance-based rating system, has focused attention on energy-efficiency and electrification – or the removal of onsite fossil fuel sources (i.e., gas boilers) – earlier than most other markets, but securing clean power remains a challenge. As a result, demand in 2030 is likely to exceed supply by 84% as the proportion of all-electric buildings remains low.

The state of play is clear: corporate occupiers must show proof of progress in their commitment to operate more sustainably, and buildings need to catch up.

From carrots to sticks

On the regulatory side, mandates driving decarbonization are building across all levels of government. The world’s largest economies including the U.S., California, Canada, UK, EU, Australia and, most recently, China, have implemented or proposed mandatory ESG disclosure rules, with first reports due by 2026 or earlier. These rules aim to improve transparency and accountability for the biggest companies around the globe while promoting the transition to a net zero economy.

Policy directly requiring emissions reductions from buildings is ramping up. For example, over 40 U.S. cities have committed to passing a Building Performance Standard (BPS) by 2026 or earlier, like New York’s LL97, requiring building energy use or emissions reductions. In Europe, the EU agreed in December 2023 to reduce the emissions and energy use of buildings by developing minimum energy performance standards. Some 16% of the worst-performing buildings will need renovating by 2030 and 26% by 2033.

Other factors are also converging to bring greater overall market stability by 2025, with global economies set to recover in 2024 and many countries emerging from major elections. For many corporate leaders, 2025 will bring more clarity and certainty around what’s required to meet carbon commitments.

2025: an inflection point for low carbon requirements

The world has less than seven years to halve emissions in line with the Paris Agreement. CRE stakeholders – from governments to corporates – need to act on net zero carbon (NZC) targets, and the built environment presents viable means to show proof of progress. While some corporate lease demand is already shifting based on ESG requirements, the next 12 to 24 months will bring widespread change. By 2025, 30% of market demand for low carbon office space will not be met - creating a tipping point for NZC target penetration in lease markets.² Moreover, 1 out of every 3 leases tied to a carbon commitment will expire in less than 24 months. In the U.S., Canada, Europe and Australia, average lease terms are 7 to 10 years; many leases signed today will collide with the first important checkpoint of halving emissions by 2030.

By 2025, low carbon space requirements will no longer be a small subset of lease markets. Building owners will have to respond. Inaction over decarbonizing real estate will lead to their economic obsolescence sooner than most investors realize. According to GRESB, the average stranding year for GRESB-submitted buildings, covering 150,000 assets, is 2024.³

Focusing on building performance boils down to three factors – energy efficiency, no onsite fossil fuel use and clean energy sources.

When it comes to reducing operational emissions in buildings, best practice is for occupiers to prioritize energy efficiency and then to electrify (move from onsite fossil fuel sources) for an optimized amount of energy use supplied by 100% clean electricity. As renewable technologies become more affordable, a clean energy future is coming faster than many expected, enabling a stronger link between building electrification and decarbonization. In the meantime, many corporates are leveraging Purchase Power Agreements (PPAs) and Renewable Energy Certificates (RECs) to secure clean energy. However, these instruments are under increasing scrutiny, especially as market forces naturally drive the transition to clean energy, and regulatory authorities reconsider their appropriateness. Because of this, a truly NZC building can insure against such regulatory risks.

As lease markets shift, greater governmental clarity around the built environment and carbon performance is emerging. In January 2024, the Biden Administration in the U.S. released its draft National Definition for Zero Emissions Building, while the UK is finalizing its own Net Zero Carbon Building Standard, following similar standards set by France and Sweden. These definitions offer a consistent and measurable basis for zero emissions buildings and respond to industry calls for a unified framework.

While operational carbon is frequently in the spotlight, ‘embodied carbon’ is an emergent issue. It refers to ‘upfront’ emissions associated with building construction, including extraction, manufacturing and transportation of materials used. Embodied carbon is critical because it addresses the environmental impact of the entire building lifecycle, not just the operational phase.

In a similar effort to its initiative for corporates, SBT is finalizing guidance for the buildings sector that addresses in-use operational emissions and embodied carbon. The guidance would require in-use operational emissions reductions to fully align with 1.5°C CRREM (v2) pathways. Before this guidance, building owners would typically reference CRREM for decarbonization pathways while corporate occupiers resorted to SBTi. These guidelines effectively bridge the gap between the two and could lead to occupiers seeking CRREM alignment for their locations and focus more on embodied carbon for new developments.

Demand for low carbon space is greatest from finance, tech and professional services sectors

Energy efficiency, electrification and clean energy are the simple answers, although prioritization across these factors will vary for different property sectors and industries. For the top five industries in the office sector, the majority (>50%) of top occupier demand is tied to a carbon reduction target, but demand will be greatest from finance, technology and professional services sectors.

Corporate NZC commitments are feeding through to leasing markets

While many in the CRE world are not recognizing the demand for low carbon buildings today, it is a growing trend. Many forward-thinking companies are making leasing decisions that fully integrate their carbon goals; for example:

Case studies of low carbon lease demand:

A shift from green certification to energy and emissions performance

Outside of the leading markets, sustainability-minded corporates are still focusing on green building certification, with ESG remaining a tick-box exercise. Premiums exist for green-certified buildings (e.g., through LEED or BREEAM), but as corporates focus on their carbon targets, they will have to go beyond certifications. This is because today’s most common certifications are typically design and construction-based and have no real correlation with better energy or carbon performance.

Our data shows that this is true for popular frameworks available globally, including LEED and BREEAM. Both the U.S. Green Building Council (GBC) and BRE, the organizations behind these frameworks, have indicated they are evolving their certifications to better reflect emissions performance. In the market today and gaining traction in the UK, NABERS is often seen as a better measure of operational carbon emissions. Canada’s GBC has made strides in creating a built environment definition with its Zero Carbon Building Standard for design as well as performance.

Nevertheless, tenants cannot wait for existing performance-based frameworks to scale or for LEED and BREEAM to evolve. London’s lease market is about one to two years ahead of most others for climate target penetration. As commitments worldwide increase exponentially, it is a feasible indicator of future tenant behavior in the near term.

Implications for building occupiers and owners

Occupiers must integrate carbon targets throughout real estate lifecycle decisions and collaborate with landlords to achieve net zero goals.

• To show proof of progress, tenants must put sustainability at the forefront of leasing decisions and make sustainable building performance an integral part of location strategies.

• ‘Flight to quality’ normally involves higher rent but an overall smaller footprint. Incorporating carbon performance in corporate downsizing actions allows for better rightsizing of leased locations to align with commitments.

• Amid limited availability of low carbon properties in current markets, occupiers need to collaborate with landlords to facilitate building retrofits. Tenants have to initiate their relocation decision processes well in advance to allow time to thoroughly explore new and existing landlord collaboration options.

Investors and owners should seize this opportunity and prioritize measurable emissions reductions across assets.

• JLL Research from January 2024 found 50% of UK investors surveyed identified occupier requirements as one of the biggest ESG drivers behind decisions to buy or bid on an asset. As commitments continue to scale, building owners should see the NZC transition as an opportunity to attract tenants willing to pay top-dollar rents for space that meets their needs.

• Decarbonizing real estate presents a win-win pathway for both owners and occupiers. Owners should look to tenants as partners in decarbonizing their buildings. Doing so can allow owners to better differentiate their asset while reducing future compliance and operating costs.

• Proactive owners will have the opportunity to unlock a cascade of benefits, which extend beyond building users and owners to support communities and cities and reframe central business districts as 24/7, sustainable destinations.

[1] Based on lease renewals through 2030, faced by companies who have made carbon commitments.
[2] Based on the Diffusion of Innovation Theory which explains how and at what rate ideas, behaviors, technologies or products gain momentum and diffuse through a specific population. JLL Research takes the threshold of 30% as a critical mass or the tipping point for carbon commitments to impact lease markets at scale.
[3] Across global GRESB - the global ESG benchmark for real estate related financial products – participants, including all regions and sectors.