Emission Critical: Hybrid Work Could Shift Emission Costs from Office to Multifamily

Workers spending less time in the office post-pandemic may seem entirely negative for the office sector but in one way, a four-day workweek can be a boon for some office property owners. One less office workday and possibly as much as 20% less office utilization and energy usage could bring unexpected relief to those New York office landlords who were facing fines for exceeding their greenhouse gas (GHG) emissions statutory limits under Local Law 97 (LL97). Conversely, if most of those in-office Fridays are replaced with people working from their NYC apartment living rooms, the burden of energy usage (and fines) could be passed to the multifamily sector.

REMIND ME: WHAT IS LOCAL LAW 97 AGAIN?

LL97 is part of the greater NYC Climate Mobilization Act⁴ which includes five local laws and is one of the largest city-level emissions reductions acts globally. In a city unique because the majority of its emissions come from its buildings rather than is transportation,⁵ it’s not surprising that all five local laws target buildings. The other laws in the package focus on energy efficiency, solar panels and green roofs, and creating a Property Assessed Clean Energy Fund for New York City.⁶ Importantly, this fund launched in 2021 and provides a funding mechanism for owners looking to implement energy retrofits to comply with LL97.

LL97 itself has provided an example for similar laws popping up in cities around the country. Under the groundbreaking legislation, most buildings with more than 25,000 square feet will be required to meet new energy efficiency and greenhouse gas emissions limits by 2024, with tighter limits in 2030. The stated goal⁷ is to reduce the emissions produced by the city’s largest buildings by 40% by 2030 and 80% by 2050. Building owners will need to report their emissions by May first every year beginning in 2025,⁸ which is the year LL97 will impose financial penalties for building owners that are not compliant with the law.

The annual penalty is the difference between a building’s annual tonnage of carbon emissions (estimated as a multiple of the energy usage depending on energy source) and its emissions limits (which are based on property type⁹), multiplied by $268. In 2021, Moody’s Investors Service (MIS) did an analysis¹⁰ of the potential fines associated with this penalty and found them to be relatively minor compared to the average NYC rent per square foot, though not an insignificant portion of property net revenue on average. Based on this analysis, most fines for exceeding 2024 and 2030 emissions caps will be less than 3% of NOI. However, for a handful of NYC buildings, the fines could be quite burdensome—potentially more than 10% of NOI.

As investors integrate this information into their due diligence and strive to understand the financial implications of LL97, other factors will adjust their analyses. As building owners and tenants explore the future of work and consider adopting long-term hybrid plans for office use, Moody’s initial findings on the financial impact might change.

BY THE NUMBERS: HOW MUCH OF A SHIFT COULD THERE BE?

For illustrative purposes, we assume a 20% reduction or increase in energy usage based on shifting one workday from the office to home. It’s important to caveat that this 20% energy shift is a ceiling, and somewhat unrealistic, given that many building systems consume energy whether or not humans are in the building.

However, it’s clear that the future of work is hybrid, so a lot of energy savings are likely found during the rest of the week besides Fridays.

For apartments, it’s more likely the increase is much smaller than 20%, as shown by studies of energy usage during the pandemic.¹¹ But, for now we’ll stick with the 20% assumption just to illustrate the extreme version of energy usage shifting due to a 20% shorter in-office workweek.

As shown in Exhibit 1, when people go to work five days a week, 14% of NYC office properties are subject to pay fines based on LL97 2024 limits, another 55% will be subject to fines in 2030. If a four-day workweek becomes the norm, and energy usage drops 20%, the number of fined office properties will be halved to just 7% in 2024. In 2030, 14% more property owners would be spared the fines from the estimated 55% down to 41%.¹²

Based on Moody’s Investors Service’s 2021 paper,¹³ among offices exceeding their 2024 greenhouse gas (GHG) emissions limits, the average fi ne was $1.15 per square foot (PSF). With a 20% reduction of energy usage, the average fine would decrease 23% to $0.88 PSF. For the 2030 limits, the average fines would decline 29% from $0.89 PSF to $0.63 PSF.¹⁴

For NYC multifamily properties, we estimate that 21% are currently subject to pay fines based on 2024 emissions limits, and 77% in 2030 (including properties that exceed 2024 limits). If there is a 20% increase in multifamily energy use as a result of a four-day workweek, the percentage of multifamily owners that will be on the hook rise from 21% to 40%. By 2030, that number will rise by 9 percentage points—from 77% to 86%.

Among multifamily buildings exceeding their 2024 GHG emissions limits, the average fine based on Moody’s Investors Service’s 2021 analysis is $0.37 PSF, which would increase 29% to $0.52 PSF with a 20% increase in energy usage. For the 2030 limits, the average fines would rise 25% from $0.48 PSF to $0.64 PSF.

THE IMPLICATIONS FOR MULTIFAMILY OWNERS

Multifamily building owners in NYC already have other challenges with mitigating the potential costs of LL97, such as:

1. Some of the highest potential fines PSF among property types
2. More complicated energy retrofits
3. Less ability in NYC to legally pass along capex to tenants
4. Less ability in NYC to raise rents aggressively with legal caps

Recognizing that the four-day in-office workweek, or another hybrid arrangement, may be here to stay, and that it may push apartment buildings past their emissions limits, multifamily building owners now have an opportunity to make gradual changes to mitigate the financial burden they face from increased work-from-home and the associated energy use. This knowledge also provides investors with additional questions to ask during their due diligence or targeted engagement encouraging building owners to get ahead of these risks.

For example, owners can consider gradual replacement of equipment like air handler units and water heaters with more efficient options as these devices reach the end of their life cycles. They can also promote their sustainability measures in their marketing to potential tenants, which is an important issue for many tenants, commercial and residential alike. This preference is so strong that there is a growing premium for buildings that have taken sustainability measures, all else equal.

This premium can help owners economically justify significant one-time retrofit investments by avoiding LL97 fines, saving on energy costs, and getting a rent premium for sustainability efforts.