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The Biggest Barrier to Retrofitting Commercial Buildings? The Commercial Real Estate Industry

December 4, 2023

To meet climate targets, progress to decarbonize commercial buildings needs to be faster. Our new report examines how conflicting interests among parties in the sector prevent more significant energy efficiency investment and identifies strategies for utilities to drive energy savings.

With the robust economic environment, businesses in the United States should be able to comfortably invest in reducing emissions from commercial buildings and reap long-term rewards. Implementing energy upgrades in buildings is a core strategy for reducing U.S. carbon emissions. But despite the demonstrated climate, financial, and health benefits of energy-saving upgrades, commercial buildings are not being retrofitted at the pace needed. Though innovative solutions to make retrofits more financially accessible are available, businesses still commonly point to cost as a barrier to retrofits, and a decarbonized buildings industry remains out of reach.

Read the Report

A new ACEEE report takes a holistic look at the commercial real estate industry to uncover the root causes of the slow pace of efficiency retrofits. We found that the problem is structural: The industry comprises many companies—building owners, tenants, contractors, and banks, to name a few—acting individually to minimize costs and maximize profits, but investing in energy efficiency requires these separate actors to work together. Utilities and policymakers must understand this fundamental challenge and collaborate to design programs that enable more businesses to implement retrofits.

The greatest obstacle to commercial retrofits is a lack of coordination among key players

People discussing obstacles to energy efficiency frequently mention the problem of split incentives. This usually refers to the fact that a landlord may not want to pay for a retrofit if a tenant pays the energy bills because the tenants will get the savings. (The incentive is “split” between the landlord and renter.) Our report argues that we must expand our understanding of the split incentives at work in the commercial building sector. There are many more conflicting interests than just the split between landlords and tenants, and together these divisions compound to further challenge commercial retrofits.

A complicated web of companies is involved in the commercial buildings value chain. For example, investors who own buildings seek to minimize costs to maximize shareholder earnings, and contractors who bid on projects present low-cost options to entice developers and the next buyers. Quick turnovers in the industry also create a split incentive; commercial buildings are typically sold every 5–10 years, and investors aren’t interested in retrofits that will pay off for the next owner but not for themselves. Even within companies, individuals may consider maintaining the energy-inefficient status quo less risky than advocating for a large, expensive retrofit project.

Finding opportunities to align interests will be vital to increase energy efficiency investments

Because conflicting interests are the main reason that retrofits have been slow to take off, opportunities to increase collaboration are critical. We highlight a few recommendations from the report here:

Utilities seeking to spur retrofits should leverage existing business partnerships. Business improvement districts and main street partnerships provide utilities with existing associations of businesses that are close to one another and share a utility provider. Utilities can scale their retrofitting opportunities by working directly with these organizations, which have their own sources of funding for improving business areas and already have relationships with the local businesses.

Utilities and community development financial institutions (CDFIs) should partner to finance retrofit projects. Though utilities have private funds they would like to lend for upgrades, they are not banks and do not have lending capacity. CDFIs, meanwhile, have lending capacity but lack the needed funds. A lending program facilitated by a CDFI through utility funding can deploy financing more effectively.

Real estate firms and contractors should collaborate to implement retrofits during periods of turnover in buildings. Retrofits are easier to implement when the building is between owners or tenants, as the spaces are unoccupied. It would be convenient for utilities to reach out to property owners when they have vacant spaces, but there is currently no information-sharing method to allow them to capitalize on these opportunities. Through policy, this could take the form of greater transparency in the permitting process so that vacant properties could be identified through public information. In the private sector, this could take the form of partnerships between providers and real estate agencies to allow agencies to act as one-stop shops for office space retrofits. In this model, property owners could rent space through a real estate agency that also retrofits spaces before renting them out.  

The split incentive problem is larger and more complex than is commonly understood, and understanding this challenge is critical to driving change. Designing programs to decrease buildings’ emissions that businesses want to participate in requires taking this complex issue into account and working to align the incentives of businesses with environmental goals.

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