Decarbonizing the Real Estate Sector
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At a Glance
  • Under EU law, the real estate sector must cut its greenhouse gas emissions by 55% by 2030. Plans are to phase out fossil fuels in heating and cooling systems by 2040.
  • In Germany, any newly installed heating system will have to be powered at least 65% by renewable energy sources as of 2024.
  • Rising CO2 prices and pressure from banks and investors add to the urgency, as three out of four buildings in the EU are still energy-inefficient.
  • Using a combination of various levers, real estate companies can lower their emissions fast, efficiently, and with a high level of social acceptance.
  • To master the complex challenge, companies are well advised to collaborate with experienced integrated partners.

Commercial and residential buildings account for some 40% of energy-related greenhouse gas emissions in the EU. Legislators are therefore introducing regulations at the national and supranational level to cut emissions. But even aside from regulatory pressures, holders of energy-inefficient real estate portfolios face substantial economic risks: the risk of growing (re)-financing costs, the risk of devaluation of buildings stock with a large carbon footprint, and even a risk of stranded assets, as more and more potential buyers, tenants, and financiers tend to steer clear of energy-inefficient property.

Challenging times for the real estate sector, no doubt. But the good news is: there is a host of helpful technologies and solutions available. There are various green energy sources in rapidly growing numbers; there are innovative technology solutions such as smart meters, radio-enabled heat cost allocators, and smart meter gateways; and, last but not least, there is (generative) Artificial Intelligence (AI), which will certainly help accelerate the necessary decarbonization. What’s more, real estate companies can get expert help in applying these new technologies: they can partner with digitally enabled energy service providers – especially those that have the required infrastructure in place – and use their expertise to master the upcoming challenges.

Ambitious targets under EU Green Deal

The EU Green Deal, first introduced in December 2019, was a wake-up call for the entire European economy. In it, the European Commission agreed on a set of commitments that translate into ambitious decarbonization goals for all industries – including real estate, where currently three out of four buildings in the EU are not energy-efficient. Specifically, the Green Deal calls for:

  • Full climate neutrality by 2050. By that point, all buildings must be Zero Emissions Buildings.
  • Reduction of greenhouse gases by 55% by 2030, compared to 1990 levels.
  • All new buildings to be zero-emission as of 2030 in terms of energy use (for new public buildings, the deadline is 2027).
  • Phasing out fossil fuels in heating and cooling by 2040.

The Green Deal was not the EU’s first step to lower energy consumption. Since 2010, the organization has been working on a legislative framework to that end, which includes the Energy Performance of Buildings Directive and the Energy Efficiency Directive. The latter was amended this September to help accelerate decarbonization and reduce the EU’s dependence on Russian fossil fuels. The new directive stipulates that monthly information for tenants on their energy consumption become mandatory as of 2027, in hopes to encourage behavioral change that way. To support this change, all submetering devices must be remote-readable by 2027. Submetering is a critical energy efficiency service helping to decarbonize buildings: it refers to the allocation of heat and warm water consumption to individual units within a larger building, allowing property management to bill tenants based on the amounts individually consumed. While some European countries have seen a significant roll-out of related services (in Germany, e.g., submetering is standard practice with most of the ~22 million eligible residential buildings), other countries need to catch-up in the years to come: the average penetration in Europe excluding Germany is estimated at ~50-60%).

German legislation adding to the urgency

In addition to the EU directives, several countries have taken measures on a national level. Germany is among the forerunners here: the country has set sectorial greenhouse gas thresholds for 2030 and moved up the net zero emission target to 2045. A legislative move particularly relevant for real estate players was the 2020 introduction of the Buildings Energy Act (Gebäudeenergiegesetz, GEG), which regulates the energy requirements and use of renewable energy sources in buildings. The GEG was amended in September 2023, introducing three major changes:

  • For new buildings, the permissible amount of primary energy needed per year has been reduced from the previous 75% to 55% of a predefined reference building.
  • When new heating systems are installed, around 65% of the heating energy must now be powered by renewables.
  • The requirement of submetering has been extended to heat pumps (a heating system considered particularly energy-efficient where electricity is used for heat generation), which have so far been exempt.

Over the next few years, especially the requirement for at least 65% renewable energy sources will result in a technological shift to district heating and heat pumps. It will also drive a trend towards comprehensive energy solutions for entire building districts (“Quartierslösungen”). Such district solutions require a professional design as well as optimized solutions for operations and heating cost allocation based on submetering.

Another factor real estate companies need to deal with is rising CO2 prices. Germany has established such a price in 2021, to be applied to fossil fuels for transportation and heating. The price is currently €30 per metric ton of CO2, and will gradually increase to €65 until 2026. For 2023, the price has been kept at 2022 levels, skipping one planned tax-hike due to the Ukraine war and the current energy crisis. From 2026 onwards, prices are to be formed by way of certificate trading on the EU Emissions Trading System (EU ETS). When that happens, prices are expected to keep rising. Also, regulators plan to introduce the sharing of the tax burden between tenants and owners, gradually increasing the owners’ share across ten housing efficiency categories. As a result, property owners will bear a cost share in line with the CO2 path and energy efficiency of their buildings, resulting in significant annual costs if the building is classified in a “lower” efficiency category (Figure 2).

Growing pressure from various stakeholders

Aside from the regulatory “push,” there is an increasing pull towards decarbonization from various stakeholders. First and foremost, institutional investors such as banks and insurance companies call for sound environmental reporting for their own “scope 3” ESG reports. Major housing associations have responded already, publishing clear pledges for decarbonization (for instance, Vonovia has committed to reduce carbon intensity in Germany to below 25 kg  CO2e/m² by 2030).

There is also increasing awareness and consciousness on the tenants’ part with regard to the energy price burden, which forms part of their rent and the generally increasing cost of living. The EU-wide spike in energy prices and the temporary energy shortage driven by the Ukraine war have certainly sharpened this awareness.

Commercial real estate with specific challenges

The commercial segment faces similar decarbonization pressures, but the dynamics and success factors are different here. One reason is that commercial buildings tend to have more complex technical installations, typically managed – and mostly handled manually – by specialized service providers. Due to this complexity, owners of commercial buildings struggle to provide adequate ESG reporting in line with EU Taxonomy.

Another aspect is that in the commercial sector, the terms of cost-sharing for heating and power are still often negotiated individually, usually with equal shares for landlords and tenants. While the German CO2 price for residential real estate will be derived from heat cost allocation through submetering, based on consumption and metering, no such practice is in place for commercial real estate. That said, government is likely to ask the sector to establish a similar practice, to be enforced as of 2025, which would result in further metering requirements. This could potentially make submetering mandatory for roughly ~0.6-0.8 million commercial buildings in Germany.

Decarbonization only manageable with combination of multiple levers

Mastering the decarbonization challenge in both the residential and the commercial real estate sectors will require a comprehensive, broad approach encompassing a combination of specific levers. Submetering as a minimally invasive measure already can deliver up to 20% reduction in energy consumption. In addition, property owners have a broad range of measures at their disposal to further reduce energy consumption, with different levels of invasive power and investment required (Figure 3), with examples including the following:

  • Thermal insulation, for instance by replacing windows, adding exterior insulation, and insulating basement and top-floor ceilings as well as piping.
  • Renewable energy installations such as PV systems and geothermal energy.
  • Heating system replacement/ upgrade by installing heat pumps, smaller heating systems, or access to district heating.
  • Data-based and monitored operational management of the existing technical infrastructure, for example by means of boiler monitoring or (green) energy contracting.
  • Consumption regulation by smart meters (or smart thermostats and/or LED lighting to measure, analyze, and optimize energy flows from multiple commodities. Smart thermostats and LED lighting are other helpful features.
  • Behavioral change among tenants – to be encouraged by measures such as consumption information, apps, or increased automation of temperature control.

There is scientific evidence that even a combination of several low-investment levers will provide significant energy savings. For example, optimizing the size of heat generators, adapting the design of the system technology and adding a corresponding system operations management along with adequate user assistance can help save up to ~20% per property. And there are other low-invest measures that lead to double-digit savings. To name just a few:

  • Typically, ~10% in energy savings are possible just by optimizing the operations management of existing systems, e.g., by contacting a professional (green) energy contracting partner or installing digital heating monitors and control systems.
  • Around ~14% in energy savings can be achieved by replacing the boiler. Currently, an estimated ~86% of heating systems are in need of an upgrade: After renovating a building, often heating systems are not adjusted; as a result, boilers are often oversized.
  • Around 10% energy can be saved when consumers with unfavorable consumption patterns turn into average consumers
  • Up to 10% reduction in annual gas consumption is possible for ~79% of all boilers, if they are switched off in summer months.
  • Mandatory monthly information on consumption is expected to bring an additional ~8% of energy savings (on top of the ~20% reduction opportunity from conventional submetering), with further potential in “smart metering”-related services such as monthly cost data information

Needless to say, better insulation or the installation of PV systems on rooftops can also go a long way. However, in the short term the main focus should be placed on cost-effective levers to ensure economical decarbonization and social acceptance – especially in times of increasing rents and interest rates. A comparison of savings vs. investment ratios reveals that smart metering (including submetering) and (green) energy contracting are more powerful than alternative measures. Submetering, in particular, accounts for less than 1% of tenants’ monthly utility costs, but can deliver up to 20% reduction in energy consumption. Submetering costs typically <€1 per sqm per year and can save 1kg of CO2; other levers typically involve more than ten times the cost. Energy contracting can lead to savings in the same order of magnitude. This way, it reduces the total cost of (property) ownership by effectively outsourcing that ownership, reducing CAPEX and maintenance costs.

Expert partners help orchestrate and execute

Installing smart metering and other eco-friendly energy sources is not part of property owners’ core business. These days, many of them have limited to no expertise when it comes to digitizing and automating the energy supply for their buildings; consequently, they lack expertise on how to leverage the latest tech developments such as generative AI – a promising technology to predict the load of and demand for energy sources or the optimization of field force. What’s more, there is currently a shortage of resources such as craftspeople and caretakers, as well as of capital to roll out such measures. Also, the frequency of new regulations for the real-estate sector coming into force calls for highly agile and digitally automated systems in order to comply – another non-core business challenge for real estate companies.

For all these reasons, most building owners will need to rely on third-party providers. These will be able to deliver a whole range of services through one platform, bundling the best individual solutions currently available in the market. Ideally, these solution bundles will cover the full value chain – from energy generation and supply to EV charging infrastructure to optimized consumption. Ultimately, key partners will be integrated energy services providers for heat, water, and electricity (e.g., for heat pumps) through a full range of energy solutions for residential (and commercial) housing.

Partners with multiple capabilities for real estate sector

To master such a complex task, key partners will need to bring a set of assets and capabilities to the table:

  • Technological knowhow is inevitable to identify the best solutions in a widening technology mix, including heat pumps and green energy sources.
  • Scale in terms of both the property base and the (digital) infrastructure is also essential, as it will be critical to ensure sufficient leverage on the fix costs involved – that is, for the hardware and IT platforms needed to provide decarbonization services to the industry.
  • Digital capabilities can be provided in-house or though renowned partners. Key abilities are processing and analyzing large data sets, increasingly supported by (generative) AI, as well as quick compliance with changing regulation.
  • Strong domain expertise and expertise on a frequently changing regulatory landscape are further key capabilities.
  • Sufficient installation capacity to equip buildings at scale with the necessary cost-effective devices is a key prerequisite key partners to real estate must meet.

Providers with these capabilities will ideally act as integrated partners, supporting the real estate sector on their digitalization and decarbonization path. First, because multiple levers need to be considered within one integrated energy system, which need to be serviced by interoperable systems to decarbonize buildings. Second, because managing the complexity of multiple levers requires data sovereignty to attend to the multiple interdependencies along the decarbonization journey. Only integrated partners will be able to combine the different levers data.

As we move from single houses to “energy districts,” real estate companies will also need partners capable of scaling up their operations. As energy management is gradually centralized, the integrated optimization of energy systems will require interconnected building infrastructures – which, in turn, will call for digitalized energy solutions for the districts. As part of this trend, we will see the emergence of new, fast-growing value pools based on new digital products – from smart metering and remote heat monitoring/control to AI-enabled data management for efficient energy usage and load prediction, load balancing, or integration of decentralized power generation in local networks.

Only large energy efficiency providers with established customer bases and digital infrastructure can benefit from the regulatory tailwinds and manage such a degree of interconnectedness and the complex systems beyond. With partners like these, the housing sector can outsource its non-core building operations in one-stop-shopping agreements. On the other hand, the interconnection of levers and management under the roof of one a single service provider will allow for advanced digitization of processes, resulting in a significantly enhanced customer and tenant experience.

Substantial benefits for real estate owners, tenants, and the environment

All in all, the collaboration of real estate companies with energy service providers will bring a number of benefits. The real estate sector will achieve the required progress in decarbonization, maintain the value of its building stock, and reduce costs for tenants. Tenants, on the other hand, will benefit from lower energy costs and usage-related billing for heat, power, and water consumption. And, quite obviously, the environment will benefit from lower CO2 emissions.

Time is marching on. In just a few years, new buildings must be zero-emission in the entire EU. Also, prices for fossil energy are expected to rise steeply, not least due to higher CO2 taxes. So, to prevent disputes with tenants, a rise in refinancing costs, a devaluation of the current building stock, and a risk of stranded assets, real estate companies should act fast.  They would be well advised to identify and put in place a fitting selection of the levers listed above. Collaborating with large energy service providers will help ensure that these levers will deliver the savings expected – for each individual building and for entire districts.

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