Source: Wall Street Journal

In the bustling cities across the United States, the echo of empty offices reverberates through the towering buildings. To add to their woes, borrowing costs have surged, and now, building owners are grappling with a new challenge –a tax on their carbon emissions. As cities tighten their climate standards, they are rolling out taxes on buildings that fail to meet these new requirements, leaving landlords with a difficult dilemma: invest in costly upgrades to reduce emissions or pay the tax.

In New York City, a pioneer in this initiative, landlords of large buildings, including residential properties, will soon be facing one of the nation’s most expensive carbon taxes. Starting next year, they will be slapped with a $268 fine for every ton of carbon dioxide emitted beyond specified limits. For landlords already dealing with cash flow problems due to a lack of tenants, this additional tax burden is far from welcome.

With the ongoing housing shortage, developers are repurposing vacant office spaces into apartments. However, not all buildings are suitable for this transformation, even as over a billion square feet of office space lies vacant across the US.

The Wall Street Journal has delved into the potential impact of these taxes on buildings that rely on funds from Wall Street investors through mortgage-backed bonds. Their analysis of Department of Building data and financial disclosures suggests that these taxes could accumulate to over $50 million for 128 properties during the initial five-year enforcement period beginning in 2024. If landlords fail to meet emissions standards between 2030 and 2034, fines for these buildings could skyrocket to $214 million. According to the Real Estate Board of New York, more than 13,000 properties could collectively face fines totaling approximately $900 million annually.

Buildings have always been carbon culprits, as primary source of carbon emissions in New York City, stemming from the use of fossil fuels for heating and air conditioning. It’s a significant contributor to the city’s carbon footprint.

The carbon emission regulating trend isn’t confined to New York City alone. Over a dozen local laws regulating carbon footprints of buildings have been enacted or are set to take effect by 2030, according to carbon accounting firm nZero. Denver buildings face compliance requirements starting next year, while St. Louis properties are slated for penalties from 2025 onwards. Similar laws in Cambridge, Mass., and Reno, Nev., will come into play in 2026.

While the initial impact of these emissions laws may seem minor, they add to the financial woes faced by landlords. For instance, New York’s projections indicate that a 51-story skyscraper at 277 Park Ave. could face fines of just $1.3 million in 2024, while its revenue was a staggering $129 million last year.

Landlords like The Stahl Organization, which owns the aforementioned skyscraper, are at a crossroads. Vacancy rates have risen sharply, with the building’s rate jumping from 2% in 2014 to 25% today. Major tenant JP Morgan Chase, occupying half the building, has a lease expiring in 2026. The bank is constructing a nearby carbon-neutral tower, which adds to the challenges faced by the landlord.

The building’s $750 million mortgage matures next August, and Stahl could face higher rates if it secures a new loan. Add in the loss of its largest tenant and the looming carbon emissions fines, and the future looks uncertain.

Shares of major landlords, including Vornado Realty Trust and SL Green, have plummeted to near-historic lows. These companies own around 30 office buildings each in New York City, and their shares have declined by about two- thirds since before the pandemic. Boston Properties Inc., another large office building owner, has seen its shares drop by over 50%.

SL Green faces potential carbon tax liabilities of up to $6.6 million by 2030, with more than 80 other properties financed through mortgage-backed bonds possibly facing nearly $27 million in carbon taxes by the same year.

Meeting the emission standards laid out by these laws will necessitate costly upgrades for some properties, which may occur when the buildings are up for sale or trying to attract tenants. In such cases, tenants are increasingly looking for greener buildings, adding to the pressure on landlords.

The silver lining is that the landlords are also benefiting from less occupied buildings, which consume less fossil fuel. According to New York City, only about 11% of the buildings covered by the law are projected to incur penalties based on the latest energy data, a drop from 20% using earlier data.

As the US moves forward with these carbon taxes and emission standards, landlords find themselves in a challenging position. While compliance may require substantial investments, it’s evident that the transition towards greener buildings is not just a regulatory requirement but also a growing tenant preference. In thisevolving landscape, landlords must weigh their options carefully to navigate the path ahead.