NYC landlords could find a lifeline in carbon trading

A potential workaround to Local Law 97 brings a complex set of challenges

(Photo illustration by The Real Deal)
(Photo illustration by The Real Deal)

The year is 2030. New York City landlords, struggling to comply with city-mandated greenhouse gas emission caps, are on the hook for millions of dollars in fines — penalties that will only multiply in the coming years. This is the daunting reality that building owners face under Local Law 97.

But there is a possible workaround.

The city is considering a program that will allow building owners to trade carbon emissions. If implemented, landlords who own buildings with high greenhouse gas emissions will be able to buy credits from lower-emitting building owners to reduce overall emissions. It could also give rise to a market for Wall Street to tap into.

The initiative, however, has not gained much steam. For starters, the city’s study on carbon trading is still being conducted. Environmental justice groups loathe the idea, and the city’s real estate industry has yet to vocally support it.

“My clients are not talking about [carbon trading] at all,” said YuhTyng Patka, co-chair of law firm Duval & Stachenfeld’s Climate Mobilization Act practice group. “The real estate industry is finally waking up to Local Law 97. Carbon trading is way too far off.”

But Patka expects that Local Law 97 will soon become a bigger deal to landlords. So far, lawmakers have not entertained previously proposed workarounds aimed at helping building owners comply with the law.

“Building owners are going to have an ‘oh shit’ moment,” said Patka.

Passing gas

Financial giants that have mastered the art of monetizing people’s physical assets, like homes and cars, are increasingly reaching for the intangible.

Wall Street is investing in virtual currencies. Investors are bidding on “non-fungible tokens,” or digital creations bought and sold as unique assets, in categories from collectible cards to digital real estate.

Financial firms are also increasingly looking at carbon as the next big tradeable commodity.

More generally, carbon trading programs — where companies can buy and sell credits, or allowances for emissions — are already in place in Europe as well as California. China is working on its own plan.

The initiative is an alternative to a carbon tax — or a direct tax applied on carbon emissions. Over the years, the idea has become more sophisticated. In late 2020, Goldman Sachs started an index that gave oil investors the opportunity to offset emissions by buying carbon permits in the European Union.

New York City would become only the second city, after Tokyo, to implement a municipal carbon trading program. The effectiveness of Tokyo’s program has been hotly debated. But a recent study suggests that it helped reduce the city’s average annual emissions by 6.9 percent.

The trading program could help spur a new $20 billion building retrofit market as a result of Local Law 97, according to the Urban Green Council, a New York-based nonprofit that advocates for improving buildings’ energy efficiency.

But there’s a major hurdle when it comes to implementing carbon trading: It’s complicated.

“This is not using beans; we are trading an invisible gas,” said John Mandyck, CEO of the Urban Green Council.

The city commissioned a study on carbon trading as part of Local Law 97. The law mandates that commercial buildings over 25,000 square feet are required to reduce their emissions by 40 percent by 2030 and 80 percent by 2050.

Initially, that study was to be released in January. It is now supposed to be released this summer.

There are a number of kinks that still need to be worked out. One is whether credits can be “banked,” which would allow landlords to hold credits in reserve for use at a later date, instead of being traded immediately.

It’s a proposal that the Real Estate Board of New York’s vice president of policy, Zach Steinberg, said he would like to see. More broadly, Steinberg said, REBNY is advocating for more ways to help building owners comply with Local Law 97.

“The city needs to be much more aggressive in getting the details of the law worked out,” he said.

Green bean counters

Rudin Management’s John Gilbert is a data evangelist.

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The longtime COO of the dynastic New York City real estate firm is using data, including from its smart buildings subsidiary Prescriptive Data, to help lower the firm’s energy usage across its 10.5 million square feet of commercial space. Since 2005, Rudin has reduced electrical usage by 43 percent and steam usage by 46 percent.

Gilbert is now applying this approach to carbon. When digging into other carbon markets that failed, he noticed a common theme.

“There isn’t enough granulated, authenticated data to create a market,” said Gilbert.

The solution to some of these problems could be blockchain technology, a virtual ledger most commonly associated with the speculative world of cryptocurrency.

Gilbert worked with Brookfield Renewable Partners, a subsidiary of Brookfield Asset Management, along with JPMorgan Chase, KPMG and the carbon accounting tech startup ClearTrace to design a system to swap carbon credits using the blockchain.

In October, Brookfield and JPMorgan reached an agreement to use the technology to track the flow of hydropower from Brookfield to JPMorgan facilities in hundreds of buildings across New York state.

The technology is being developed, but tracking carbon is much more difficult than tracking other commodities. It relies on a sophisticated set of calculations with no universal benchmarks.

“What is desperately needed in the carbon accounting world is a clear standard,” said ClearTrace CEO Lincoln Payton.

The carousel

Carbon trading is not just tricky because of the logistics. It is also largely hated by environmental justice groups.

To opponents, the program amounts to a “get out of jail free” card for polluters — a loophole around emissions caps for some of the city’s biggest sources of carbon.

They have some precedent to rely on. Some of the world’s largest carbon emission trading programs have become victims of fraud. Over a decade ago, fraudsters set up fake shell companies in Europe to trade carbon credits with each other. The scheme, known as a “carousel,” resulted in billions of dollars being siphoned out of European governments. French media dubbed it the “fraud of the century.”

More recently, carbon trading in California has come under scrutiny. A state-implemented program allowed polluters to “offset” their carbon emissions by purchasing credits from owners of forested land, thus incentivizing their preservation.

But a recent investigation by ProPublica and MIT Technology Review, citing findings from CarbonData, reported that the state’s program generated between 20 million and 39 million credits that did not “achieve real climate benefit.”

The Urban Green Council recognized these concerns in an initial report on carbon trading.

One solution is to tilt investment to environmental justice areas to make them a priority. Another is to use carbon trading to fund energy upgrades and retrofits in these areas.

“However we enact [carbon trading] in New York, it will be one that advantages environmental justice communities,” said Mandyck, whose organization is working on the city’s study.

The ‘oh shit’ moment

Despite the looming consequences of noncompliance, Local Law 97 has thus far remained a relatively low priority among landlords and developers. It was passed in 2019, the same year the state passed its controversial rent regulation laws. Then there was the broker free ban that was supposed to go into effect. Not to mention a global pandemic that kept people hunkered down at home.

That could change as lenders start to press landlords on their compliance with city law. A May report by Moody’s predicted that 80 percent of New York City commercial properties underlying mortgage-backed securities are on track to face fines under Local Law 97.

“Lenders are starting to ask questions,” said Daniel Spitzer, an environmental law attorney with Hodgson Russ.

Some landlords will face a difficult time answering those compliance questions. For landlords with energy-intensive tenants, such as data centers or trading floors, the emission mandates under Local Law 97 could become impossible to meet even with solar panel installations or energy efficiency upgrades.

“What’s left is carbon trading, or else these buildings are just going to pay fines,” said Mandyck. “We don’t get carbon reduction.”