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January 16, 2020

Stroock Special Bulletin

By: Raymond "Rusty" Pomeroy II, Brian Diamond, Karen Scanna, Ross F. Moskowitz, Joseph B. Giminaro,

On December 19, 2019, Mayor de Blasio and Council Speaker Johnson announced their respective appointments to the newly established New York City Climate Advisory Board, kicking off what will be a tumultuous next several years as the City begins to undertake the studies and promulgate the rules and standards necessary to implement its aggressive Climate Mobilization Act (the “Act”). The Act, which was signed into law on April 22, 2019 (Earth Day), and the rules and standards made by the Advisory Board will have long-term and wide-ranging fiscal and operational impacts for building owners, buyers, sellers, lenders and tenants.

The Act targets reductions of greenhouse gas emissions from the City’s building stock of 40% by 2030 and 80% by 2050, off a 2005 baseline. These significant reductions will be achieved through at least three rounds of increasingly stringent mandatory building emissions limitations, effective in 2024, 2030 and 2035. In order to achieve the emissions reductions, the Act will require owners of  “covered buildings” to implement energy efficiency retrofits to bring down overall energy usage and/or utilize available alternate compliance measures. The Act will impact approximately 50,000 NYC buildings, representing nearly 60% of the City’s building area. Early estimates are that $4 billion of capital will be spent to comply with the Act’s initial reduction targets.

This Stroock Special Bulletin is the first in a planned series we are issuing aimed at informing the real estate community about the Act’s requirements and implementation. Initially, we will focus on key things to know about the Act, and ways you should prepare now as the Act takes effect. Subsequent bulletins will focus on the following more granular topics:

 

  • Landlord-Tenant – analyzing key lease considerations raised by the Act, such as pass through expenses and green lease provisions;
  • Tax, Valuation and Assessment – discussing the potential availability of ICAP abatements for the significant capital expenditures that some buildings will require;
  • Due Diligence – reviewing the steps buyers, sellers and lenders will need to take to assess the risks associated with compliance;
  • Regulatory Framework – assessing the implications of the Advisory Board’s actions and how interested parties can participate;
  • Alternate Means of Compliance – reviewing the Act’s provisions for compliance by purchasing Renewable Energy Credits (RECs), carbon offsets, and/or installing distributive energy resources; and
  • Litigation – planning for successful litigation over exemptions from the Act and temporary adjustments to the building emissions limitation.

 

Five things you should know about the Act:

1. Buildings Governed by the Act

Subject to specific statutory exemptions, the Act’s building emissions limitations provisions apply to “covered buildings.” Covered buildings are defined as (i) buildings that exceed 25,000 gross sq. ft.; (ii) two or more buildings on the same tax lot that together exceed 50,000 gross sq. ft; or (iii) two or more buildings held in condominium ownership that are governed by the same board of managers and that together exceed 50,000 gross sq. ft.

The Act provides exemptions from the emissions limitations requirements for (i) industrial facilities primarily used for the generation of electric power or steam; (ii) buildings of three stories or less which have HVAC or hot water heating systems serving no more than two dwelling units (garden style apartments); (iii) City-owned buildings; (iv) buildings that contain at least one rent regulated unit or participate in project-based federal housing programs; (v) housing developments and buildings on land owned by the NYC Housing Authority; (vi) houses of worship owned by religious corporations; and (vii) buildings owned by a housing development fund company organized pursuant to the New York Business Corporation Law and the New York Private Housing Finance Law.

Importantly,  even “exempt” buildings must implement “prescriptive energy conservation measures” (e.g., adjusting temperature set points, repairing heating system leaks, maintaining heating systems, installing individual temperature controls, insulating pipes, etc.) and file a report, certified by a registered design professional, documenting compliance.

 

2. What the Act Requires

Beginning in 2024, the Act prohibits covered buildings from having annual building emissions higher than the annual building emissions limits established for the building pursuant to the Act. By May 1, 2025, and each May 1st thereafter, building owners are required to submit an annual report, certified by a registered design professional, attesting to the building’s actual annual emissions. Building emissions are defined as greenhouse gas emissions emitted as a result of operating a covered building.

To calculate a building’s annual emissions limit, the Act provides building emissions intensity factors for 10 categories of building code occupancy groups. The building emissions intensity factor is multiplied by the building’s square footage to result in the annual emissions limit. The emissions limit is expressed in metric tons of carbon dioxide equivalents per year. Where more than one occupancy group exists in a building, the annual emissions limit for each use group is calculated separately based on the square footage dedicated to each, with the building annual emissions limit being the sum of those individual calculations.

The Act provides building emissions intensity factors for the initial compliance period of 2024-2029, and more stringent intensity factors for the following compliance period, 2030-2034. Even more stringent intensity factors for 2035-2050 will be established by rule, not later than January 1, 2023. The initial 2024-2029 building emissions intensity factors are intended to capture the most energy intensive 20% of buildings, while the second phase factors for 2030-2034 are expected to require energy efficiency measures for about 75% of the City’s buildings.

To calculate the greenhouse gas emissions attributed to a building’s energy use during the year, the Act provides factors for utility electricity delivered to the premises through the electrical grid, natural gas combusted on the premises, #2 and #4 fuel oil combusted on the premises, and district steam consumed on the premises.

 

3. How Building Owners Comply

Compliance with the building emissions limits will be accomplished primarily through energy efficiency retrofits that directly reduce energy consumption. In an effort to support these retrofits, the Act creates a new Property Assessed Clean Energy (“PACE”) low interest loan program to assist building owners in financing necessary capital expenditures through a special assessment on the building’s property tax bill. Owners with existing debt will need to be aware of lender prohibitions or consent requirements regarding this potential additional debt.

The Act also provides building owners with certain alternative compliance measures, including renewable energy credits, greenhouse gas offsets and distributive energy projects.

 

a. Renewable Energy Credits

Renewable energy credits (“RECs”) are certificates representing the environmental value of one megawatt-hour of electricity generated from a renewable source (e.g., solar, wind, hydro). The Act permits a building owner to deduct from its annual building emissions RECs purchased by the building owner. Important restrictions apply to this deduction. Most particularly, only RECs generated from a source located in, or directly deliverable to, the NYC electrical grid are permissible. This constraint significantly diminishes the utility of RECs as an alternative compliance measure due to the lack of a sufficient REC market in the NYC area, and the presumption that the limited RECs currently available will be trading at a premium with the increased demand as a result of the Act.

New York State also enacted sweeping energy legislation in 2019 (the Climate Leadership and Community Protection Act). CLCPA sets aggressive targets for new solar and off-shore wind projects requiring that 70% of the State’s electricity must come from renewable sources by 2030, and targets 9,000 megawatts of off-shore power by 2035, along with 6,000 megawatts of solar power by 2025. As new CLCPA projects come online, they will add to the pool of RECs available for use as alternate compliance measures under the Act.

 

b. Greenhouse Gas Offsets

Greenhouse gas offsets are defined by the Act as units equaling one metric ton of carbon dioxide equivalent emissions reduced, avoided, or sequestered by a project, which has been verified by an independent, qualified third party in accordance with the standards and rules of the Department of Buildings.

The Act limits the use of offsets to the initial compliance period, 2024-2029, and permits a building owner to deduct up to 10% of the annual building emissions for purchased offsets.

 

c. Distributed Energy Resources

Distributed Energy Resources (“DERs”) are projects that either generate clean energy at a building (rooftop solar, wind, or geothermal) or that store energy at a property for use during peak demand periods (battery storage).

As with offsets, the Act limits the use of DERs to the initial compliance period, 2024-2029, but provides a deduction from the annual building emissions in the amount of the calculated output of the DER.

 

4. Opportunities for Adjustments

The Act provides limited opportunities for temporary “adjustments” to a building’s emissions limitation. These adjustments are granted in the discretion of the Department of Buildings, and must be applied for by July 1, 2021.

Adjustments may be granted where there are legal (e.g., landmarks designation) or physical (e.g., space constraints, lack of access to energy infrastructure) barriers to implementing necessary retrofits, or where the implementation of retrofits would prevent the owner from earning a reasonable financial return. The applicant for such an adjustment, though, must show that it has complied with the Act to the maximum extent practicable, by, for example, making a good faith effort to purchase RECs or offsets, and availing itself of all available incentive programs and financing opportunities.

A limited adjustment may also be granted for the initial compliance period, 2024-2029, to an existing building that had actual building emissions in 2018 that are more than 40% above the building’s 2024 emissions limitation. This adjustment is limited, and will result in a 2024 building emissions limit that is 70% of the building’s 2018 actual emissions. Moreover, the adjustment requires, among other things, that the building owner show that the building emissions limit is the result of special circumstances related to the use of the building (e.g., 24 hour operations, operations critical to human health and safety or other energy intensive uses, such as data centers or industrial processes), and submit a detailed plan setting forth a schedule to bring the building into compliance by the second compliance period, 2030-2034.

 

5. Non-compliance Is Not a Viable Option

Penalties for non-compliance with the emissions limitations may be significant.

The Act provides that where a building’s annual report demonstrates that emissions exceeded the building emissions limitation, the building owner will be subject to a civil penalty of not more than $268 times the difference between the actual and permissible emissions. The Act provides that any such fine can be enhanced or reduced based on aggravating or mitigating factors, such as the owner’s good faith efforts to comply, history of compliance, and whether the non-compliance was the result of unexpected or unforeseeable circumstances outside of the building owner’s control.

Failure to file the required annual emissions report is subject to a penalty of up to $.50 per square foot, for each month that the violation is not corrected. Further, making knowingly false statements in a report or other submission to the Department is a misdemeanor and subject to a fine of up to $500,000 and/or imprisonment.

 

Five things you should be doing now:

1. Benchmarking

A critical first step for an owner of a covered building is understanding its historic energy use, in the context of the City’s greenhouse gas energy consumption calculation scheme, and to reasonably project future energy consumption based on anticipated changes in use or occupancy. For many buildings, this data already is readily accessible. Local Law 84 of 2009 required owners of buildings over 50,000 sq. ft. to provide annual energy consumption data for benchmarking purposes. Local Law 133 of 2016 amended Local Law 84, expanding the energy consumption benchmarking requirement to buildings larger than 25,000 sq. ft.

Owners also should undertake initial calculations of the building emissions limitations that will apply to their buildings in 2024 and 2030, based on the building’s use, square footage, and the type(s) of energy consumed.

Understanding the building’s historic energy consumption and its applicable building emissions limit under the Act will allow building owners to understand when they will become subject to the Act’s emissions reduction requirements, and how significant those reductions will need to be. This information is critical to developing a compliance strategy that may include retrofits, purchases of RECs or offsets, or DERs, or applications for adjustments.

 

2. Identifying Easy Retrofit Opportunities

Energy efficiency retrofits come in all shapes and sizes. Building owners should undertake a thorough assessment of the building’s energy consumption and begin to identify which energy efficiency measures can be easily adopted, at little cost, and with quick return on investment. The assistance of a qualified design professional can be helpful in this regard.

Some easy energy efficiency retrofits include optimizing/commissioning of building HVAC systems to ensure they run at peak efficiency; re-lamping to more energy efficient lights; weatherization; and automated temperature and lighting controls. In the aggregate, these measures may substantially improve a building’s energy consumption profile.

 

3. Planning for Adjustment Applications

An owner who determines that an application for adjustment to the building emissions limit will be necessary should begin that process now. Applications for any of the Act’s permitted adjustments must be submitted to the Department no later than July 1, 2021.

To be considered for an adjustment, the Act requires that the building owners make affirmative showings to the Department. Depending on the particular adjustment sought, these showings may include establishing the infeasibility of compliance due to legal or physical limitations; the owner’s good faith efforts to comply with the Act to the maximum extent practicable; the owner’s good faith efforts to acquire RECs or offsets as an alternate means of compliance; the owner availing itself of all available incentive programs; and the owner developing a detailed compliance plan and timeline.

Establishing the above requisites to qualify for consideration of an adjustment will be a time consuming process, and the application deadline is just 17 months away.

4. Engage With Tenants

The Act’s requirements fall exclusively on building owners. Thus, owners of covered buildings should be undertaking a careful review of existing lease provisions to determine the extent to which, if at all, capital costs related to necessary energy efficiency retrofits may be passed through to building tenants. Owners should also be revising lease forms for new tenants to incorporate green lease principles, which more closely align the energy efficiency goals of the landlord and tenant, and provide incentives to motivate tenant energy efficiency.

For certain corporate tenants, sharing in the building’s energy efficiency goals can help support corporate ESG statements, and bolster their green credentials with employees and investors.

 

5. Planning for Capital Expenditures

Owners of covered buildings with current emissions in excess of the 2024 emissions limits must start planning now for the capital expenditures that will be necessary to implement energy efficiency retrofits. Similarly, while most covered buildings will not be impacted by the Act’s building emissions limitations until the second compliance phase, 2030-2034, as the emissions limitations become more stringent, the percentage of covered buildings impacted and the costs to implement necessary retrofits will increase significantly. The demand for qualified design professionals and contractors who design and implement energy retrofits will grow as more buildings are impacted, dramatically reducing supply and increasing the cost and duration of projects.

Financing for retrofits may be available through the Act’s PACE program. Building owners should consider how necessary energy efficient retrofits can be integrated into existing capital expenditure  plans, and the extent to which such expenditures may qualify for property tax abatements under the ICAP program. ICAP may be a way to partially offset potential property tax assessment increases that may result from capital expenditures for new energy efficient infrastructure projects.

In addition to the above, all of which apply primarily to owners of covered buildings, buyers and lenders also need to be acting now to revise their standard due diligence items. The prospect of potentially significant future capital expenditure requirements for energy efficiency retrofits, along with potential fines and penalties for poor performing buildings should drive prospective buyers and lenders to include an in-depth assessment of the building’s current energy usage, reasonably projected future energy usage, and the emissions limitations that will be applicable.

This diligence could potentially be added to the scope of work for a Property Condition Assessment, but not all consultants will be qualified to conduct this type of review, or have the requisite knowledge of the Climate Mobilization Act. In order to receive accurate diligence that buyers and lenders can rely on, a qualified design professional/engineering firm may need to be engaged to provide a report on CMA compliance.

Purchase and sale agreements, and loan agreements will also need to reflect CMA compliance obligations and expectations both in terms of representations and covenants as well as in pricing.

Summary

The Act’s laudatory goals of reducing building greenhouse gas emissions by at least 40% by 2030 and 80% by 2050 will require significant operational changes and capital expenditures for New York’s building stock. The City is just beginning to undertake the studies and promulgate the rules necessary to implement the Act. The relative scarcity of current qualifying RECs and offsets in the NYC grid system likely means that owners of covered buildings will need to rely primarily on retrofits to meet the ambitious emissions limitations, although recent State legislation may help make alternative means of compliance more readily available.

Prudent building owners will assess their buildings’ energy use, and plan for compliance now. Similarly, prudent buyers and lenders will amend their due diligence plans to incorporate building energy efficiency reviews.

Stroock will follow the implementation of the Act and provide additional Special Bulletins to help the building owner community understand and comply with the Act’s requirements.

______________________________

For More Information:

Raymond "Rusty" N. Pomeroy II

Brian Diamond?

Karen Scanna

Ross F. Moskowitz

Joseph B. Giminaro

Jennifer S. Recine

This article is for general information purposes only. It is not intended as legal advice, and you should not consider it as such.

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