Why Commercial Building Decarbonizaton Stubbornly Refuses to Scale

Or why a Polyannish approach isn't getting us there

Decarbonization in commercial buildings is totally stuck. Some have declared that it’s because all the efficiency has been wrung out of commercial buildings. Having run retrofits of dozens of commercial buildings I can tell you that’s not the case. Instead, there are a number of structural barriers holding up the industry. Addressing these will benefit both building owners and efficiency/decarbonization industry players.

The opportunity

The opportunity for decarbonization is there. The idea that we’ve wrung all efficiency out of buildings can only be held by people who have never been shown what is going on in buildings. When I was running an ESCO, we’d go into a building and drop energy use between 20 and 30 percent as part of a very standard lighting and controls retrofit. It’s not easy, which is why we don’t see enough of it, but hundreds of thousands of commercial buildings are ripe for decarbonization.

Walk a privately-owned commercial building today more than 10 years old. You’ll see fluorescent tubes everywhere, when LED lights would use 25% of the energy. You’ll see pneumatic thermostats on the walls, which means the building is running on a technology first developed in 1895 – and for which there is a much more efficient digital modern replacement. You’ll see gas boilers running at 82% efficiency, when modern boilers clock in at 98%. 

There are about 74 billion square feet of non-government-owned commercial buildings in the U.S. – if half of those could benefit from a decarbonization retrofit, and the average retrofit in my experience is $3-4 square foot, that’s a pool of roughly $125 billion in decarbonization project available to benefit the private sector. A tiny tiny fraction of this work is actually being done.

The structural barriers

There are five structural barriers holding the industry back from reaching any kind of scale. 

Financial

In most privately-owned buildings, landlords own the building and the equipment but tenants pay most of the energy costs. This is the so-called split incentive problem. Owners don’t have a way to bill tenants back for all of the capital costs of a decarbonization project and tenants don’t have a way to benefit from an upgrade if they leave before the project’s savings are fully realized. Unless there’s an on-bill financing program that cures the split incentive problem, projects are often dead in the water before they start.

The problems of project finance in private commercial buildings are mostly those of securitization. With a commercial building, you can’t touch the mortgage, or the bank that holds that mortgage will throw a fit. And the privately-owned buildings themselves are often not directly financeable entities as they are owned by cash-poor LLCs that are subsidiaries of other LLCs set up precisely so that parent funds are not reachable in a property’s bankruptcy.

So instead you try all kinds of ways around that. The PACE programs tried to address it with local property taxes but that’s proved too cumbersome. The OBF programs try to address it using utility bills, but the hoops to go through make projects hard to pull off. Additionally some utilities do their best to kill OBF projects, as efficiency is at the top of their “do not like” list right next to rooftop solar power. 

Also, large chunks of commercial real estate seem like a very bad bet to lenders right now. An empty office building might be an energy hog but it’s also a big red number on a balance sheet and lenders are wary of getting near it.

In the market, selling decarbonization projects to commercial building owners tends to be very expensive. Energy Services Companies (ESCOs) engage in a ground war, driven by relationships on the ground, sometimes with support from upper management and often not. The funds that own vast holdings of real estate nearly always have their portfolios broken up into groups of 10-20 buildings.

The management teams of these mini-portfolios operate relatively independently you can’t make a CEO-level sale and have it roll out through the fund’s portfolio.

Finally, decarbonization of natural gas-fired heating is still extremely expensive, at least in large buildings. Large heat pumps in large commercial buildings aren’t quite there yet, technology- or cost-wise. The physical design of hot water heating systems in many buildings is incompatible with the output temperatures and size requirements of current-generation heat pumps.

Lack of Trained personnel

This is a hidden issue, but is an acute one in the industry. 

First, building owners have few to no people in-house that are focused on energy use and even fewer conversant in decarbonization. Individual building chiefs have some awareness of their building’s energy use, and would like to alter it. But they aren’t supported by energy managers in the organization, because these people do not exist. And chiefs don’t rise through the ranks to run funds that own buildings. These organizations are run by asset managers, with a financial management background, not a physical systems management background. And because energy is generally a pass-through the financial managers don’t focus on it as they move up through the ranks.

Second, the industry as a whole is short-staffed when it comes to engineers who can go through a building and redesign the systems as part of a retrofit. This became clear to me as we tried to hire mechanical engineers when I was running an ESCO. We found a few that had been let go from Meta, but they demanded salaries we could not pay. There are a lot of engineers that have served utility programs over the years, but they tend to be compliance-focused rather than creative in the way you need to be to get a project through.

I believe the cause of the shortage is that young engineers don’t go into mechanical buildings systems, and when they do they’re usually focused on the design of new buildings rather than the retrofit of old buildings. The money just hasn’t been there in retrofits to pull along the pipeline of talent we need. 

Operational difficulty

Decarbonization projects are wicked in their complexity – you are all of a sudden embedded in the ongoing operations of a client. Buildings are nearly like living beings, all with their own quirks and needs to run properly. The people who run the buildings are part of that, again with their own quirks and needs. 

A building cannot stop working just because you’re in the ceiling changing out all of the controls on the variable air volume boxes. If a building shuts down because of a programming mistake, as I’ve nearly seen happen, your client loses millions of dollars. More quotidien problems like scheduling around tenant working hours, making sure lighting color temperatures and lighting levels meet expectations, and making sure the building engineer knows how to use the fancy new building management system, and hang up a project for weeks or months.

Finally, projects do not always perform as expected or designed. Sometimes this is because operational parameters aren’t what the project designers hoped for – e.g., a building engineer likes to turn the building on early for a feeling of safety. Sometimes there are design errors – buildings are large systems governed by complex interactions. Sometimes project proponents are over-optimistically-oriented, a tempermental requirement to make the sale and get the project through.

Luckily, experience begets success operationally – groups learn from their experience and manage to risks more tightly.

(Lack of) Sexiness

This is a little bit the X factor. It’s hard to articulate, but careers are not made based on how much money was saved. They’re made based on acquiring and managing big assets so that people – investors and tenants – are happy. Energy use and especially carbon are something that people have a very tough time getting their head around. It’s easier to point to a small parking lot solar installation than the fact that your data center now has a 20% smaller carbon footprint.

Solutions

These barriers can be overcome. At the same time, the solutions to these issues are hard and will take time and focused effort. 

• Some work is being done around financing barriers, but more needs to be done. More capital that can get around the securitization issues – likely ratepayer or taxpayer dollars – needs to be in place. Building owners need to have a firm plan in place for how they will finance the billions of dollars in upgrades needed – and from which they will benefit due to lower building operational costs.

• Some efficiency should just be mandated, like California is doing with elimination of fluorescent bulbs. The downside of this particular mandate is that it may all but eliminate the lighting projects that often carry deeper controls and mechanical retrofits, with their typically longer paybacks, along with them. 

• Personnel training and education is something that all organizations that own real estate should do as part of their continuous improvement package. But HR and promotion incentives must be aligned and corporate decarbonization goals should be firmly entrenched in the organization for these sort of changes to take place. Ownership groups should start hiring mechanical engineers in house to guide decarbonization implementations, therefore providing a career path for young engineers. 

• Making decarbonization and efficiency sexy has always been the industry’s conundrum. The power to do this lies with tenants, who have a lot of leverage right now on building owners to demand fixes to buildings. Tenants should focus on pushing building owners to continually reduce the carbon footprint of their buildings. In the same way that a new lobby or architectural lighting looks sexy, tenants can and should demand the sexiness of a well-designed control system that keeps them comfortable.