Local Law 97 Building Compliance Brings a New Layer of Economic Implications to CRE Transactions and Lease Negotiations

While Local Law 97 passed nearly five years ago, it officially went into effect earlier this year. Part of the broader Climate Mobilization Act designed to significantly decrease New York City’s carbon emissions, Local Law 97 targets the commercial real estate (CRE) industry, which accounts for about 70% of the city’s emissions.

Local Law 97 includes multiple compliance periods: 2024 – 2029, 2030 – 2034, 2035 – 2039, 2040 – 2049 and 2050 and beyond. Each period has a designated set of increasingly stringent standards for compliance. Buildings that fail to meet these standards will be subject to penalties, with fines set at $268 per ton of carbon annually. So the mandate will only affect the real estate owners with buildings subject to compliance currently in their portfolios, right? Wrong. The law could impact the economics of every building subject to it as well as future transactions involving any building of 25,000 or more square feet.

David Goldstein, president of the New York Tri-State Region for Savills, the largest adviser for corporate tenants, and Josh Winefsky, a partner in our Real Estate practice, led a detailed discussion on transactional considerations related to the mandate at a recent Avenue of the Americas Association presentation.

The mandate poses both philosophical and economic considerations for the building industry

Local Law 97 will play a major role in helping New York City achieve net neutrality by 2050. As corporations prioritize their sustainability programs and work to adopt more climate-friendly postures, compliance may help better position companies in front of investors.

“You have to think of the social overlays involved,” said Goldstein. “New York City is home to some of the most diverse companies in the world, and their investors are taking a close look at their sustainability and ESG policies, and cutting carbon emissions has become an important element on the scorecards of these large, global occupiers.”

Forecasting a building’s future performance will be key to mitigating operating expenditures

While the mandate will advance New York City closer to its climate goals, it presents a new dynamic for evaluating a building’s forecasted operating expenditures and overall profitability. Winefsky explained that real estate owners will need to assess the trade-off of investing in energy-efficient upgrades to meet the law’s emissions thresholds versus being fined $268 per ton of carbon annually for being in excess of limitations. These fines can significantly impact a building’s operating expenses and overall profitability, making it crucial for real estate professionals to accurately forecast these costs when evaluating a property’s financial viability.

Winefsky and Goldstein explained that this could have a widespread effect on the city’s building owners. “[More than] 90% of buildings comply with the 2024 emissions target, but this is a very easy threshold. It will become harder to meet the designated standards in 2030, and even more so in 2035,” said Winefsky. “Understanding how a building is expected to perform and be penalized in the coming years will enable us to understand how that building might plan for capital expenditures to mitigate those penalties.”

“With this law in effect, scrutiny of data and due diligence are needed to understand how a building will perform before you enter into any [CRE] transaction,” explained Goldstein. “Emissions must be cut by 50% by 2030 and 75% by 2035, which is why it’s coming to the forefront in leasing negotiations today.”

Goldstein also noted that with the law being so new there is some uncertainty around what this means for corporate occupiers.

In an office lease negotiation, owners seek to pass through to tenants various types of operating expenses, and Local Law 97 has a direct effect on this dynamic. “Traditionally, landlords pass through to tenants capital expenditures that are necessary to comply with a law that is enacted or takes effect after the lease is signed,” Winefsky shared. “Now, landlords are taking the position that Local Law 97 compliance is not cut off at lease signing, so any capital expenditures performed to comply with Local Law 97 are eligible to be passed through, making the extent of this pass-through the subject of negotiation.”

Winefsky and Goldstein explained that compliance’s economic impacts extend past lease negotiations to include critical considerations for all CRE transactions. “If you’re looking to acquire a property, you need to know what you’re acquiring and factor in [whether] the building will need meaningful upgrades in the next decade,” said Winefsky. “It also directly impacts development deals, financings, selling a property and understanding how this correlates to its marketability. And with joint venture equity investments that require capital work, it will need to be determined who is responsible for carrying those expenses. Understanding Local Law 97 and performing due diligence regarding its impact on a property should now be a part of every single transaction for New York City properties.”

Goldstein and Winefsky ended the presentation on a high note, explaining that the grid will only continue to get greener as renewable energy is incorporated into property portfolios, which will help with compliance overall.