Reducing carbon emissions is becoming a prominent investment theme in real estate, driven partially by a regulatory shift that directly ties recently implemented building performance standards to financial repercussions. These standards are emerging across cities and states around the globe, requiring decarbonization in commercial and residential buildings and penalizing those that fall short.

New York City’s Local Law 97 illustrates how quickly the economics can change. Beginning in 2024, buildings over 25,000 square feet must comply with emissions caps or pay penalties of $268 per metric ton of CO₂e over the limit. In the early years, penalties may be negligible and building owners may opt to pay fines rather than pursue expensive retrofit projects; however, the caps tighten in 2030 and beyond, which can drastically change the math for building owners. For investors, this shift means that carbon risk is financial risk, and it must be priced accordingly.

Decarbonization Strategies and Institutional Capital

Institutional capital appears poised to play a significant role in shaping how decarbonization strategies take form in real estate over the next several years. Net zero commitments, once long-dated aspirations, are beginning to influence allocation decisions more directly as deadlines draw nearer. Decarbonization strategies targeting “brown-to-green” transitions of real estate assets are gaining traction, though the competitive landscape of investable opportunities remains relatively narrow today. Real estate investment managers with strategies tied to decarbonization often concentrate in major gateway markets, where regulations are binding and tenant demand is strongest. Residential and industrial assets feature prominently, while office is approached more selectively today given broader sector headwinds.

In this environment, a competitive advantage comes not from simply marketing a green strategy but from proving the ability to execute retrofits that generate quantifiable outcomes and the potential for stronger long-term returns.

Property-level initiatives can range from lighter retrofits to deep, capital-intensive upgrades. Lighter retrofits—such as upgrading to LED lighting, installing smart meters, or modernizing building management systems—can often be undertaken while tenants remain in place, generating some interim income while still improving efficiency.

More transformative deep retrofits, by contrast, usually require vacancy and significant downtime, but they unlock the greatest potential for long-term value creation. These projects might include replacing fossil fuel-based heating and cooling with efficient heat pump systems, installing high-performance windows and insulation, or integrating on-site renewable energy generation and storage. Additional measures such as flood protection, resilient facades, efficient water systems, and EV-charging infrastructure can further future-proof assets.

Together, these interventions represent both a spectrum of decarbonization strategies and a spectrum of risk-return profiles, offering investors multiple ways to align with climate targets while managing income stability and capital appreciation.

Costs vs. Returns

The question for investors is how to balance the cost of these initiatives (as well as the cost of non-compliance with building performance standards) and financial returns. There is a natural tension between pursuing deeper sustainability upgrades that deliver greater reductions in energy use intensity and the capital outlays required to achieve them. Depending on the retrofits pursued and the associated costs, there can be a tradeoff where those expenditures can begin to dilute returns, even if they meaningfully improve an asset’s environmental profile. In the absence of a standardized framework for weighing environmental impact against financial performance, these choices are often made on a case-by-case basis, with managers applying judgment to determine the right course for each property.

For institutional investors, this underscores both the complexity and the importance of aligning incentives so that decarbonization goals and financial outcomes can be pursued in tandem. One potential way managers could reinforce this alignment is by tying carried interest to measurable reductions in carbon emissions, ensuring that financial rewards are linked directly to progress on sustainability targets.

These decarbonization funds could look to sell their upgraded assets, once business plans are completed, to market participants that prefer to be long-term owners of energy-efficient buildings compliant with emerging performance standards. Buyers of these assets may take the form of Article 9 funds—vehicles defined under the E.U.’s Sustainable Finance Disclosure Regulation (SFDR) as having sustainability as their explicit objective—where demand for climate-aligned assets is expected to grow.

European markets already provide a useful precedent: According to EU-Startups, as of 2024 nearly 1,000 Article 9 funds managing over €300 billion exist across various asset classes, with demand driven largely by institutional investors such as pension funds, insurers, and sovereign wealth funds. Real estate remains a relatively small portion of that capital base, highlighting both the opportunity and the room for growth in markets where building performance standards are gaining traction.

While Article 9-style funds have not yet translated directly to U.S. real estate, they provide a useful reference point for how capital might flow once comparable standards take hold. Open-ended funds explicitly structured around decarbonization are still uncommon, but early indications suggest such vehicles could emerge as investors increasingly seek stable, sustainable holdings with perpetual liquidity. If these trends converge, the scale could be significant, with the potential for substantial capital to flow into climate-aligned real estate strategies over the coming decade.

Building performance standards are set to tighten in markets where they have already been approved and could gain prominence in additional jurisdictions, with penalties expected to escalate and tenant demand likely to tilt further toward climate-aligned space. Properties that fall short of regulatory thresholds could face pressure on net operating income from mounting fines, elevated vacancy risk, and potential challenges in accessing capital. By contrast, assets that succeed in lowering carbon intensity are more likely to remain liquid, finance-able, and resilient under regulatory scrutiny. Decarbonization is evolving from a sustainability aspiration into a core consideration for investors aiming to safeguard long-term value.