Japan’s long road to net zero

Real estate managers face important challenges to cut emissions under the country’s latest target, but the ambitious goal is not impossible to achieve.

Japan’s commitment to cut its greenhouse gas emissions by at least 46 percent by 2030 and reach net zero by 2050 has put real estate in the spotlight, since it accounts for one of the highest carbon footprints in the country.

Commercial and residential buildings made up 33 percent of the country’s total energy-related CO2 emissions in 2020, including indirect emissions from electricity use, according to the Climate Action Tracker, known as CAT, citing official Japanese government data. Compared with 1990, the emissions in these two sectors have increased by 39 percent and 29 percent, respectively.

Real estate players are accelerating efforts to meet Japan’s ambitious goal, but the road to decarbonizing buildings is full of pitfalls. One of the key challenges cited by the industry is the low renewable energy composition of the utility grid. The country’s power sector is more dependent on fossil fuels than in other developed economies, making it more difficult to source zero-carbon electricity for buildings.

“In Japan, there is a relatively low percentage of renewable energy facilities or plants in operation,” says Helen Gurfel, global head of sustainability and innovation at CBRE Investment Management. “Almost 80 percent of Japanese energy sources rely on fossil fuels. In part, this is due to ongoing conversations regarding resuming nuclear power production and development costs associated with establishing renewable energy plants.”

In 2021, the government of Japan approved the Sixth Strategic Energy Plan, which sets the energy policy toward achieving carbon neutrality by 2050 and the 46 percent carbon reduction target by 2030. Under the plan, renewables should account for 36-38 percent of power supplies in 2030, which is well above its previous 2030 target of 22-24 percent.

Japan is still far from meeting this goal, although its efforts to increase renewable energy over the last few years have produced results. In 2021, renewables accounted for 22.4 percent of all electricity generated in Japan (including on-site consumption), an increase of over 10 percent from 2014, according to the Tokyo-based Institute for Sustainable Energy Policies.

One of the first property sectors in Japan to observe the use of clean energy through on-site generation was residential. In the early 1990s, a compact photovoltaic generation system was developed for easy installation on houses and legislation was introduced to allow power companies to buy surplus electricity back from homeowners.

Presently, Japan’s Ministry of Land, Infrastructure, Transport and Tourism aims to have all new residential housing meet Zero Energy Home (ZEH) standards by 2030, which, according to real estate services firm Savills, is driving many developers to shift their focus to such condominiums. One example is from joint developers Mitsui Fudosan Residential and Mitsubishi Estate Residence, which will complete Japan’s largest ZEH condominium development in 2025. This will feature just over 1,000 units, on-site power generation and virtually zero CO2 emissions for both electricity and gas.

Within BELS – a Japanese real estate green certification that evaluates energy consumption efficiency in houses – the ratio of ZEH is now over 50 percent across Japan, which represents progress in the popularity of such condominiums, says Elke Kornalijnslijper, head of sustainability consulting, Asia-Pacific at broker JLL. However, the ZEH ratio increase needs to accelerate “substantially” to meet the 2030 carbon reduction goal, which is expected to happen, she adds.

In the commercial space, meanwhile, some players have implemented major initiatives toward decarbonization involving renewable energy sources. Japanese property developer Mitsui Fudosan will begin powering some of its large-scale commercial properties with electricity produced at its own solar power plants. According to the financial newspaper Nikkei Asia, when all the planned facilities are in operation, the company’s carbon dioxide emissions will be reduced by about 10,000 tonnes per year compared with buying electricity from utilities such as Tokyo Electric Power.

“On-site renewable power generation in Japan is being looked at more now than a couple of years ago, partly because electricity has become much more expensive,” says Adam Donahue, head of custom accounts for Asia-Pacific at investment manager LaSalle. “We manage a number of shopping malls in Japan and last year we did an installation of solar panels on the roof of one of [them]. This year, we will do an installation at a separate shopping mall and hope to generate 800 kilowatts of electricity from these solar panels.”

Retrofitting challenge

Despite efforts to source clean energy through the utility grid or on/off-site renewables, “progress is slow and managers cannot rely solely on decarbonization of energy supplies to deliver on the 2030 goals,” says Mark Cameron,  head of sustainability for Asia-Pacific at Nuveen Real Estate, the pension fund’s investment arm.

A global challenge, that is also seen in Japan, is time and pace of action when it comes to decarbonizing existing buildings, Cameron adds. “Retrofitting of buildings needs to meet around 3 percent of existing stock annually to hit global decarbonization goals. There is a risk in Japan, as with other nations, that action isn’t taken early enough to have meaningful impact.”

“In the Japanese real estate sector, electrification is a major driver of emission savings in addition to achieving energy efficiency”

Elke Kornalijnslijper, JLL

The retrofitting challenge – particularly in larger Japanese cities, where approximately 80 percent of the building stock that will be standing in 2050 has already been built – will require the financial and physical commitment of both owners and occupiers, Kornalijnslijper says.

Private equity real estate firm Hines, for instance, is spending $15 million of capex after the 2021 acquisition of Yokohama New Stage, a 538,000-square-foot office building constructed in 1993. “To reduce the carbon footprint, we completed an energy audit and long-term carbon reduction plan. To begin, we are installing natural wind cooling, converting to LED lighting, and applying anti-UV film onto the glass atrium. We will also be upgrading aged MEP [mechanical, electrical, plumbing systems] over time to more energy efficient equipment,” explains Jon Tanaka, senior managing director for Japan at Hines. 

Assets in Japan tend to be newer, however, so underwriting and capital plans do not often include replacement of building fabric or systems to make them greener, Cameron says. “Alongside this, the industry faces rising construction costs, which, while more muted compared with regional peers, are creating challenges when weighing up the feasibility of retrofitting and improvement of standing assets,” he adds.

Property players canvased by PERE are not anticipating interest rate hikes as an additional hurdle that would diminish available funds allocated to sustainability projects. Interest rate increases in Japan are expected to be modest, especially in comparison with other developed countries. However, moderate inflation of 4 percent and supply-chain difficulties – which, while improving, remain an issue – are contributing to increasing the costs of environmental initiatives, Tanaka says.

For Donahue, the main challenge for real estate managers looking to reduce their carbon footprint today is to continue the momentum to reinvest in green assets at a time of higher costs and stagnating rents. “To refurbish existing buildings, we generally start from converting lights to LED, investing in water fixtures, automated sensors, and then looking at building management systems and HVAC,” Donahue says. “We start from items that have faster payback before we tackle more transformative enhancements.”

While there are a number of challenges for owners of existing buildings to reduce emissions by 2030, there are also positive factors when it comes to retrofitting.

According to McKinsey & Company’s 2021 How Japan could reach carbon neutrality by 2050 report, because Japanese building owners often retrofit their properties to withstand frequent earthquakes, there are increasing opportunities to install better insulation and more sustainable heating solutions. 

In addition, a large proportion of Japan’s urban office and residential buildings are owned by a handful of major real estate companies, making it easier to implement widespread change, the consultancy firm says.

Own path to decarbonize

Although Japan has an ambitious goal for its reduction in carbon emissions by 2030, there are no specific regulatory policies or laws in place to mandate this target. This means that real estate owners and managers need to forge their own paths and actions toward decarbonization, Gurfel says.

“The Real Estate Companies Association of Japan, one of the largest associations for the industry, has requested that the government develop a regulation or standard that could help real estate companies set a specific carbon reduction goal,” she notes.

According to Savills’ ESG in Japan Real Estate report, a step that could help property owners in this respect is the commissioning of comprehensive energy audits. Another is seeking green building certifications – such as the Global Real Estate Sustainability Benchmark – or upgrading existing ones to improve a building’s standing. “Once energy-use data has been collected and analyzed, owners can consider what improvements can be prioritized,” Savills says.

But the measuring of energy consumption across portfolios has also proven to be challenging. “In our interactions, when we receive offers from real estate managers to cut emissions and energy from buildings, we normally face difficulties to figure out how the energy is used in the buildings,” Kornalijnslijper says. “This challenge is compounded by a lack of access to architectural and schematic plans of existing facility conditions and insufficient energy meter maintenance data, especially in older buildings across Japan.”

Tanaka notes transitional buyers such as opportunity funds have an additional difficulty, given the limited amount of time they have to implement carbon reduction initiatives, which tend to be a longer-term investment and involve operational strategies. “Collaboration with stakeholders is absolutely critical to implement operational changes and go beyond carbon reduction achieved by simply upgrading MEP,” he adds.

Particularly in the residential space, tenants are not willing to disclose their energy consumption, which makes it difficult for real estate managers to influence a reduction in carbon footprint by occupiers.

“In order to overcome this challenge, utility and software-as-a-service companies are discussing how to create a service to measure the energy consumption of the whole building, taking the tenants out of the equation,” Gurfel says.

While fraught with difficulty, the path to decarbonizing buildings is not a dead end road. According to McKinsey & Company’s How Japan could reach carbon neutrality by 2050 report, for Japan to reach its 46 percent emissions-reduction target by 2030, it would need to eliminate about 500 metric tons of carbon dioxide equivalent (MtCO2e), out of which 70 metric tons would come from buildings, representing a 55 percent reduction compared to 2017 levels. 

This drop – which would involve cost savings of $57 per MtCO2e – can be achieved by installing better insulation and switching to electric heat pumps instead of fossil-fuel boilers, the consultancy says.

The remaining emissions cuts to achieve carbon neutrality by 2050 can be attained through more expensive technologies, such as hydrogen boilers, in addition to better insulation and electrification, which would raise the average abatement costs to $6 per MtCO2e, according to McKinsey.

Since the majority of the 2030 real estate stock is already online, more focus on retrofitting buildings is needed to reduce carbon emissions, which requires innovation and substantial investments, Kornalijnslijper says.

“In the Japanese real estate sector, electrification is a major driver of emissions savings in addition to achieving energy efficiency,” Kornalijnslijper adds. 

“This, in combination with efforts to create a more sustainable electricity supply under the Sixth Strategic Energy Plan, will lead to a net zero carbon by 2050 and Japan meeting its interim 2030 goals.”

Linking sustainability with value creation

The Japanese market is in the early stages of valuing and penalizing assets that do not display the requisite sustainability performance, says Mark Cameron, Nuveen’s head of sustainability for the Asia-Pacific region.

“We have recently reconsidered deals in Japan during due diligence, due, in part, to elevated exposure to physical risks associated with climate change,” he notes.

As an increasing number of offshore institutional investors look to Japan for opportunities to deploy capital, more scrutiny on the sustainability credentials of an asset is expected. This is particularly noticeable with European capital, as managers review assets for their ability to align with mandatory and voluntary ‘green’ reporting standards as well as organizations’ own net zero carbon commitments. “This has the potential to lead to lower liquidity for assets which cannot show performance, or a clear, feasible path to improvement,” Cameron says.

Helen Gurfel, global head of sustainability and innovation at CBRE Investment Management, is also increasingly seeing that sustainability and value creation go hand-in-hand. For example, she says, energy efficiency projects drive a reduction in expenses, creating a higher net operating income, and leasing a logistics roof for solar implementation creates an additional revenue stream.

“There are two sides of the sustainability equation: value creation and risk mitigation, and making sure that our assets are positioned for long-term success is equally as important,” she says.