While it’s imperative to decarbonize single-family homes, apartment complexes and large commercial and industrial facilities, don’t forget about all the Class B and C office buildings, small factories and mom-and-pop stores in strip malls.

RMI makes a strong case for capital investments to retrofit existing small and midsized commercial facilities in its report “Financing Building Decarbonization.”

“Although large buildings in the commercial segment currently attract the most climate-aligned investment and capital, more climate-aligned investment should target small and medium-sized commercial buildings to produce meaningful reductions in U.S. real estate carbon emissions,” the report’s authors wrote.

The stats to back this up are clear, according to the report: building operations generate 23% of U.S. annual carbon emissions, and commercial buildings contribute 37% of U.S. building emissions. Over half of these emissions are from small and medium-sized buildings.

“Although conventional wisdom assumes the largest share of building carbon emissions are generated by very large properties, in reality, small and medium-sized commercial buildings generate a larger share of emissions than large buildings,” the authors wrote.

That’s because there’s just more of them. Large commercial buildings (>200,000 square feet) represent 17% of commercial real estate emissions or about 6% of total buildings’ emissions. In contrast, small and medium-sized commercial buildings account for 56% of all commercial real estate emissions and over 20% of total U.S. building emissions.

While the green bond market has expanded significantly in recent years and buildings have represented a substantial portion of the use of proceeds—U.S. real estate investment trust (REIT) green bond issuances were nearly $12 billion in 2021 alone—volumes still represent a small percentage of overall issuance, comprising 16% of annual bond issuance for that year, according to the report.

“Furthermore, REITs tend to own larger commercial buildings, so investment in small and medium-sized commercial properties is small relative to this subsector’s full extent of carbon emission,” the authors wrote.

Indeed, 28% of commercial green debt issued by REITs was allocated to office buildings, though office buildings are only responsible for 16% of commercial building carbon emissions, according to the report. Similarly, although healthcare contributes roughly 11% of commercial building carbon emissions, only 5% of green bond activity has been in the healthcare segment.

“Based on our findings that most U.S. commercial real estate emissions reside in small and medium-sized buildings, lenders and investors can offer specific financing solutions for their clients that incentivize the decarbonization of those properties,” the authors wrote.

Specific recommendations include:

Lenders could require a cost-benefit analysis of making efficiency upgrades and replacing fossil fuel technologies with renewable technologies as part of their underwriting process. Such an assessment could give lenders and borrowers a clearer understanding of building systems’ conditions and establish a timeline for their replacement.

“It holds the potential advantage of putting green replacement costs on a required schedule and utilizing existing IRA tax credits and rebates to design financing packages,” the authors wrote. “Similar to home improvement loans, the lender could offer additional bridge loans for green building improvements until the IRA rebate or credit is collected, and/or they could offer discounts on the shorter-term portions of the loan to incentivize adoption.”

Lenders could also utilize replacement reserves for efficiency upgrades. Such reserves typically assume “like for like” replacement—if a building has a gas heating system, the reserves assume replacement with a new gas system. Instead, lenders could proactively work with borrowers to replace fossil fuel-powered systems with higher-efficiency electric systems.

“In some cases, leveraging the Inflation Reduction Act subsidies for these replacements would lower or eliminate any incremental cost to the borrower in choosing the green system replacements,” the authors wrote. “Lenders could also offer favorable financing terms to address any remaining incremental costs.”

Moreover, rather than focusing only on financing high-efficiency buildings, lenders should target poorly performing buildings and incentivize improved energy performance through lower rates or improved terms, the authors recommended.

“Building decarbonization capital flows in the U.S. often focus on investing in a relatively small number of low-carbon transactions and reducing exposure to higher-carbon transactions, which disincentivizes decarbonization of existing buildings,” the authors wrote. “However, alternative approaches that target emissions reduction in less efficient existing properties have been piloted in other markets.”

For example, ING’s pilot product in the Netherlands offers discounted loans to low-performing commercial properties to improve their energy performance to the standard currently required by the government. In another example, Bank of Montreal offers retrofit financing at discounted rates dependent on greenhouse gas emissions reductions.

“The recently passed Inflation Reduction Act and the increased focus by investors, lenders, regulators and policymakers on building decarbonization, positions the sector to take meaningful action,” the authors wrote.