California’s New Climate Regulations Shine Brighter Light on Real Estate’s Carbon Emissions

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California’s recent landmark legislation on climate disclosure, passed in fall 2023, will drive new evolution in real estate reporting on climate risk and provide more public insight than ever into the industry’s impact on climate change.

The two laws, SB 253 and SB 261, require large public and private companies in California to report their total greenhouse gas emissions and the impacts of climate change on their financial performance. Although these two laws pertain to companies operating in the state (and to ones with more than $1 billion and $500 million in annual revenue, respectively), California’s outsize influence as the world’s fifth-largest economy means this legislation is likely to make climate risk reporting a standard of practice, alongside existing disclosure requirements in Europe and forthcoming rules by the U.S. Securities and Exchange Commission.

As reporting kicks off in 2026, companies that act now by developing strategies to accurately measure and reduce their emissions and climate-related financial risks will be best positioned both for compliance and market advantage.

Growth in climate risk disclosure

Many leading real estate firms have been assessing and reporting their carbon emissions and climate impacts on their business for several years, a foundational step in reducing the roughly 40 percent of global emissions that the industry generates.

This practice increased rapidly with the introduction of such frameworks as the Sustainable Finance Disclosure Regulation (SFDR) in Europe and the Task Force on Climate-related Financial Disclosures, both of which lay out rules and guidelines for how companies should publish their impact on climate change and its impacts on their business for investors, regulators, end users, and the public to better understand.

For instance, the number of companies reporting environmental performance data to global disclosure nonprofit CDP rose from about 9,600 in 2020 to more than 23,000 in 2023, and the Global Real Estate Sustainability Benchmark (GRESB) has undergone similar growth in recent years. ULI’s own sustainability benchmark, managed by ULI Greenprint, has tracked consistent expansion as well and now represents 16,500 assets and more than $2 trillion in assets under management.

California’s new laws help ensure that companies, to be considered competitive in today’s environment, need accurate data on climate risks and strategies to mitigate them while enhancing value.

What are the new laws?

California’s SB 253 and SB 261, as this summary from the Real Estate Roundtable explains, call for the following:

• SB 253 requires annual corporate disclosures of all Scope 1, 2, and 3 emissions, not just emissions generated in California, for companies with total revenue exceeding $1 billion. Emissions must be third-party verified. Reporting begins in 2026 for Scope 1 and 2. Companies failing to report can be subject to penalties up to $500,000 per year.
  
• Scope 1 emissions are those from direct fossil fuel use in assets, such as heating, hot water, or cooking systems running on natural gas, fuel oil, or similar energy source, and can be reduced by switching to electric systems and using on-site renewable energy.
  
• Scope 2 emissions come from assets’ use of grid electricity, and can be lower in areas with cleaner grids or by generating/purchasing renewable energy.
  
• Scope 3 emissions, by far the biggest share of real estate emissions, include tenant energy use; emissions from building materials, construction, and demolition (also known as embodied carbon); and potentially other sources, such as employee travel. Scope 3 emissions are the most difficult to measure and require deep collaboration across supply chains and end users to reduce. Reporting on Scope 3 therefore begins later, in 2027.
  
• SB 261 requires companies with annual total revenues exceeding $500 million to report their climate-related financial risks and the actions taken to mitigate those risks. Companies can follow the Task Force on Climate-related Financial Disclosures (TCFD) framework or upcoming SEC framework to satisfy this requirement. Reporting must include both transition risk and physical risk, which, as ULI and Heitman’s recent report Change is Coming: Climate-Risk Disclosures and the Future of Real Estate Investment Decision-Making, explains:
  
• “Transition risk is a broad grouping of business risks associated with climate change and the transition to a low-carbon economy, such as changes in the regulatory backdrop, reduced resource availability, increased cost for insurance (and diminished access), higher taxes, and the potential for reputational and market shifts.
  
• “Physical risk is the risk of damage to assets due to climate-related factors. Physical risk can be short term, such as damage from extreme storms, or longer term, including threats from rising sea levels or prolonged drought.”

How do these rules differ from the SEC proposal?

This chart from PBS NewsHour explains the key differences and similarities—in short, the SEC rules are less strict and more broad, as they apply to public companies only, but ones of any size, that do business anywhere in the U.S. The SEC rules require climate-related financial disclosures on transition and physical risk but do not require Scope 3 emissions, unless they are “material” or the company has set a target for reducing them.

These disclosures will provide companies, investors, tenants, and regulators with more accurate insight into how exposed real estate assets and portfolios are to climate risk. They will also demonstrate which firms are taking meaningful action to protect existing value and enhance future value by carefully integrating the results of their assessments and disclosures throughout their business, not just checking reporting boxes, and transitioning to low-carbon buildings that are prepared for extreme weather.

Reporting itself has been shown to drive action to reduce emissions, so mainstreaming disclosure is a critical step. These changes will help companies avoid getting stuck with stranded assets that can no longer comply with increasing local and national regulations in the U.S. and Europe, as with New York’s Local Law 97, which requires low-carbon or low-carbon energy buildings.

Plus, the California rules reach further in requiring Scope 3 emissions than do the SEC rules. This addition is likely to build a clearer picture of the true extent of real estate emissions and how much progress companies are really making on managing the transition to a low-carbon industry.

Additionally, given how closely investors are looking at impacts of climate on business performance, the mainstreaming of reporting will reward companies that have made climate action a priority. For example, a recent study by the National Association of Real Estate Investment Trusts (NAREIT) found that REITs which voluntarily disclose to GRESB financially outperform REITs that do not disclose.

The upshot

Climate risk is central to real estate performance, even though it has not been fully understood to date. These new California bills will create much greater transparency into how companies are being affected by climate risks, and which companies are truly leading the way on sustainable, resilient real estate.

Firms prepared to manage climate risks and use what they disclose to create better products will be best positioned to distinguish themselves in the market and remain competitive for investment in the future.