Green Buildings and Energy Efficiency: The India Story

INTRODUCTION

With 10 million new homes required to be built every year to keep pace with Indian housing demand, significant opportunities exist with regard to establishing new techniques in climate-responsive construction. Within this market, green buildings¹ have immense investment potential for both residential and commercial use.

Most markets around the world, including emerging ones, remain deeply engaged in the process of articulating, and eventually pursuing, sustainability and/or other allied goals, such as those stemming from climate change, global warming, as well as environmental, social, and governance-related (“ESG”) priorities. As part of their short-term goals on ESG, listed developers may want to substantially increase their green portfolio by the end of the decade, along with ramping up deployment of renewable energy. Further, an increasing number of real estate investment trusts (“REITs”) are participating in global ESG benchmarks for commercial real estate.

Accordingly, it is useful to examine the actual cost of pursuing such goals. This pursuit includes making informed estimates about the availability of resources and funding with respect to goal-realization, especially given extant housing demand in India in terms of both residential buildings and Grade A commercial/industrial assets.

PRESENT FORECASTS

The global pivot on sustainable development has revitalized preferences among both occupiers and developers for green certified commercial buildings². According to a JLL³ study conducted last year across major Indian cities, well above two-fifths of all commercial Grade A office stock had a green certification⁴. Further, this penetration rate was poised to cross 50% over the next decade⁵. Moreover, almost three quarters of new supply is likely to be rated green, while older projects may undergo upgrades for the purpose of reducing their carbon footprint.

In this regard, according to a more recent real estate outlook (the “Colliers Report”) released by Colliers International Property Consultants, Inc. earlier this month (March 2023)⁶, a burgeoning ESG focus has created significant opportunities for landlords and developers to upgrade outdated office assets⁷. Further, this year promises to witness greater activity from developers towards improving both efficiency and sustainability in their buildings⁸. Among other considerations, such upgrades are expected to provide long-term benefits and enable the underlying assets to remain competitive. In addition, 2023 is predicted to evidence increased green financing, as domestic and offshore investors seek good quality Grade A projects that are sustainable and ESG compliant.

BRSR

Further, according to a recent consultation paper⁹, the Securities and Exchange Board of India (“SEBI”) soon plans to introduce an assurance-driven reporting regime (“BRSR Core”) as a subset of the wider Business Responsibility and Sustainability Reporting (“BRSR”) framework – which, in turn, SEBI had introduced in May 2021¹⁰ to ensure standardized disclosures on ESG-linked parameters. While the top 1,000 listed companies in India (by market capitalization) could make these ESG-based disclosures on a voluntary basis until now, from FY 2022-23 onwards, such disclosures are mandatory. In addition, the list of mandated reporting entities may be expanded upon later.

While BRSR Core, by design, has been formulated on the basis of ‘reasonable assurance’ (similar to an audit verification), the general BRSR framework also requires quantitative data with respect to ESG across key performance indicators (“KPIs”), such as the quantum of investment made towards reducing a company’s environmental footprint¹¹. The environmental footprint of a building, for instance, can be measured in several ways – ranging from the amount of carbon used in construction, as well as to maintain a building through its lifecycle; to the everyday consumption of resources such as water and energy; to the amount of waste produced. Thus, based on the KPIs under the wider BRSR regime, reporting about both investments made and capital expenditure incurred in respect of green and/or energy-efficient buildings (e.g., through the use of environment-friendly and sustainable building materials, or providing for ‘smart technological’ heating or ventilation) may significantly improve ESG ratings, and thereby reduce the cost of future capital.

THE REGULATORY ENVIRONMENT

The Energy Conservation Act, 2001 (the “EC Act”) specifies norms and standards for appliances and equipment, as well as in respect of building construction. Established by the EC Act, the Bureau of Energy Efficiency (“BEE”), a body functioning under the Ministry of Power, administers such standards through interventions such as: (1) a ‘star labeling’ system for ACs¹², (2) a voluntary rating program for commercial buildings, and (3) the ‘Perform, Achieve, Trade’ (“PAT”) scheme¹³. Formulating building codes with regard to energy conservation also falls within the EC Act’s ambit. Accordingly, the BEE has pursued initiatives such as the Energy Conservation Building Code (“ECBC”)¹⁴.

Recently, the Energy Conservation (Amendment) Act, 2022 (the “EC Amendment”) came into force. Among other important changes, the EC Amendment has now included large residential buildings under the EC Act’s regulatory regime, along with enhancing the scope of ECBC.

GREEN BUILDINGS: OPPORTUNITIES AND CHALLENGES

Emerging evidence suggests that green buildings are a higher-value, lower-risk asset than standard structures. Further, new constructions offer a significant opportunity to integrate energy efficiency into building design from the outset, avoiding the bother of expensive retrofits later.

However, there are a number of constraints in this regard, which include the perception of high construction costs, a lack of alignment between incentives and benefits, as well as a mismatch between (1) short hold periods with respect to real estate assets in portfolios, on the one hand; and (2) long building lifespans on the other – especially when coupled with the possibility of stricter future regulation. Nevertheless, there does exist strong market sentiment along with corresponding demand for energy efficient buildings in India. Local developers are increasingly realizing that the additional capital expenditure (“capex”) incurred upfront is likely to be offset by the significant savings made on operational costs (“opex”) over the longer term.

INVESTORS AND FINANCERS

Real estate financers and investors may influence the market for green buildings in meaningful ways. In terms of commercial bank lending – construction finance, mortgages, home improvement loans, and green financial products for resource-efficient buildings can significantly accelerate the uptake of green buildings, along with lower interest rates and longer tenors. As a result, such banks can diversify their client base and product offerings, build higher-value and lower-risk portfolios, and access new sources of finance through green bonds, green securitizations, and green credit facilities. On the other hand, institutional investors that participate in green real estate can help inject liquidity in such markets and enable primary lenders to free up capital to develop new green lending products.

In addition, multinational development finance institutions (“DFIs”) such as the International Finance Corporation (“IFC”), can catalyze nascent markets and facilitate the entry of private investors, including foreign ones. DFIs provide a range of financial products not readily available in most markets, often in combination with technical support and capacity-building programs. These institutions can also build the government’s capacity to develop enabling environments. Indeed, DFIs such as IFC have actively invested in affordable housing in India. DFIs also have specific ESG and other sustainability standards/policies that are required to be monitored and complied with, which would include investments in green and resource-efficient buildings.

THE GOVERNMENT

The government can create a pipeline of green building assets and incentivize financers to route their capital to this sector. Specifically, it can enhance investor appetite by requiring public buildings to be green. In turn, this can build technical capacity and skills among designers, engineers, and workers, who might then become better equipped to construct privately financed green buildings.

Fiscal incentives like tax breaks, grants, subsidies, loans, and rebates, complemented by non-fiscal incentives such as preferential or expedited permits, can also be put into play. Further, mandatory building codes may ensure that green measures are incorporated from the outset.

BUILDING CODES

While the ECBC represents a key regulatory policy with regard to space cooling in new commercial buildings (such as offices, malls, hotels, hospitals, airports, educational institutions, etc.), the results of implementation have been relatively modest, including on account of the absence of a strong enforcement regime. A recent report¹⁵ by the Ministry of Environment, Forest and Climate Change (“MoEFCC”) has suggested concrete steps for public departments to: (1) integrate ECBC across government-led construction, and (2) operationalize recommendations for space cooling as issued by the India Cooling Action Plan (“ICAP”).

Nevertheless, the EC Amendment has now introduced the idea of sustainability, where a new building code related to energy conservation will provide norms for the use of renewable sources, as well as for green buildings. Further, while the ECBC applies to a specified category of commercial buildings only, the new code will apply to office and residential buildings as well, subject to certain specifications¹⁶.

Given emerging ESG trends and ESG-related organizational policies around the world, most multinational companies (“MNCs) looking to lease or set up offices in India are keen to occupy premises with green energy/sustainability ratings, thereby incentivizing Indian developers to incur additional capex to procure such ratings. In turn, such developers can effectively monetize Grade A commercial and industrial assets since the target end-users and lessees are often large-scale MNCs.

VOLUNTARY COMMITMENTS

A surge in the voluntary adoption of green construction practices by private real estate developers and owners can create much-needed momentum. Current commitments range from greening individual buildings and portfolios to joining ambitious pledges through international platforms and initiatives. Such commitments have been primarily linked to, and delivered through, green building certification programs.

RATING SYSTEMS

Voluntary green building ratings systems – such as the Indian edition of the Leadership in Energy and Environmental Design (“LEED”), Green Rating for Integrated Habitat Assessment (“GRIHA”), Indian Green Building Council (“IGBC”), etc. – have proved somewhat successful in the commercial building segment, driven by green policies among larger companies. However, India does not yet have a mandatory green construction code or a set of mandatory green building standards like in the US – where the International Green Construction Code (“IgCC”)¹⁷ and ASHRAE 189.1¹⁸, respectively, apply in specific cases.

Nevertheless, the LEED benchmark has been recognized by most developers and builders in India. Further, GRIHA was adopted as the national rating system for green buildings in India by the Ministry of New and Renewable Energy (“MNRE”) in 2007¹⁹. GRIHA evaluates the environmental performance of a building based on quantitative and qualitative criteria, providing a definitive standard for green buildings.

ENFORCEMENT

Strictly enforced labeling and energy performance certifications for buildings and appliances by the BEE can ensure better compliance with green standards, catalyze the market for energy-efficient technologies, and generate market data to help financial intermediaries select efficient buildings to invest in.

Further, various policy options can be adjusted to suit local legal frameworks as well as unique socioeconomic contexts. Training construction industry professionals and officials can make enforcement easier. Stakeholder engagement that incorporates the interests and expertise of the public and private sectors, respectively, can help remove some barriers to compliance. Mandating third-party certification can address ‘greenwashing’ concerns and ensure that only legitimate recipients receive incentives without overextending public sector overheads.

AT THE STATE LEVEL

The National Building Code of India, 2016 (“NBC”)²⁰ has been revisited in certain Indian states to serve the latter’s particular sustainability goals. In Haryana, for instance, the government has incentivized GRIHA/IGBC/LEED-rated projects by awarding additional floor area ratio (“FAR”) in respect of all building use (except plotted residential), and especially for the purpose of achieving such ratings pursuant to an amendment in the Haryana Building Code, 2017. The Pune Metropolitan Region Development Authority also offers additional FAR to developers with gold/platinum IGBC ratings.

THE WAY FORWARD

Future digitalization may further expand opportunities for space cooling across buildings. The diffusion of internet-connected devices in the residential and commercial sectors may allow added integration across demand and supply. From the government’s perspective, policies need to take into consideration the opportunities that arise from the emergence of digital technologies – which, in turn, can make cooling and other buildings-related energy services more sustainable. For instance, the roll-out of smart thermostats can reduce energy consumption in response to real-time price signals.

However, there are concerns with widespread digitalization as well, including in respect of data security and privacy, along with technical and economic considerations. Given the fragmented nature of local laws on construction, sustainability goals vis-à-vis buildings are often compromised in terms of implementation. With the rise in demand for Grade A assets with appropriate green energy ratings for commercial and industrial leasing, there is much to be done in terms of addressing additional capex requirements.

DISTRICT COOLING AND TRIGENERATION

India’s large-scale space cooling requirements can be met through new technologies, including through the use of delivery/distribution models involving ‘cooling as a service’ (“CaaS”). However, viable implementation models will be necessary to support such business and operations, such as those of district cooling systems (“DCS”). A DCS produces chilled water in a central plant and delivers it to buildings through an insulated distribution network and via energy transfer stations. The idea of a ‘merchant’ DCS in India is relatively new: it involves the aggregation of different demand groups such as special economic zones (“SEZs”) and large commercial business districts in a CaaS model –. Nevertheless, emerging examples include the GIFT City in Gujarat and Amaravati in Andhra Pradesh. In the latter case, a foreign cooling service provider entered into a long-term concession agreement with the state government.

Globally, DCS projects have been developed under various business paradigms. A variety of stakeholders such as municipal corporations, state governments, building developers, international finance providers, special purpose vehicles (“SPVs”), etc., can invest in such projects. For example, in Dubai, building developers double up as utility operators to provide services such as water, waste, power, and cooling in integrated townships. Other business models (e.g., in London, Paris) are based on public utilities investing directly in such integrated projects, with their investment linked to the underlying incentives related to land, access to energy sources and wastewater connections, as well as to revenue streams. Accordingly, an Indian implementation agency could coordinate among various stakeholders and manage the different processes involved, such as those of tendering, financing, and setting up a district cooling network, including under the aegis of a public-private partnership (“PPP”) model.

For instance, a couple of years ago, Energy Efficiency Services Limited (“EESL”), a state-owned Indian company, entered into a memorandum of understanding (“MoU”) with GAIL (India) Limited to develop trigeneration projects. Tri-generation is a process that provides combined cooling, heating, and power from a single generator, producing electricity and utilizing the residual heat to generate chilled water for air-conditioning or refrigeration using a chiller. Pursuant to this MoU, EESL will be responsible for the upfront capital costs and risks, as well as provide tri-generation to customers through an offtake based on a long-term power purchase agreement (“PPA”). This model may serve as a template to create a viable ecosystem for tri-generation projects in the future, along with standard contractual and operating processes to develop a CaaS model.

Finally, scaling up new cooling technologies and business models will require cities to become ‘smart’ and have longer horizons for meeting space cooling demand in a sustainable manner. Concomitantly, cities need robust incentive structures to become active stakeholders in respect of DCS adoptions. Infrastructure development programs such as the Smart Cities Mission can be utilized accordingly.