The commercial real estate sector is facing a looming crisis driven by regulatory performance standards rather than traditional interest rate fluctuations, posing new financial risks for property owners.
As new building performance standards tighten across U.S. cities, the commercial real estate sector is confronted with a structural risk that is regulatory, cumulative, and largely unpriced. Unlike previous cycles that primarily responded to interest rate changes, the current landscape indicates a shift towards performance-driven challenges.
For decades, the commercial real estate market has followed a predictable cycle: rising interest rates lead to compressed values, tightened credit, slowed refinancing, and widespread stress across portfolios. However, a new risk is emerging—one that is deeply rooted in regulatory changes rather than market fluctuations.
Across the United States, various cities and states are implementing Building Energy Performance Standards (BEPS) that mandate existing buildings to meet specific energy or emissions thresholds. Notable examples include New York City’s Local Law 97, Boston’s Building Emissions Reduction and Disclosure Ordinance (BERDO), and similar regulations in Washington, D.C., and Montgomery County, Maryland. These policies are no longer isolated initiatives; they represent a broader regulatory shift that connects building performance directly to financial outcomes.
While the market continues to view these requirements primarily as compliance issues, they actually introduce a new category of systemic risk. The next commercial real estate correction is likely to be performance-driven rather than interest-rate driven.
A growing proportion of the commercial building stock is now subject to these standards, particularly larger office, multifamily, and mixed-use properties that are often institutionally owned and frequently refinanced. Public benchmarking data reveals that a significant number of covered buildings are already non-compliant or only marginally compliant with current thresholds. As these standards evolve and tighten over time, many buildings that meet compliance today may fail in future assessments unless substantial capital investments are made.
Compliance with performance standards is not a one-time hurdle; it is an ongoing obligation that escalates over the life of an asset. For buildings that do not meet compliance requirements, BEPS introduces recurring financial penalties directly tied to performance shortfalls. These penalties act as a new operating cost, diminishing Net Operating Income (NOI) each year they remain unresolved. Unlike deferred maintenance or optional upgrades, these costs are enforceable, predictable, and cumulative.
This financial exposure is exacerbated by rising and increasingly volatile energy costs. Buildings with poor energy performance face a dual impact—first from higher utility expenses and second from regulatory penalties that compound the financial burden. Many underwriting models still depend on relatively stable utility cost projections, an assumption that is becoming increasingly unreliable as energy markets tighten and demand for electrification grows. For inefficient buildings, energy costs and performance penalties reinforce each other, compressing cash flow well before refinancing pressures arise.
Despite these challenges, most commercial real estate underwriting frameworks are not equipped to price performance risk adequately. Traditional analyses focus on metrics such as rent, vacancy rates, operating expenses, Debt Service Coverage Ratio (DSCR), Loan-to-Value (LTV), and interest-rate sensitivity. While these tools are effective for assessing cyclical market risks, they provide limited insight into regulatory exposure linked to building performance.
Few lenders systematically evaluate projected BEPS penalties over the life of a loan, the timing and costs of necessary energy upgrades, or the likelihood that a building will remain compliant as standards tighten. Technical assessments are often considered optional, and potential penalties or energy savings are rarely factored into repayment capacity. Consequently, many assets continue to be valued and financed as if performance requirements are peripheral rather than central to their long-term viability.
This mispricing will become evident during refinancing. Between 2026 and 2030, a substantial volume of commercial real estate debt is set to mature. As these loans come due, lenders will need to reassess assets under a regulatory environment that now includes mandatory performance standards. Buildings with established compliance pathways and credible performance plans will likely secure refinancing, while those with unresolved performance gaps or escalating penalty exposure may face higher costs, stricter terms, or even failed refinancings.
This scenario illustrates how assets can become stranded—not due to a lack of tenants, but because they cannot economically meet regulated performance requirements within their existing capital structures.
The scale of this exposure is often underestimated. While per-square-foot penalties may seem manageable in isolation, they accumulate annually and interact with other financial pressures such as insurance costs, capital reserve requirements, and tenant expectations. When aggregated across portfolios and over multiple compliance cycles, performance penalties and unfunded retrofit obligations represent significant value at risk, particularly for older, fossil-fuel-dependent buildings that struggle to pass costs onto tenants.
Simultaneously, building performance is increasingly influencing financial outcomes. Energy performance directly impacts operating expenses, regulatory exposure, and the predictability of future cash flows. Enhancements in performance can lower energy costs, eliminate or avoid penalties, and stabilize NOI—factors that lenders and buyers increasingly value, even informally. Properties that proactively address performance issues retain liquidity and valuation flexibility, while those that delay face widening discounts and increasing refinancing difficulties.
Compounding this risk is the fact that many building owners are not leveraging existing resources designed to aid compliance. In various markets, technical assistance, performance planning, and lower-cost, long-term capital are available through green banks and similar public-purpose finance institutions. These resources are specifically intended to bridge structural gaps that traditional lending does not address, yet they remain underutilized across much of the building stock. As a result, performance risk is often perceived as unavoidable when, in reality, viable pathways to compliance exist but are not integrated early enough into asset planning and capital strategies.
This dynamic signifies a departure from previous commercial real estate cycles. While interest rates fluctuate, performance standards, once established, tend to tighten. Buildings that fail to adapt do not simply wait for market conditions to improve; they confront an escalating compliance curve that directly influences cash flow, valuation, and financeability.
Early signs of repricing are already emerging. Buyers are discounting assets with significant unfunded retrofit needs, and lenders are increasingly inquiring about energy performance, even as standardized underwriting frameworks lag behind. Owners are discovering that postponing action only increases both cost and complexity.
The commercial real estate industry has historically managed market volatility but is less prepared for the regulatory performance mandates that reshape asset economics over time. Building Energy Performance Standards introduce a new form of financial risk—recurring, escalating, and unevenly distributed across the building stock. Ignoring this risk does not delay its impact; it magnifies it.
The next disruption in commercial real estate will not be driven solely by interest rates or vacancy rates. It will stem from buildings that cannot meet mandatory performance standards and capital structures that were never designed for a regulated performance environment. Recognizing this shift early is not pessimism; it is prudent risk management.
According to The American Bazaar, the commercial real estate sector must adapt to these evolving challenges to ensure long-term viability and financial stability.