Energy costs are on the rise, and the commercial real estate (CRE) sector is feeling the heat. A complex mix of economic, geopolitical, and environmental factors is driving this surge. And it’s not just a minor operational issue for CRE owners and tenants; this significant headwind impacts profitability, asset valuation, and investment decisions. To navigate today’s market requires understanding these drivers and their implications.
The drivers behind rising energy costs
Several key factors are driving up energy prices, creating a challenging environment for everyone.
Fossil fuel volatility and geopolitical instability
The global energy market remains highly sensitive to geopolitical events. The war in Ukraine has had a profound impact on international energy supply chains, particularly for natural gas. Since fossil fuels generate nearly 50% of U.S. electricity, fluctuations in their prices — driven by global conflicts, supply disruptions, and evolving trade policies — directly translate into higher costs for consumers. The international nature of these markets means that even localized conflicts or sanctions can create a ripple effect, increasing prices for natural gas and crude oil, which suppliers pass on to electricity users.
Surging demand
The electricity demand is growing at an unprecedented rate, a trend that’s been accelerating since the post-pandemic economic recovery.
The rapid expansion of AI and the proliferation of data centers are creating a massive new source of energy demand. AI data centers are particularly power-intensive, consuming up to 10 times more energy than a standard data center. With more companies adopting AI, the world will need additional energy infrastructure to power these facilities.
Extreme weather events, a consequence of climate change, are increasing the demand for heating and air conditioning. This increased demand puts pressure on the grid during peak usage times, which can lead to higher prices and a greater risk of blackouts.
Supply chain and infrastructure challenges
Even with increased demand, the energy supply isn’t keeping pace, thanks to various bottlenecks and infrastructure shortfalls.
The U.S. power grid is struggling to handle the influx of new energy sources, especially renewables. There are thousands of gigawatts of energy, primarily from solar, wind, and battery storage projects, waiting to be connected to the grid. The current transmission infrastructure has created a bottleneck because it’s not sufficient to transport this energy from where it’s generated to where it’s needed.
The energy industry is facing a scarcity of critical components, such as gas turbines. The backlogs have grown considerably, with wait times of three, four, and even seven years for these turbines. These long lead times make new power plant projects more expensive and delay their completion, hindering the expansion of supply.
Tariffs on imported components, like solar panels and their materials, can also increase the cost of new clean energy projects, discouraging investment in the very sources that could help diversify the energy mix and stabilize prices. The Inflation Reduction Act (IRA) helped to counter these costs by offering significant tax credits and incentives for renewable energy projects. However, on January 20, 2025, Executive Order 14154 (Unleashing American Energy) directed agencies to stop disbursing funds earmarked by the IRA, including terminating $20 billion in National Clean Investment Fund and Clean Communities Investment Accelerator Grants.
Climate crisis impacts
The effects of climate change have directly impacted the cost of energy infrastructure. Extreme weather events like hurricanes, wildfires, and floods cause extensive damage to power lines and other critical grid components. Utility companies are forced to spend more on repairs and upgrades, and often pass these costs directly to their customers through higher bills. Additionally, some utilities are facing increased insurance costs due to the risk of wildfires sparked by their equipment, another expense that ends up on the customer’s bill.
Implications for CRE
Rising energy costs have a wide-ranging and significant impact on the CRE, affecting everything from operating expenses to tenant relationships and asset valuation.
Squeezed operating expenses and lower net operating income
For most commercial buildings — especially office and industrial properties requiring extensive heating, cooling, and lighting — energy represents a considerable operational expense. As energy costs rise, so do these expenses, which then reduce the building’s Net Operating Income (NOI). A lower NOI can directly impact the property’s valuation, as asset values are often calculated based on a capitalization rate (cap rate) applied to the NOI. A decrease in NOI, assuming a stable cap rate, will lead to a reduction in the asset’s value.
In many net-lease agreements (especially a triple net lease), tenants pay for their own utility bills. In this scenario, rising energy costs act as a “hidden rent increase,” squeezing the tenant’s profit margins. This “hidden” expense can make it harder for tenants to pay their rent or may even discourage new businesses from leasing a space, leading to higher vacancy rates.
The “flight to quality” and tenant demands
In a high-cost environment, tenants regularly seek solutions for cutting their expenses. This quest has led to a growing trend known as the “flight to quality,” where businesses willingly pay higher rents for smaller, but more modern and energy-efficient, office spaces. This shift is driven by a desire to reduce their operational costs, as a new, green building can have much lower utility bills.
CRE owners are finding that attracting and retaining tenants requires investing in energy-efficient upgrades. Tenants now expect a higher level of transparency and data on a building’s energy consumption. Buildings with an ENERGY STAR certification, for example, use 35% less energy and cost about $0.50 less PSF to operate. This energy efficiency makes them more attractive to tenants and can also lead to higher rental rates and increased asset value.
Increased focus on ESG and sustainability
Environmental, Social, and Governance (ESG) standards have become a major consideration for investors and tenants. In the context of rising energy costs, the environmental component of ESG has taken on new urgency. Property owners have recognized that implementing sustainability measures is not just about corporate responsibility; it’s a strategic financial decision.
Buildings with strong ESG performance often command higher valuations and can access a wider pool of capital. Should they be implemented again in the future, tax credits and incentives, like those provided by the Inflation Reduction Act, will further sweeten the deal, making it more financially viable to invest in renewable energy sources and energy-saving retrofits. For now, building owners who’ve invested in improving older, less-efficient “brown buildings” or who have purchased newer, high-performing “green buildings” will see greater ROI.
The call for capital improvements
The current climate of rising energy costs is forcing CRE owners to re-evaluate their capital improvement strategies. Old, inefficient buildings are becoming a liability. To stay competitive, owners are making a variety of upgrades:
- HVAC Systems: Heating, ventilation, and air conditioning systems are often the single largest energy consumer in a commercial building and can account for up to 40% of a building’s energy consumption. Upgrading to high-efficiency systems or implementing smart controls can lead to substantial savings.
- Lighting: Replacing outdated incandescent or fluorescent lighting with LED systems can reduce lighting costs by up to 90%. Implementing motion sensors and daylight harvesting systems further enhances efficiency.
- Building Envelope: Improving insulation, sealing air leaks around windows and doors, and upgrading to energy-efficient windows can drastically reduce the need for heating and cooling.
- Renewable Energy: Investing in on-site renewable energy sources, such as solar panels or geothermal heat pumps, can reduce reliance on the grid and provide a long-term hedge against volatile energy prices.
For many CRE owners, the conversation around energy involves more than talking about paying the bills. It’s about a fundamental shift in how they manage their assets, interact with tenants, and plan for the future. Those who adapt to the new energy landscape by investing in efficiency and sustainability will position themselves to thrive in a market defined by higher energy costs and a growing demand for a greener built environment.
Are you a commercial real estate investor or seeking a specific property to meet your company’s needs? We invite you to talk to the professionals at CREA United, an organization of CRE professionals from over 90 firms representing all disciplines within the CRE industry, from brokers to subcontractors, financial services to security systems, interior designers to architects, movers to IT, and more.
