Decarbonizing the built environment
How do we get to net-zero in both new builds and retrofits?
By: Sam Smith-Eppsteiner and Josh Rapperport
When you assess human activity and the global economy to find out where most carbon emissions come from, one thing stands out: buildings are a major culprit. If we include construction and operations, but not the manufacturing of materials like steel and cement, roughly 30% of emissions in the U.S. come from buildings. Historically, the real estate industry has had little incentive or imperative to transition to new technology and standards to address its massive emissions. Fortunately, that’s beginning to change. Regulation such as Local Law 97 in New York, along with intense pressure from investors and tenants, is beginning to move the industry forward.
What does decarbonizing buildings actually mean? In short, that the future of buildings is electric. Gas fired furnaces, heaters, boilers, and stoves will soon be replaced by heat pumps, electric hot water heaters, and induction stoves. The transition has reached a critical inflection point as cost savings, performance, comfort, emissions reduction, and non-market incentives are all pointing in the same direction, leading to strong ROI for commercial real estate owners and homeowners alike.
The gains in energy efficiency, product performance, and reductions in cost — across all the devices depicted above — have been driven by incredible technology and manufacturing improvements. Given where we are in the technology and adoption cycle, we’re spending most of our time at Innovation Endeavors on accelerating the rollout of electrification, improving orchestration and optimization, and reducing friction in deployment.
There are many ways to frame the task at hand, but the most straightforward poles are existing buildings (i.e., retrofitting) vs. new build, and commercial vs. residential. We need to retrofit the existing building stock with new, more efficient electric systems, and we also need to ensure greenfield development is utilizing the most sustainable technology. So what are the bottlenecks to get to a net-zero built world, and where is the opportunity to innovate?
Framing building decarbonization
Retrofits
Now we need to get these systems into every one of the 6 million already-standing buildings in the U.S. (and beyond).
Commercial
For commercial owners, one of the major challenges for retrofits is how to plan and make informed capex decisions. The problem is complex. At a high level, asset owners with large portfolios need to plan and execute a strategy to hit their increasingly common net-zero commitments. To make this happen, owners need to bring together emissions scenarios, capex outlay, energy models, budgets, regulation, and building requirements. For most, understanding these process inputs and what to do with them is cumbersome and relies on outdated data and basic models. Furthermore, solutions to the multi-parameter problem of optimizing across building performance, ROI, and CO2 emissions are proposed by disjointed and siloed facilities, finance, and sustainability stakeholders at large organizations.
Externally, many of the decarbonization reports and recommendations offered are developed by consultants who often charge millions for their white-glove service models. Using consultants to assess techno-economic scenarios — which need to look 20+ years into the future and recommend the best options to retrofit — isn’t scalable for the scope of work at hand.
One exciting company we recently invested in tackling this challenge is OPTIML, a commercial real estate decision making and decarbonization platform. OPTIML’s product generates digital twins and thermodynamic models of buildings, which are used to (1) understand existing energy and emissions profiles, and (2) optimize go-forward planning for the capex decisions associated with upgrades and retrofits, the resulting operational costs and carbon footprint, and overall portfolio performance. Fundamentally, OPTIML aims to power the long-term investment and capex planning for real estate portfolios by automating and bridging the methodological gaps between energy system modeling and real estate portfolio management. This kind of sophisticated tooling is critical to ensure we’re making the right investment decisions today, as efficiently and scalably as possible.
Residential
On the residential side, where homeowners also need accurate information, and easy and cheap installation of new electric systems, similar challenges exist. We’re excited to see solutions tackling the entire home electrification opportunity, but given 44% of energy consumption by U.S. housing stock goes into heating and air conditioning — and heating and cooling buildings is roughly 15% of total US emissions — it’s clear HVAC stands out as the largest lever. To set the stage for the magnitude of the opportunity, it’s helpful to understand the trends around residential electrification of HVAC, and the tailwinds for heat pumps.
- Currently ROI positive for many → Installing a heat pump is ROI positive for tens of millions of homes today (this was true even pre-IRA). Based on current performance and installation costs, Rewiring America and RMI indicate that the total cost of ownership is reduced for customers in several retrofit scenarios; note that these are often correlated with geography:
- For customers switching away from propane or heating oil
- For gas customers who would otherwise need to replace both a furnace and air conditioner simultaneously
- For customers who bundle rooftop solar with electrification
- For customers in mild climates without extremes in temperature
- Putting numbers to it, at least 87% of households in the United States — 104.7 million — could save an aggregate of $37.3 billion a year on energy bills if they were using modern, electrified furnaces and water heaters instead of their current systems
- Future ROI looking even better → There is a clear positive trajectory of heat pump ROI for homeowners with improving technology and falling system costs.
- Hitting an inflection point in subsidies and awareness → The Inflation Reduction Act will transform the HVAC industry. Trends toward electric systems are going mainstream with the incoming rebates, tax incentives, and public marketing. New funding alone — more than $23 billion — will provide more than 7 million heat pumps to American homeowners.
- Global trend… → Last year, E.U. climate chief Frans Timmermans said Europe plans to double yearly heat pump installations, building out 10 million units within the next five years. Countries like Poland and Germany have seen incredible adoption curves, up 120% and 53%, respectively, in 2022.
- …Backed up by regulation → Bans on fossil fuel-based heating — both in new-build and existing installed base — are emerging at all levels of government; conversely, conservative regions like Texas are actively blocking such regulation.
- Energy security and geopolitical tailwinds → Volatility in energy prices and geopolitical unrest are major tailwinds for electrification as the recent energy crisis in Europe demonstrated.
How can we more effectively install tens of millions of electric devices over the coming decades? This massive challenge brings the HVAC and electrical trades into the spotlight. If we use heat pumps as an example to understand how we might accelerate their rollout, it is helpful to dig into the costs and profit drivers associated with a retrofit. We can assess the two primary aspects of a retrofit, hardware and install:
- Hardware: The cost of buying a heat pump directly from an OEM varies substantially based on efficiency, brand, and size. Small units cost as little as $1000, while a high-end unit could be up to $12,000.
- Install: When an installer provides a bid to install a heat pump, it includes the cost of the hardware, install, and all materials involved. The installation costs often exceed the cost of purchasing the unit itself. The typical all-in price range in the US is between $4000 and $7000 but can go up to $15,000. The national average is $5600. There are roughly 100,000 HVAC install and service companies in the US, and most are sole proprietorships or family-run businesses.
Installers use a mix of tools like Service Titan, Manual J calculations, and OEM apps (e.g., Carrier Enterprise App) to size, spec, quote, generate takeoffs, install, and finance heat pumps. Due to their lack of precision, none of these products fundamentally improve installer margin, labor productivity, sales conversion, customer qualification, or rework.
Problems we’d like to see solved:
So where does all this leave us? Some of the problems across commercial and residential that technology can address, and we’re excited to see worked on, include:
- Software for HVAC installers: As described above, the lack of modern software in HVAC gives contractors few tools to improve margin, labor productivity, sales conversion, customer qualification, or rework rates. Companies like Arch and Conduit are leading the charge to build the next generation of products.
- Tech enabled installers and managed marketplaces: HVAC and electrical are the trades that underpin the electrification of buildings, and they will struggle to meet demand unless new business and operational models are brought to bear. Companies like Elephant Energy, Helio Homes, Haven, Green Zuru, Tetra, and others are rethinking these domains much like Sunrun did in rooftop solar.
- Bidirectional charging infrastructure: The promise of being able to back up your house with the EV in your driveway has a long way to go. Solving the integration and power management challenges across 3rd party inverters, chargers, and auto OEMs is a growing opportunity.
- Better financing options: There are no sophisticated financing mechanisms for heat pumps, hot water heaters, stoves, etc. that compare to residential rooftop solar (i.e., what Sunrun has done with tax equity). Personal loans for home improvement don’t solve the high upfront costs for homeowners, and come with high interest rates. What’s next for financing and reducing friction for the incredible rebates and incentives coming from the Inflation Reduction Act?
- Whole home optimization and orchestration: Many kinds of software and hardware companies are vying for the opportunity to stitch together demand response, optimization, utility programs, and flexible load management for homeowners. Next-gen panel manufacturers, home battery startups, energy retailers, utility connectivity companies, and even thermostat providers are all taking a piece of the value today. How will the fully electric home of the future be managed, and what kind of hardware and software will bring these numerous systems (i.e., heat pumps, solar, batteries, EV chargers, etc.) together?
- Open APIs for building data: Data will be the backbone of the next generation of proptech and climate companies for the built world. Given the average age of commercial buildings in the US is 50+ years old, most mechanical, electrical, and HVAC systems are a mess of siloed, non-digital records and system integrators, and there is no easy way to build on top of the data. Companies like Mapped are beginning to build this API layer, and it will be a key aspect of future innovation.
New build
If we’re going to go through all of the effort to retrofit the existing housing stock one by one, we better be sure that every new building is fully electric and decarbonized. The challenges of building the next generation of modern, electric, and efficient buildings are numerous and encompass the entire construction industry. Our firm has focused on five key themes in construction: labor, tools, off-site building, products & procurement, and design.
First, on labor and tools, companies like Canvas are transforming the speed and efficiency of large-scale projects, and in doing so, reducing emissions and waste in the construction process. In fact, if the entire US construction industry switched to Canvas’s method of drywall, 41 million industrial cardboard boxes — equivalent to 10 megatons of carbon — would be taken out of the picture, as their joint compound is mixed on-site and delivered in barrels. Building more efficiently will require continued progress of the technology and tools that crews use every day.
Second, we see off-site construction — and the design behind it — as a way to drive scalability, speed, quality, and performance in home building; our research into the opportunity, culminated in our incubation and launch of Aro Homes (blog post on our thesis, incubation effort, and investment here). Aro is rethinking how to replace end-of-life housing using advanced engineering, full integration, and data science. The result is a brilliant design, a negative carbon footprint — using 75% less power and 50% less water — and a much lower cost of ownership (maintenance etc.) for the homeowner. This first-principles approach to home building allows Aro to construct the most efficient homes ever designed — homes that are Passive House rated and produce more power than they consume.
Lastly, the products used in buildings are advancing quickly. Over the past two decades, lighting, for example, has come down in cost by over 20 times while improving in quality — the luminous flux — by 40 times. Not only has this created huge savings, it has also delivered massive carbon reduction. For example, the Indian LED market has grown 130-fold in five years, resulting in 30 terawatt hours of annual energy savings, enough to power the whole of Denmark for a year. Similarly, in plumbing, novel polymer and pipe materials are dramatically reducing costs while increasing durability and longevity, and awareness of greywater systems — which can protect against overuse and drought — is surging. Despite this progress, the manual, relationship-based sales process in construction means builders often aren’t aware of what new — and often more efficient — products are available. Companies like Parspec are bringing modern software to the procurement process, ensuring the most climate-friendly products are reaching the market.
Problems we’d like to see solved:
- Modern AEC tooling: Architecture, Engineering, and Construction (AEC) applications have not kept up with the cloud-based, collaborative, and dynamic capabilities of modern software. Building information modeling (BIM) software can move beyond the Figma-for-BIM model and also focus on search, auto-detailing (e.g., co-pilot for architects), and a “graph of representations” that will allow architects, engineers, and fabricators to seamlessly interact with any level of design detail. This will enable the next generation of AEC to design efficient and low-carbon buildings that inspire.
- Creating financial alignment: One tension we see in new build is that builders care about margin (capex, construction costs, and sale price), while homeowners care both about equity (purchase & sale price, mortgage rate, etc.) and opex. That misalignment — where builders bear the upfront capex cost of green upgrades (e.g., solar install) and homeowners stand to benefit from the opex (e.g., energy cost) reductions — is the crux of the issue. How do we create the right incentives for builders to make climate-friendly decisions at scale? And, how do we make the value of reduced opex clear to buyers?
If you’re working on something in building decarbonization, or just thinking about it, please reach out! We look forward to hearing from you. There’s a lot to build ;)
