SPR Webinar: Obsolescence: an increasing risk for real estate?
6 July 2022

A mountain to climb

Researchers speaking at this webinar explained how climate-related obsolescence looks set to have a big impact on costs for real estate going forward.

In his opening presentation, Mark Unsworth of Oxford Economics suggested that the costs of extending the range of an asset’s life by 15 years to meet evolving regulatory and occupational requirements will range from 7-30% of value, with hotels the most expensive to align.  This implies that for City of London offices, current market pricing and cost levels mean that 6% pa rental growth will be needed to make such renovation projects stack up, much more than the 1% pa growth seen of late.  Moreover, if yields move outward over next two years, costs will be even more difficult to justify.

This analysis reflects the recent acceleration in governmental efforts to align with net zero targets for real estate.  Minimum energy efficiency standards (MEES) are likely to require a minimum B EPC rating for commercial buildings by 2030, while there are also wider influences including EU disclosure standards and IFRS requirements that will impact listed property companies.  In her presentation, Clare Bailey of Savills said that an ‘astonishing’ amount of money will be needed to get UK office buildings up to EPC B by 2030, given that 1bn sq ft of stock now has a lower rating.  And even if this isn’t legislated for, occupiers are likely to demand it anyway.

There is clearly a flight to quality among occupiers, she suggested, which is attracting a rental premium, even if many are taking less space post-pandemic.  In the panel discussion moderated by Robin Goodchild, Lee Bruce, a valuer at CBRE, proposed that the premium could be as much as 6% for offices.  He indicated that valuers were now reflecting EPC data for buildings as well as other ratings like BREEAM, with clients increasingly demanding energy use to be taken into account – this is now being incorporated into valuers’ training.
Lucy Winterburn of Savills IM, also speaking as a panellist, said that the threat of climate-related obsolescence has become a ‘massive minefield’ for investors.  As manager of an institutional pension fund, which she suggested was ahead of the market in this respect, her emphasis has been on buying assets at a level of pricing that allows for the upgrades needed to meet tenants’ more challenging demands. But she admitted this can be very difficult in sectors such as leisure and hotels, where leases tend to be long, which limits the possibility for restructuring and improvement.  Green leases are essential to ensure that buildings are used in an energy-efficient way, she argued, though this needs to be as part of a collaborative approach with occupiers.

The overall thrust of the webinar was that the majority of investment market players are now embracing the need to meet net zero targets at an accelerating pace, which means that the related building obsolescence can also only accelerate.  At the same time the costs of remediation have risen substantially – at least in terms of short-term construction costs; however, Unsworth noted that innovations such as modular construction and the use of alternative materials, like timber, could help ease the situation.

Tim Horsey