Some of the biggest names in the real estate world on both sides of the Atlantic are gearing up for a very particular challenge: taking old office buildings that are big carbon emitters, making them more energy efficient and profit.
Fund managers like Tishman Speyer and Patrizia have raised funds for brown-to-green strategies. Brookfield privatizes a publicly traded German company at the forefront of making more sustainable offices. And UK REIT Great Portland Estates sees buying and improving stranded assets as a key pillar of its strategy going forward.
“I’ve been doing this for 30 years, and it’s been one of the most interesting moments of my career,” GPE chief executive Toby Courtauld said ahead of an appearance at bisnowThursday’s London Future of Office event.
It’s a strategy that can be profitable for both real estate and the planet. To tap into a shot is a huge challenge, but also a huge opportunity, if done right.
For property owners in cities like London or New York, making assets energy efficient is no longer much of a choice.
In New York City, Local Law 97 will impose fines on building owners whose carbon emissions exceed a certain level. And in London and the UK, the Energy Performance Certificate scheme will make it illegal to rent offices that do not reach a Grade B standard or better by 2030. Only 4% of offices in London currently meet this requirement, according to data from Cushman & Wakefield. , highlighting the scale of the problem for current asset owners as well as the size of the opportunity for those with capital ready to deploy.
The nature of this opportunity involves taking non-compliant buildings and making them compliant in the regulatory sense, as well as meeting the demands of occupants who have their own ESG goals and brand issues in mind.
“The EPC regime is the most important because it’s the only one that carries a regulatory burden,” Courtauld said. “But companies are also looking at their brands. I look at my kids, they want the company they work for to reflect their values, and that’s a big change from a generation ago. And your building is now a big part of your company’s brand value. »
But how do you identify the right buildings and buy them at a price that still leaves room for making money? Office buildings don’t have a big sticker on the front saying they are energy inefficient. Potentially stranded assets come in all shapes and sizes, from large prominent offices in the City of London to small mid-century assets in the West End.
Courtauld said that a few years ago the company went to a large brokerage firm and asked for a list of buildings with particular qualities: a low EPC rating and an upcoming rental event. With this information, the company could begin to determine which buildings could be renovated and re-let at improved rental levels.
However, one crucial element must be taken into account for the strategy to be carried out profitably: the current owners.
“There are a lot of owners who maybe haven’t even started thinking about these regulations yet,” he said, citing private investors and family offices that don’t have external stakeholders. These entities may not have felt pressure before to tackle ESG performance, but they will increasingly be pressured to move forward.
“There are a lot of people who might rather sell than invest more money to bring things up to standard, or who might want to set up a joint venture with someone who has the expertise to undertake the necessary renovation,” Courtauld said.
Courtesy of Trilogy Real Estate/Aidan Brown
The Republic program in London’s Docklands
Office assets are now starting to be priced taking into account the cost of renovating them to meet sustainability regulations, he said – if it costs x to bring a building up to code, then buyers want pay y minus x. As deadlines for meeting regulatory requirements draw closer, those rebates will deepen, he said.
The benefit comes from being able to rent the renovated building at a higher rent, although the improvement may take a different form.
“I think you’ll see the difference between capital values before rents,” said Trilogy Real Estate managing director Robert Wolstenholme. “All the big funds, especially the Europeans and Canadians, are interested in it now, and where they go, everyone follows. I have investment officers asking me, ‘Wolfie, can you take this building and give it a 5-star NABERS rating, because the yield will be 100 basis points tighter.’ That investment agents tell you about it is unheard of.
Wolstenholme said the cost of upgrading a building with an EPC G or F rating and bringing it to a C rating was around £150 per SF. Achieving a B rating, which could involve replacing glazing, cost around £175 per SF, and achieving an A rating, with replacement glazing and heating and ventilation systems, cost around £200 per SF.
There are other challenges facing those seeking to undertake this strategy.
“It’s much more difficult to upgrade small buildings,” Wolstenholme said. “For something like replacing glazing or insulation, you don’t get economies of scale.”
Material costs may well be the factor inhibiting the ability of homeowners, new or old, to undertake renovations now.
“The recent spike in inflation makes it more expensive to try to undertake this type of repositioning right now,” said Maria Wiklund, partner at CBRE Investment Management. “I wouldn’t be surprised if a lot of these projects are made too expensive right now. But of course, everyone hopes that high inflation won’t be there forever.
At a more systemic level, another problem could hinder these renovations. Wolstenholme pointed out that many green labels applied to buildings base their scores on the energy emitted during the operation of the buildings, but do not take into account the embodied carbon used to construct them. So a brand new building may look incredibly energy efficient and receive an excellent rating, but use a lot of carbon in its construction.
“To give you an example, at Republic [Trilogy’s refurbished office campus in east London], we had a consultant do a calculation on the additional carbon that would have been created by the previous owner’s plans, destroy it and build 1 million square feet of resi,” Wolstenholme said. “It was 100,000 tonnes of additional carbon. But the current system gives us no credit for saving that carbon.
Ultimately, Wiklund said, owners will have to embrace the asset refurbishment strategy. Otherwise, the losses could be large and serious.
“At the start of the pandemic, everyone thought working from home would have the biggest impact on offices, but in fact it turned out to be ESG,” she said. “There’s a lot of talk about green bounties, but right now it’s only for the best buildings. The biggest risk to the whole market is brown discounts.