May 24, 2023
For the commercial real estate industry, the push to hit net zero targets is here, and it is non-negotiable. The UK government’s changes to Minimum Energy Efficiency Standards (MEES) came into force on 1 April. They extend the scope of MEES to existing tenancies of most commercial property and restrict a landlord's ability to continue to let any property with an ‘F’ or ‘G’ rating.
Moreover, the government has introduced requirements for an EPC ‘B’ rating for all privately rented non-domestic buildings in England and Wales by 2030, with significant fines for those that fail to make the grade. The government has suggested that implementing the EPC B target will cover around 85% of the UK’s non-domestic rented stock, taking the UK a giant step closer to its target of net-zero carbon emissions by 2050.
According to the World Green Building Council (WGBC), buildings are responsible for 39% of global energy-related carbon emissions. 28% comes from the energy required to heat, cool and power buildings and the remaining 11% from materials and construction. Therefore, efforts by the government to help incentivise the real estate industry, to help the UK achieve net zero by 2050, should be supported.
The UK has too many ageing and energy-inefficient buildings. These regulations will go some way to making UK buildings more energy-efficient, reducing costs for owners and tenants at a time when it is much needed.
The scale and ambitions of the government’s targets are laudable and the speed at which building owners are tasked with getting buildings upgraded presents a huge challenge. The vast majority of building owners have an expensive – and increasingly urgent – job on their hands to try to retrofit ageing buildings. Many are also being forced to change their plans for new buildings.
As always, liquidity is critical. The capital expenditure some building owners have spoken to us about can vary wildly from 10% to well over 100% of the building’s gross asset value. In many cases, we are talking about ripping out and replacing entire electrical, plumbing and heating systems, while – carefully and laboriously – leaving the shell of the building intact. This will all come at significant cost. Not just the cost of the retrofitting, also the cost of having vacant (i.e., non-income producing) buildings for long periods. It is a huge challenge for the asset owners. And let us not forget this is all taking place in challenging market conditions; where capital is restricted and costs more than any time in recent years. Furthermore, labour and material costs are only slowly settling down following COVID and the disruption brought about by the war in Ukraine.
This is an unusual situation where the vast majority of building owners will be forced into drawing on a vast array of resources in a very short timeframe. Seven years is not much time, given the amount of work that needs to be done and deferring action in the hope for government delay or U-turn seems like a losing strategy. It is easy to foresee a huge bottleneck of labour (architects, environmental consultants, constructors) and material supply as we get closer to the 2030 deadline, which will lead to even higher costs for developers. The sooner building owners start planning and implementing what is required, and thinking about the associated costs, the better.
Sourcing that cash will depend on several factors, not least the age and condition of the building itself leading to the sums that retrofitting with involve. Traditional funding methods such as raising equity or debt capital will be fully explored. All building owners will be doing exactly the same thing; therefore these avenues will be increasingly competitive. And – especially where the amounts required equal the building’s value – they may prove unrealisable. It is therefore important for owners to consider all financing avenues and consider the pros and cons of each.
IPSX is a straightforward option for many building owners.
IPSX is the only regulated stock exchange dedicated to commercial real estate assets. Through us, building owners can sell any percentage of the building’s equity to fund refurbishment and upgrade costs, or just to realise capital value from the business for owners and other shareholders.
The EPC regulations are undoubtedly going to be a heavy financial burden for many building owners.
For those currently weighing up their liquidity options, there are good reasons to execute on their plans sooner rather than later. Carrying out the necessary refurb work to bring buildings up to a B rating will make finding and acquiring good longer-term tenants that much easier.
With the 2030 deadline already in sight, getting ahead of the rest of the market could make a significant difference to the long-term viability of any commercial asset.
Written by Rupert Snuggs, Head of Capital Markets, IPSX, the world's first regulated stock exchange dedicated to trading commercial real estate.
IPSX Wholesale is a market exclusively for institutional and professional investors.