A regulatory cliff edge for unrentable European offices

Europe’s real estate market faces the threat of most assets becoming stranded, or unlettable, if their energy efficiency isn’t improved through retrofitting in the next few years, due to regulatory updates coming to the region enforcing higher environmental standards. 

In the UK for example, the Minimum Energy Efficiency Standards mean that from April 1 this year it will be unlawful to let a commercial property with one of the least effective energy performance certificate (EPC) ratings of F or G, while from April 2030 all non-domestic rented buildings must have an EPC rating of A or B. However, as this week’s Chart Room shows, currently only a quarter of existing office stock in the UK is of a standard to meet those 2030 requirements according to a study by estate agency Savills, suggesting three quarters of the UK’s office buildings would be left as stranded assets. With the UK’s office segment valued at around £263 billion as of the end of 2020, a back-of-the-envelope calculation suggests assets worth around £195 billion could become obsolete.

There is a similar story playing out in the Netherlands, where from January this year all office buildings required a Dutch energy label rating of C or higher and where from 2030 all commercial rented properties will need an A rating. While almost half of Netherlands offices are currently rated A+, A, or B, another 34 per cent have a rating of F or G or are unrated - and so can’t be leased without owners facing penalties for non-compliance.

But it’s not only the risk of holding stranded assets, sanctions, or fines that should be prompting building owners to improve the environmental performance of their assets. Although Savills estimates the average cost of raising an office’s EPC rating from D to B is around €500 per square metre, there is also a clear financial benefit for building owners: more sustainable offices can demand a substantial green premium, with rents around 6 to 8 per cent higher for properties with green building certificates and capital values around 14 to 16 per cent higher than average. For occupiers, meanwhile, green buildings can be far cheaper to operate, with savings made on energy costs on buildings with a better EPC rating outweighing even the higher rental costs of the property.

Of course, retrofitting real estate brings environmental as well as an economic benefits. Buildings in Europe are responsible for 40 per cent of the region’s energy consumption, and improving a building’s EPC standard by just one grade can represent a 30 to 40 per cent reduction in CO2 emissions per year. Given the carbon intensity of buildings in Europe, the stakes are huge.