With net zero targets drawing near – at least if the general election result goes the way the polls suggest – many are keeping an eye on the energy efficiency of their buildings.

Stranded in London: experts say owners of inefficient office buildings will be forced either to retrofit properties or to sell them

While uncertainty remains over their timing and detail, there is clearly only one direction of travel for Minimum Energy Efficiency Standards (MEES) and regulations around Energy Performance Certificate (EPC) ratings. And concerns over just how much of the UK’s existing commercial stock will be out of date, resulting in more ‘stranded assets’ and billions in lost rental opportunity, will surely increase.

A recent report by property data insights firm Search Acumen reveals that despite requirements introduced in April 2023 to hold an EPC rating of ‘E’ or above, almost 18,000 commercial rental properties are still rated ‘F’ or ‘G’. As a result, commercial landlords will miss MEES targets by almost a decade, equating to a yearly rental loss of £750m (p11, 21.06.24).

Meanwhile, the British Property Federation warns that 84% of commercial spaces will fall short of their MEES targets. And a study by data intelligence group Deepki reveals that 98% of UK real estate asset managers questioned have high levels of financial risk from stranded assets, with 71% saying more than 30% of their commercial assets are already stranded.

Reflecting on this data, Sandra Fives, chief strategy officer of environmental, social and governance (ESG) at specialist consultancy Catalyst, says this “is no big surprise”. She adds she expects these figures to rise further, especially with the number of transactions taking place muted by economic difficulties.

“The devaluation of the asset is a trend we see in the markets,” she explains. “There are multiple reasons, one being access to debt. Debt is more expensive, so refinancing is getting very tricky.

“About 50% of London’s commercial real estate assets are now worth less than what they were acquired for. You have loads of asset managers sitting with portfolios that are not even worth half of what they were acquired for. Do they have the financing capabilities to renovate all those assets and bring them back up to market standard? Probably not.”

This view is echoed by Marion Baeli, principal of sustainability transformation at architecture and masterplanning practice 10 Design. She says crunch time is coming and that landlords and investors with older stock will have to map out their risk. She adds that within “a couple of years, they’re going to press the buttons and decide which ones to keep, which ones to sell and which ones to retrofit”.

What the future holds

So, what is going to happen to out-of-date stock? Baeli believes London alone will see “at least half its commercial stock stranded in the next five years”. She adds: “Either [asset owners] are going to suck it up and just splash out and do the retrofit themselves or they’re going to release their assets.”

Damien Sharkey, managing director at developer HUB, agrees. Despite HUB’s experience in retrofitting older commercial stock, he admits that “overall, quite a small percentage of these assets can actually be converted” for other purposes.

Giles Heather, director at construction consultancy Linesight, claims that ongoing government regulation around MEES and EPCs has played a “significant role” in terms of the number of at-risk assets. “I think clients are very aware of the potential impact of that,” he adds. “That informs and impacts their investment decisions on whether they hit the ‘go’ button for certain buildings or projects.”

Fives says regulation coming in will put more pressure on asset managers to retrofit buildings. “It’s putting on pressure, but for me it’s going in the right direction,” she adds. “We’re working with clients who are really well advised and aware this is coming and getting ready for it. These will become the leaders of tomorrow.

Shop tactics: many believe the retail sector has the biggest hurdles to overcome

“Then we’ve got people who are just not considering it enough, waiting for regulations to be clear and not acting until they are clear. But that cost of inaction is going to be quite big. Their portfolios are really going to suffer.”

According to Deepki’s report, the retail sector has the biggest hurdles to overcome in this regard, both in the UK and across Europe.

Baeli says the sector is “more energy hungry because the fit-out has a short shelf life”. She adds: “The carbon footprint of retail is much higher than an office space. So, that’s definitely making it harder for these guys to decarbonise.”

However, Katerina Papavasileiou, director of ESG and responsibility at Federated Hermes, believes the office sector is most at risk. “Commercially it’s a bigger push for the offices,” she explains. “We’ve got a shopping centre where we’re doing really well on our ESG and decarbonisation.

We find it easier to decarbonise when it comes to industrial because it’s a simple structure. For the office, it’s a little bit trickier.

“Based on what is happening in the market, the demand is at a low. Occupiers who want to buy space focus on the brand-new, energy-efficient buildings.”

Location, location, location

Both Deepki chief executive Vincent Bryant and Baeli point out that location also plays a factor, with commercial schemes outside key towns and cities at greater risk. “It all depends on the location of the asset,” says Baeli. “Retrofitting and building on Oxford Street is more valuable than on a Milton Keynes industrial estate.”

Heather adds: “There’s a lot of opportunity outside London. But within the regions where retrofit might not be the best option, maybe it is better to demolish.”

Time will tell whether the planning policy of the next government will support this.

Papavasileiou suggests conversion offers another potential solution. This is highlighted in a recent report from Lambert Smith Hampton, which reveals that nearly 13m sq ft of office space in the South East alone has been targeted for residential conversion.

However, while HUB specialises in converting older commercial stock into residential accommodation, Sharkey warns there is a “misconception that every stranded asset can be converted into living”. He adds: “We look at approximately 40 opportunities before acquiring one, just to give you an example of how difficult it is to find an office building that meets all the requirements.”

Fives argues there “needs to be a really strong incentive coming from the government” to support older assets, adding that further financial support is vital to “enable the transition to decarbonising old stock”.

She adds: “If you can show the potential of the building, this is where you can have a proper discussion with your lender. Having good-quality data about the performance of the building, and giving intimate transparency, is key.”

Meanwhile, Baeli points to the debate around VAT. “We’ve got 20% VAT on refurbishment and retrofits and 0% on new builds,” she says. “We need to tip this on its head. It’s an impossible challenge and I don’t think it’ll happen. But if you’re asking what policy would make it a game-changer, that would definitely do it.”