5 min read 19 Jul 23
Meeting net zero targets begins with detailed audits of existing portfolios to develop decarbonisation pathways. Designed to identify assets that are at risk of becoming significantly devalued or ‘stranded’ without investment, these pathways inform decisions about the most effective, feasible course of action – whether refurbishing, selling or developing assets.
Determining where and when to allocate capex is often based on the cost and time involved in implementing a particular measure. Timing is crucial, given the cost efficiency of carrying out work during a lease break, for example. Equally, investing in a building that is unlikely to need alteration in the next 15 years could be more cost effective than ploughing capital into a building that will require a large-scale retrofit in five years’ time.
“Ideally you want a program of improvement initiatives that can happen in and around a tenant’s occupancy,” says Laura Jockers, M&G’s Global Head of ESG, Real Estate. “That might mean working creatively with the space by condensing occupancy from three floors to one, for example, while work is carried out on those levels. Or lighter touch works like lighting upgrades, which can have a significant impact without heavily disrupting tenants. Where it gets tricky, is when major works such as insulation, heating and cooling upgrades are required. These works can make a building inoperable and may only be possible when a building is up for vacant possession.”
“That's were understanding the sort of lease, the timing of the lease, and the longer-term plan for the building is really important,” says Jockers. “ESG can’t be a ‘tag on’ factor anymore; it needs to be properly integrated into how buildings are managed and how these events and negotiations happen.”
With less available capital and higher construction costs, financial viability is more challenging in the current environment. Yet impetus for asset repositioning is gaining. More stringent regulation will require some investment to keep buildings in line with EPC standards for example. Demand for green buildings from occupiers and investors also continues to rise.
“We’ve seen a sea change in thinking, from ‘location, location, location’ to ‘location, specification and sustainability’,” Jockers observes.
Against this backdrop, asset owners are taking a selective approach to capex allocations. “Initiatives that represent low hanging fruit are unlikely to be a problem; the big decision point is whether to invest heavily or not,” she says.
These decisions will be based on a number of factors such as the investment proposition for the asset, and whether a building has reached a point in its lifespan where equipment needs recommissioning or replacing.
ESG benefits are part of that, by virtue of higher specification kit for example. However, ESG costs won’t be the tipping point for whether large-scale retrofits happen or not.
“The cost of implementing green measures is increasingly seen as an investment rather than a cost as it ultimately creates an asset that is lettable, and less likely to depreciate or face obsolescence,” says Jockers.
In the near term, focus is likely to concentrate on measures that target maximum energy savings for least cost.
“If we’re looking at 2050, every building will need to be addressed. But if we’re looking at the next ten years, targeting maximum energy savings for least cost will get the real estate industry on the road,” says Jockers.
This is an equation of costs versus potential energy savings, the change in a building’s energy use intensity, and the long-term benefits of shifting to renewable energy systems and electrification of buildings. Typically, the deeper the retrofit, the higher the cost and the higher the energy savings. However, aiming for measures that deliver the lowest cost per kilogram of CO2 saved could be more viable.
Possible measures are dependent on the building, since installing equipment in a more simple structure such as a warehouse is typically much easier than in an office, with many internal walls and often different energy systems in different parts of the building.
While economic fundamentals are more challenging, regulation is non-negotiable and tenant demand is rising for energy efficient buildings with lower running costs. Maximising asset management strategies is therefore key in order to achieve progress in the current environment. “This will require a greater level of integration between asset management and ESG teams to make the most of every possible opportunity to make a green improvement without incurring additional work or disruption to the tenant,” stresses Jockers.
The value of investments will fluctuate, which will cause prices to fall as well as rise and investors may not get back the original amount they invested. Past performance is not a guide to future performance. The views expressed in this document should not be taken as a recommendation, advice or forecast.