UK construction, refurbishment costs to soar on tighter climate change regulations, materials and labour inflation

London

BRITISH real estate construction and refurbishment costs are forecast to soar in the next few years because of tighter climate change regulations, the coronavirus pandemic, and materials and labour inflation.

Ahead of the Glasgow climate change conference in November, UK developers, commercial landlords, estate agents and lawyers are shifting their attention towards energy and environmental building improvements to cut carbon emissions.

Landlords in London and other cities across the UK need to install minimum energy efficiency standards in both residential and commercial real estate by April 2023.

If landlords do not have energy performance certificates (EPCs), they will neither be allowed to let nor sell their properties. They are expected to try and pass on part of the charges to tenants on the grounds that the improvements will reduce their expenses.

Higher rental lease negotiations will depend on market conditions. In terms of the legislation's new standards, buildings in England and Wales must have an energy efficiency rating of at least "E".

The EPC minimum covers insulation, lighting, heating and other improvements. The most unacceptable energy efficiency rating is "G" followed by "F".

In a cautionary analysis, real estate agent Colliers estimates that around 20 million square feet of London's central office space, or 9 per cent of the 232 million square feet total, have an EPC rating of "F" or "G".

Unless the properties are historical listings that have exemptions, these units will have to be refurbished to meet the minimum EPC requirements, according to Guy Grantham, London Research director at Colliers.

"While 'new builds' are likely to find favour with occupiers and listed buildings will be given less stringent requirements, refurbishment will be the only option for some owners," he said.

"In many respects, refurbishment programmes, as opposed to demolition and complete rebuilding, offer stronger green credentials."

Between 2018 and 2020, refurbished properties only accounted for 23 per cent of the market, said Colliers in a report. To meet regulations and attract new tenants, the firm expects many owners to refurbish their units in the next 18 months.

So far, legislation has not been passed, but major real estate companies such as British Land and Land Securities are already aiming at meeting government and industry proposals to raise energy efficiency to "B" and "A" by 2030.

The companies are also selling lower-quality units and developing new buildings. Both companies stated in latest reports that they are committed to moving towards zero carbon emissions by 2030.

They intend to incorporate smart technology to increase energy efficiency, improve ventilation and workspaces to improve workers' well-being. Some new buildings will include solar panelling, rainwater harvesting and electric vehicle charging points.

"Net-zero obligations have been accelerated by the pandemic," said Nick Compton, head of corporate capital markets (EMEA) at JLL.

Many companies are bringing forward net-zero deadlines and investors are also raising standards, he added.

Their new and refurbished buildings that are designed to maximise efficiency and minimise running costs, aim at achieving a Building Research Establishment Environmental Assessment Method "excellent" rating as well as an EPC "A" rating.

In the short to medium term, however, the cost of these changes will be huge. Real estate analysts of Jefferies, the investment bank, for example, reportedly downgraded the shares of British Land and Land Securities recently from "buy" to "hold".

They fear that the companies' sustainability policies could cost hundreds of millions of pounds, although it is likely that these costs will be spread out over the next eight years or so.

Tenants will also benefit from lower electricity costs and other smart technology improvements. As such, depending on demand for quality space, the companies could adjust their rental contracts upwards.

Colliers estimates that average recorded rents of refurbished London offices are £71.50 (S$132) per sq ft (psf) compared with £83 for new developments. The London West End average is £85.60 psf, while Canary Wharf refurbishments is £56 psf.