With the real estate sector accounting for 40% of the UK’s energy and process-related greenhouse gas emissions, retrofitting our built environment to meet new regulatory requirements will be a crucial part of the journey towards meeting the country’s 2050 net-zero target.
Stricter standards, which will raise the minimum energy performance certificates (EPCs) required for both residential and commercial real estate, are anticipated to be phased in during 2025-2035.
While this will be a key driver for real estate owners, occupiers and funders to accelerate the pace of retrofit investment in built assets, the scale of the challenge and delivery timetable is daunting.
Upping the pace
With more than 29 million residential properties alone in the UK identified as requiring ‘transition’ to meet the new EPC standards, the current rate of residential retrofit will need to increase seven-fold to meet government net-zero targets at an estimated cost of up to £330bn.
A coherent industry-led roadmap to support a collaborative transition journey for building owners, managers and occupiers will be critical. It will need to be underpinned by robust data on operational building performance, necessary efficiency measures and financial viability in the context of rising inflation and overall return on investment.
At the publicly listed and institutionally owned end of the market, participants are further along the curve in signing up to clearly defined sustainability strategies, reflecting the environmental, social and governance (ESG) commitments of shareholders, investors and corporate tenants. This contrasts with the privately owned market, where shareholder pressure is less pronounced and tenant demand more disparate.
Improved industry-led guidance and introduction of stricter regulation will be key ‘push’ factors in accelerating retrofit activity. At the same time, greater landlord understanding of actions required and the associated financial viability of investment, coupled with clearer direction around the consequential impact on asset and rental values, will act as necessary ‘pull’ factors for change.
Access to finance is key
Instigating informed and decisive action is only part of the challenge, with successful delivery of the retrofit programmes also dependent on accessibility of finance, availability of necessary skills and fulfilment capacity within the sector.
From a financing perspective, again there is a divergence between listed and institutionally backed real estate owners on the one hand, and smaller-scale, privately owned landlords on the other.
The former group can access pools of well-priced liquidity in both the bank and debt capital markets owing to scale, asset diversification and strong underlying credit fundamentals.
In contrast, private landlords have more limited access to capital markets and utilisation of financing can be more constrained by underlying credit risk parameters around leverage and cash flow which limit incremental debt capacity due to lower diversification. Privately owned asset portfolios often lack the same flexibility compared with the larger listed and institutionally backed real estate owners to support assets being taken offline or landlord concessions being granted to enable investment to be made.
This is driving an increased focus from lenders on transition risk across their client portfolios and a need to re-evaluate their approach to retrofit financing and protect existing risk exposures.
Barclays acknowledge this financing gap exists and we are actively working with our clients to help them formulate a strategy for the transition through early engagement on regulation and transition risks.
Meeting the challenges
Climate change arguably represents the single biggest challenge for real estate owners, occupiers and lenders. Greater consistency across the industry and collaboration among investors, regulators, insurers, occupiers and other stakeholders is imperative. This needs to be supported by improved access to data to better inform strategic decisions and drive the necessary momentum. Finance providers are a key stakeholder in discussions on retrofit and overall portfolio strategy and an active and early engagement with banks and investors on a transition strategy is key to managing transition risks for real estate owners.
Joe Mellings is an industry director, specialist real estate at Barclays Corporate