Following the successful outcome to the Paris Climate Agreement, UK environmental policy will inevitably tighten and regulations will be ratcheted up. Buildings are responsible for approximately one third of global greenhouse gas emissions*. The improvement of building energy efficiency will make a significant contribution to meeting emissions targets.
The UK government has been one of the leaders in terms of adopting some of the strictest property environmental regulations in the world. The UK is on track to comply with the EU’s 2020 targets, but meeting the 2030 targets will require a step change in effort.
Investors need to invest to “future-proof” their property assets, or risk diminishing returns and obsolescence of assets. Those who adopt this strategy should be well positioned to benefit from the generation of “green alpha” – the additional returns that can be attributed to sustainability and energy efficiency initiatives.
Rigorous environmental building regulations
UK Energy efficiency performance standards are covered by Part L of the UK building regulations. These are revised every three years, and will inevitably ratchet up with a subsequent impact on Energy Performance Certificates (“EPCs”). These were introduced in 2007, and are now mandatory for all new commercial buildings. All commercial properties will be required to have a minimum EPC of “E” by 1 April 2018. It is estimated that a fifth of all EPC rated buildings in the UK may not meet this standard and risk becoming unlettable in 2018. This poses a considerable threat to the value of many commercial property portfolios. However the focus should also be on buildings currently rated F or G. These lower ratings are likely to be phased out over the next few years and require considerable investment for refurbishment so that they comply with much tighter standards and are brought up the scale.
How others are assessing the risk
France, Sweden and Australia appear to be several steps ahead in their longer term thinking and assessment of the impact of climate risk when investing in property.
France is forging ahead with the first-ever investor climate reporting law. French investors are already required by law to integrate ESG factors into their investment process, but in addition they are now faced with a mandatory evaluation of the implications of climate change. This applies to all investments, including property.
Meanwhile, Sweden is considering legislation based on carbon footprinting, which should make investment strategies focused on energy efficiency still more attractive to investors.
The UK is also considering launching a benchmark on a par with the more stringent Australian NABERS (the National Australian Built Environment Rating System). NABERS requires all new buildings to be designed and built to the highest energy efficiency specification and future-proofed with an on-going improvement plan (“plan for performance”) once the property is occupied. This ensures buildings are kept up to date with subsequent improvements and operating efficiencies. In Australia this has also resulted in a dramatic increase in occupier engagement in energy efficiency to the level where tenants actually specify the standards they want. This model differs from that in Europe in that it is the property owner and not the tenant who is legally required to take responsibility for the running and operation of the building, and ensuring regulatory targets are met.
It is critically important for investors to understand the cost, benefits and legislative framework behind energy efficiency when investing in property. Not only is there is a rising tide of mandatory standards, but also rapidly rising occupier demand for the most sustainable buildings. The Paris Agreement has provided an overarching framework for future regulation, and reaffirmed that staying ahead by investing in future-proofed, energy efficient property is an attractive investment opportunity – and the only viable long term strategy for investors in this asset class.