18 September, 2024

Future Shock: the Coming Wave of Office ObsolescenceChallenge Two – Environmental and Design Obsolescence

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The single biggest quantifiable threat to many offices is their poor environmental performance. Part of this is driven directly by legislation.

Under Minimum Energy Efficiency Standards (MEES) legislation, The UK Government has already made it unlawful to let or sell buildings with an Environmental Performance Certificate (EPC) rating of F or G. It is consulting on making B the minimum permissible rating by 2030, with a possible intermediate step of C in 2027. Given some of the issues around EPCs – namely, their lack of reliability and questions around their relationship with actual building performance – the Government has also previously considered introducing an alternative measurement system. This would likely be along similar lines to the Australian NABERS certification, which involves measuring actual operational carbon emissions and energy efficiency. This would be unlikely to make the problem less significant.

At the same time, businesses’ own requirements are becoming more stringent. Many have their own plans to reduce carbon emissions based around either net zero or science-based targets, which mean it will be hard for them to own, stay or move to poorly performing buildings. Even if the rate of change slows or government goalposts are shifted, the direction of travel is apparent – which means that the poorer the environmental rating of an asset, the less attractive it is as an investment. Furthermore, occupiers know that younger employees are increasingly environmentally aware and prefer to work (and stay) at companies that demonstrate their sustainability credentials – and what is more public and obvious than their premises? This is part of a wider trend in which offices and workplace design support corporate branding as well as recruitment and retention. Investors, who must take a longer-term view, are also critically aware of these factors and increasingly see poor environmental performance as a major risk, whatever the regulatory system.

Until more reliable measurement systems are in place, EPCs remain both the only real comprehensive source of data, and as they are legally binding, they are of great importance to the office market. There is a huge geographic variation, which is partly a result of the underlying distribution of offices (which are highly concentrated in London and a few other centres) but also the longer history of where these buildings have been constructed and how.

It is also difficult to generalise about how much it will cost to retrofit office buildings, as it varies significantly. However, there are tools emerging such as our own ME:EStimate, which provide rapid, reasonable indicative estimates of retrofit costs. Such estimates can help inform early-stage thinking on refurbishment versus change of use.

WHERE THE PROBLEMS ARE

The chart below shows the 20 biggest local authority office markets in England & Wales, measured by both the amount and the percent of workspace which would fail to meet the provisional 2027 criteria that only EPCs of A-C would be permissible for letting (See note 1 in PDF).

The colour of the dot provides an indication of whether the rents and other market conditions are likely to support development, at least in certain locations within the area.

Birmingham, Leeds and Bristol have somewhat more of a problem in percentage terms, although, over the cycle, these markets should offer at least some opportunities for refurbishment. Tower Hamlets may have more specific problems given the high vacancy levels in the Docklands market. But perhaps more of a concern are the cities in
the top left-hand corner – all of which have reasonably large office stocks, of which 50% or more is potentially “non-compliant”.

AS CAN BE SEEN, THE MOST SIGNIFICANT PROBLEMS IN TERMS OF QUANTUM ARE IN LONDON, PARTICULARLY IN THE CITY AND WESTMINSTER, ALTHOUGH IN PERCENTAGE TERMS THESE ARE FAR FROM THE WORST – AROUND 60% OF BUILDINGS WOULD ALREADY PASS THE LIKELY 2027 CRITERIA OF C OR ABOVE.

Rents in Liverpool, Nottingham, Sheffield and Bradford (and perhaps Newcastle too) are generally too low to enable large-scale refurbishment. This is a problem as the cities do have (at least in some cases) some economic vibrancy. Vacancy rates are actually not particularly high in these cities, which suggests that the lack of rental evidence (and recent development) may be the underlying problem, not a real lack of demand for office space.

This points to the need for carefully targeted local intervention by the public sector or perhaps for local occupiers to work more closely with landlords. The alternative is a vicious circle in which a lack of appropriate stock degrades the city’s attractiveness, which in turn puts downward pressure on rents, making it harder to provide new or refurbished offices. Applying a similar approach to the next 75 local authorities produces the chart below. A similar pattern emerges.

In contrast, there is also a cluster of markets at the bottom of the chart with much less of a problem. They are in economically buoyant parts of the country, with significant recent development (explaining the relatively good environmental performance of the stock). These include Solihull, Wokingham, South Cambridgeshire (where a lot of “Cambridge” office stock has been built), as well as Salford, effectively an extension of Manchester City Centre.

However, the most serious problems are found in the top left of the chart, where over 60% of the stock is poorly performing. These are largely “struggling towns” such as Wolverhampton and Portsmouth, but more prosperous centres such as Norwich and Northampton are also present. Unfortunately, rents and market conditions in many of these locations are unlikely to support extensive refurbishment although in some cases this may reflect a lack of rental evidence. This is a potentially serious social, economic and political problem, adding to the existing issues around, for example, retail vacancy.

WHILE THIS ANALYSIS HAS FOCUSSED ON THE REGULATORY AND LEGAL ASPECTS OF ENVIRONMENTAL SUSTAINABILITY, THIS SHOULD NOT IMPLY THAT THIS IS THE ONLY DRIVER. EQUALLY IMPORTANT IS OCCUPIERS’ INCREASING INSISTENCE ON OFFICES THAT MEET THEIR OWN CARBON-REDUCTION TARGETS. AND INVESTORS’ GREATER UNDERSTANDING OF ENVIRONMENTAL RISK.

In addition to the environmental problems, there are also wider redundancy issues. Surveys tend to show that for some time office design has become more central to the choice of premises and wider business decisions.

Rather than simply a cost that cannot be avoided, some see them as investments that can help improve productivity, innovation, retention and recruitment. This has put a greater premium on new offices – perhaps also newly refurbished offices with character – as well as the location and the amenities either provided on-site or nearby.

As many older offices cannot provide this, their viability has become increasingly challenged. This increasing focus on best-in-class workspace has been intensified by the experience of Covid-19 and its aftermath. Given that EPCs tend to vary mostly depending on age (and are probably also to some extent a measure of quality), the environmental and “design” redundancy aspects may be very closely related.

If offices are becoming obsolescent more quickly, it is important for landlords to develop strong relationships with thier tenants, to consider how services and refurbishments can keep them in situ, and how they can move tenants around their estate as leases break or end. Together with shorter lease terms, this ‘accelerated obsolescence’ means that void risks (and refurbishment cost shocks) are becoming more of an issue earlier in asset life cycles.

CONCLUSIONS - WHAT IT ALL MEANS FOR OFFICES

  • Investors with substandard offices should assess retrofit need and... consider whether local market conditions justify refurbishment or whether change of use is more appropriate.
  • Local Authorities and Planners need to consider how to rejuvenate office stock... (if appropriate) or how to enable change of use as part of wider regeneration plans. They should also consider how this can support more viable office use by providing the amenities and vibrancy that encourage workers to come to the office. They could also engage with local landlords to ensure awareness of the issue and available solutions and to proactively address problems in their own housing stock - while calling from more clarity from the government.
  • Occupiers of substandard buildings... particularly in cities that are economically vibrant but lack active property markets, may need to work more closely with the private sector and local authorities if they wish to see more modern buildings emerge.
  • Landlords need to consider their service offer... to, and relationships with, tenants to keep them as loyal customers as obsolescence accelerates and void risks loom earlier. Tools such as green leases could help formalise collaboration.
  • The Government needs to confirm future EPC targets... and any changes to the exemption outline so the industry can plan ahead with confidence.

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Chapters

  1. 1) Executive Summary
  2. 2) Introduction
  3. 3) The Urbanisation of the Economy
  4. 4) Environmental and Design Obsolescence
  5. 5) Hybrid and Remote Working
  6. 6) What is the Market Evidence?
  7. 7) What Are the Implications?
  8. View Full Report