Market Research

Assessing Environmental Obsolescence Risk and Retrofit Opportunity in London Office Markets

September 4, 2023 20 Minute Read Time

Environmental Risk

The following piece is a collaboration between PLACEMAKE.IO and CBRE Investment Management, written by Dr Chlump Chatkupt, founder and CEO of PLACEMAKE.IO and Dominic Smith, Head of UK Research at CBRE Investment Management.

One of the most significant climate-change regulations that directly impacts real estate is the Minimum Energy Efficiency Standard which requires that, from 1 April 2030, every nonexempt nondomestic private rented property has an Energy Performance Certificate (EPC) rating of B or higher. As is now well known, most offices are currently noncompliant, yielding a ticking time bomb of soon-to-be stranded assets—but also a significant opportunity to generate an outsized return and carbon savings through the transformation of a noncompliant asset into a compliant one.

The Energy Performance of Buildings Register provides the address, property type, total floor area, and EPC rating of every property with an EPC. (Because not every property has an EPC and because multiple EPCs may cover overlapping properties, such as a building and a floor within it, interpolation and transformation of properties into nonoverlapping spatial units are required to generate a comprehensive and coherent assignment of EPC ratings.)

Compliant office stock is estimated by identifying every office property with an EPC rating of B or higher and summing the floor areas of all such properties while total office stock is estimated by summing the floor areas of all office properties.

The PLACEMAKE.IO Office Energy Efficiency Compliance Index characterizes the degree of compliance, defined as the ratio of compliant office stock to total office stock.
Though compliance has increased, it remains exceedingly low in major office markets.
As is now well known, most offices are currently noncompliant, yielding a ticking time bomb of soon-to-be stranded assets—but also a significant opportunity to generate an outsized return and carbon savings through the transformation of a noncompliant asset into a compliant one.

Figure 1: Mean compliance across major office markets

Sources: PLACEMAKE.IO | Energy Performance of Buildings Register

For example, in London, compliance across the 15-minute station catchments remains extremely low, meaning that most office stock is at risk of becoming stranded and consequently devalued.

Figure 2: Compliance across major London 15-minute station catchments

Sources: PLACEMAKE.IO | Energy Performance of Buildings Register

But for a value-add or opportunistic investor, these low-compliance markets—especially those with otherwise favorable features—hold prized opportunities:

  • A vulnerable office could potentially be acquired at a significant discount.
  • A noncompliant office could be upgraded and transformed into a compliant one to generate a green premium.
  • A green office in a low-compliance market may be rare and stand out amid the profusion of noncompliant offices, attract occupiers drawn to green credentials and potentially significantly outperform the local market.

Our experience suggests that while the cost of upgrading an office from an EPC rating of C or D to B can be relatively low, the cost increases exponentially when upgrading from an EPC rating of E, F, or G, making conversion of the latter more challenging.

Therefore, a simple framework for analyzing the different risk characteristics of retrofitting noncompliant office stock involves characterizing markets into four categories according to the relative proportions of existing stock with an EPC rating of B or higher and existing stock with an EPC rating of E or lower, resulting in the following risk matrix.

Figure 3: Risk matrix

Source: : For illustrative purposes only.

There are two key principles to consider:

The greater the amount of office stock with an EPC rating of B or higher
  • The greater the conviction that demand, land and office values are sufficiently high to underwrite higher-rated stock
  • The greater the draw for ESG-driven occupiers
  • The greater the competition from higher-rated stock
  • The lower the potential to stand out based on green credentials alone
  • The lower the potential gain from upgrading
The greater the amount of office stock with an EPC rating of E or lower
  • The greater the opportunity to acquire a noncompliant office at a discount (and the greater the potential discount)
  • The lower the competition from upgraded office stock (given the obstacles to upgrading)
  • The greater the potential to stand out after upgrading
  • The greater the potential gain from upgrading
  • The greater the potential for dereliction should a high amount of noncompliant office stock not get upgraded
Plotting a bubble chart of London 15-minute station catchments (with the bubble size characterizing office-stock density) reveals the risk profile of each office market. (Note that only sufficiently large markets with office-stock density of at least 50,000 square meters per square kilometre are considered and that, by construction, the area above the diagonal is infeasible.)

Figure 4: EPC distributions of London 15-minute station catchments

Source: PLACEMAKE.IO | Energy Performance of Buildings Register

Several points are worth noting.

  • The upper lefthand region is sparse and consists entirely of Stratford markets with newer office stock.
  • The upper righthand region just below the diagonal is completely empty, indicating that, in fact, there are no markets with both a higher amount of office stock with an EPC rating of B or higher and a higher amount of office stock with an EPC rating of E or lower.
  • The cluster in the lower righthand region consists of Docklands markets (such as Crossharbour DLR Station and Mudchute DLR Station) and Croydon markets (such as East Croydon Rail Station and Tram Stop and Church Street Tram Stop).
  • Most markets fall within the lower lefthand region, likely reflecting historical complacency, satisfaction with an EPC rating of C or D, an assumption that offices will be fairly easy and cheap to upgrade and inertia.

Notably, with its proportion of office stock with an EPC rating of B or higher sitting at 11% and its proportion of office stock with an EPC rating of E or lower sitting at 14%, the market that is closest to the origin in the chart is London Marylebone Rail and Underground Station.

In conclusion, while the Minimum Energy Efficiency Standard presents considerable asset-management challenges, it presents, by the same token, significant opportunities for a value-add or opportunistic investor to capitalize on market dislocation as long as the associated risks can be adequately mitigated. At the same time, an office that cannot be upgraded, but is in a favorable place may turn out to be an ideal candidate for office-to-residential conversion.