Property investors already hit by high interest rates are now facing the prospect of significant devaluations triggered by new European regulations.
Property owners across the region will have to invest large sums in renovations to ensure their buildings do not emit illegal levels of carbon dioxide or consume excessive amounts of energy, according to industry lawyers.
The situation is “causing huge problems,” said Rory Bennett, managing partner at real estate firm Linklaters in London. Portfolios containing energy inefficient buildings face “the task of spending a huge amount of capital to bring them back to net zero, along with refinancing or redeveloping at the highest interest rates we have seen in decades.”
This month, European Union lawmakers passed the Energy Performance of Buildings Directive. The rollout will be gradual – lasting more than a decade – but property owners who fall too far behind risk finding themselves saddled with assets that can no longer be sold or rented.
The directive is aimed at forcing property owners to undertake large-scale renovations to improve the environmental credentials of buildings across Europe and ensure the bloc meets its commitment to the Paris Agreement. For now, renovations in the region reduce annual energy consumption by just 1%, according to the European Commission. To meet its climate requirements, the EU says property owners must increase spending on renovations by 275 billion euros ($300 billion) a year.
“These are huge sums of money,” Bennett said. “The reality is that there will be some who simply cannot afford or would choose not to comply with the legislative directive on the basis that paying a fine is, at least in the short term, easier than having to spend a huge sum of their own money. reserves to bring your supplies up to par.
For real estate investors, the new wave of green requirements adds to the fallout from rising interest rates. The situation has started to attract short sellers, who are now targeting the weakest links in a global real estate market struggling on multiple fronts.
The new European law on energy performance will likely affect tens of thousands of buildings across the region. By 2033, property owners will need to renovate a quarter of the EU’s largest energy-intensive buildings. Gone are fossil fuel boilers and buildings are ready for solar panels. And by 2030, all new buildings must be emissions-free.
The directive is part of a package of initiatives taken for the first time in recent years to green the EU economy and provides for legal liability for failure to address environmental damage, as well as mandatory disclosure of data on energy, emissions and water use.
The UK is also planning rules that will force property owners to undertake environmental improvements. Mount Street, a London-based company that manages €65 billion in European real estate loans, estimates that around 70% of UK commercial properties currently have an Energy Performance Certificate (EPC) of grade C or lower. This means important future updates as the UK plan gives all building owners until April 2027 to achieve a grade of at least C. By April 2030, a building’s grade cannot fall below B for it to remain operating.
Jim Gott, who runs the asset surveillance team at Mount Street, says the current proposal implies an investment need of £150 billion ($189 billion).
“In a lot of places, you’re going to struggle,” Gott said. “If EPC targets are not met, it effectively becomes illegal to rent the space. This will affect the capital value of the building.”
Around 60% of UK warehouse space is on track to fall short of a B rating by 2030, according to law firm Ashurst, which cited data published in Logistics Matters.
Tighter EPC rules are becoming a potential “regulatory edge for unrentable European offices,” said Kim Politzer, head of European real estate research at Fidelity International. “Poor quality buildings in secondary locations require expensive capital refurbishment” and “the sums are becoming increasingly difficult to add up”.
According to the European Commission, in the EU, around 85% of buildings were built before 2000. Due to poor energy performance, they are the largest users of energy in an era where fossil fuels make up two-thirds of energy sources for heating and cooling. The EU wants emissions from the sector to be reduced by 60% by 2030.
Such considerations have taken on increasing importance in investment negotiations and decision-making, said Jean-François Vandenberghe, real estate specialist at Baker McKenzie. Some asset owners and managers are embracing the new trend, while others are focused on mitigating obligations, he said.
On the other hand, already green buildings are more in demand than ever. In major EU markets, 22% of office stock was certified sustainable as of mid-2023, compared to 15% in 2019, according to CBRE, a real estate consultant. Other CBRE research found that when accounting for the effects of size, location, age and renovation history of a building, certified green buildings command a 7% rent premium.
According to a November report from Jones Lang LaSalle Inc., demand for green real estate from the EU’s largest companies currently exceeds availability by more than 50%.
Linklaters’ Bennett says he is regularly called into meetings where “we spend hours talking about what to do”.
For now, real estate investors are just hoping that the broader economic situation improves and softens the blow of the impending regulatory shock.
“If the economic environment picks up, interest rates will come down and that will really help decision making,” Bennett said. It would give real estate investors “a little more breathing room.”