How the £300BN ‘Retrofit Revolution’ can benefit contractors and subcontractors (Pt 3)

PART 3 OF 4: HOW TO PROFIT FROM THE ‘COMMERCIAL / INSTITUTIONAL RETROFIT’ OPPORTUNITY.

Before we get into the detail, let’s have a brief recap.

WHAT IS THE RETROFIT REVOLUTION?

The ‘Retrofit Revolution’ refers to the national need to retrofit the majority of existing homes and commercial buildings to EPC B by 2050.

In London, Deloitte estimates that approximately 15 million sqft of office space will need to be upgraded/retrofitted by 2030. That’s 80% of all London office space.

C-Link’s data suggests that the average cost of a heavy office refurb is circa £140sqft to £180/sqft.

This would place the value of the ensuing office upgrade work between £2.1Bn and £2.7Bn (or up to £385 million per year between 2023 and 2030). The good news for construction professionals is that these building owners must conduct these works or their buildings cannot be leased legally. From April 2023 it will be unlawful to let or continue to let a commercial property with an EPC rating of F or G.

It’s a big challenge and a big opportunity.

WHAT IS COMMERCIAL/INSTITUTIONAL (LARGE BUILDING) RETROFIT?

‘Commercial/ Institutional Retrofit’ means upgrading the energy efficiency of a building that is used for commercial or institutional purposes (Universities, office buildings etc). This can be achieved by doing one or a combination of the following things:

• Increasing the thermal efficiency of the building’s fabric. The method for upgrading the fabric of large buildings depends on the construction of the building, and its structural frame. This can be as simple as external cladding/rendering the external walls, or as complicated as completely removing the facade and installing a new one.
• Installing solar panels (along with battery storage) so the building can generate a portion of its own energy as well as draw down energy from the grid when it is cheap.
• Swapping its heating system with air source heat pumps.
• Installing ice thermal storage (often on the roof) to reduce energy costs associated with HVAC systems. This can be particularly powerful because aged HVAC can be as much as 40% less efficient than modern systems.

HOW DO THE PRIORITIES OF OFFICE BUILDING OWNERS DIFFER FROM INSTITUTIONS?

Office building owners have 3 key priorities when it comes to Commercial Retrofit.

Legal Lease-ability: Top of mind for commercial building owners is the quickly approaching change to leasing legislation. From April 2023 it will be unlawful to let or continue to let a commercial property with an EPC rating of F or G. By 2030 (7 years time) all non-domestic buildings must have an EPC rating of A or B.

To give an idea of the scale of the opportunity. Savills estimates that approximately 87% of the UK’s offices have an EPC of C or below.

In London, Deloitte estimates that approximately 15 million sqft of space will need to be upgraded/retrofitted by 2030. That’s 80% of London’s office space.

This means that owners of low EPC commercial buildings must either sell (into a challenging real estate market) or invest money in retrofits in a bid to retain, or increase building value.

They really don’t have another choice.

This pressure represents a massive opportunity for larger contractors and subcontractors. It will almost certainly lead to more work than current Tier 1 contractors can manage.

Commercial Lease-ability: Beyond legal leasing, office building owners must also keep up with their tenant’s interests. And for the last few years, office building tenants have shown a growing and strong bias towards energy-efficient buildings. This preference is so strong that tenants and their young teams are starting to exchange new, glassy, towers for trendy retrofitted warehouses or retrofitted buildings with character and attractive sustainability credentials.

• Back in 2019, a survey by Fast Company confirmed that around 70% of millennials said they prefer to work in a company with a strong sustainability agenda.
• Research from Savills showed that you are 70% more likely to achieve a top decile rent if your building has a BREEAM rating of Very Good or better.
• While a global survey from RICS confirmed that green-certified buildings attain a price premium over comparable non-green buildings. This green premium can be as much as 10%.

What this means is that office building owners who do not immediately need to retrofit their buildings may still be losing out on top-quartile rents and exciting tenants because their buildings are energy inefficient.

For the tenants, this isn’t just about values or attracting talent. The UK commercial energy price cap expires in May. This will leave many businesses facing increases in energy costs as high as 350%. Leasing an energy-efficient building saves businesses money.

Sale-ability and Value: As mentioned above. Office building owners with EPCs below B only have 2 choices, to retrofit their assets or to sell.

If a disposal/sale is made without a retrofit. The original owner would have to accept a discounted price because the EPC liability will fall to the new owner.

If they want to sell for a good price, they will need to commission a deep retrofit which will add more value than it costs. Anything less will feel like a painful loss.
If sold at a discount the market and legal context remain unchanged.

The new owner may opt to demolish the building and start again. In this case, a large demolition and construction contract will be tendered. Although, as material and capital costs continue to inflate, this option looks less and less attractive. Not least because lenders prefer buildings as collateral, rather than building sites.

HOW DO THE PRIORITIES OF INSTITUTIONAL BUILDING OWNERS DIFFER FROM COMMERCIAL BUILDING OWNERS?

Institutional building owners (Universities, Hospitals, Government etc) have 3 key priorities when it comes to Institutional Retrofit.

Energy Costs: As mentioned above. For building operators, energy efficiency equals lower bills. Because Institutional building owners can own and operate their buildings for decades, they can often afford (from an investment perspective) a longer payback period. In this way, they are much more like the domestic homeowners described in our last blog.

Many institutions have serious energy cost challenges. 44% of councils have warned they will be unable to pay their energy bills unless they retrofit their buildings to make them more energy efficient.

The challenge to working with these kinds of building owners is they often have very long and arduous decision-making processes. And these processes can become more fraught when it comes to ‘signing off’ expensive and potentially disruptive projects, like a whole building retrofit.

Brand Values: Many institutions have adopted sustainability pledges. Either because of their convictions or to attract their target market/clients (students etc).

As a result, many have realised that the ‘elephant in the building’ is often their own real estate portfolio and its energy efficiency. According to the Princeton Review, US Higher-education institutions boast 3,850 LEED (Leadership in Energy and Environmental Design) certified buildings, more than any other industry.

Research from Shakespeare Martineau revealed that 79% of students were attracted to Universities with clear sustainability plans. And 90% of prospective students said they would be ‘proud’ to study on a ‘green campus’.

Regulation: Beyond energy costs and brand values. Institutions must also contend with new regulatory requirements.

It is not guaranteed but there is a high likelihood that the UK (like many other G7 nations) will introduce some form of a carbon tax. To enable accurate taxing/monitoring of companies and institutions they will need to be able to prove and quantify how much carbon they emit during the course of their operation.

The emission-generating business activities are split into 3 categories (or scopes).

Briefly:

• Scope 1 Emissions: These are emissions produced directly by the company. This includes company buildings, company vehicles and primary industrial processes. (This is what retrofit addresses.)
• Scope 2 Emissions: These are emissions which are produced as a result of the energy used by the business. (If a business is able to generate its own energy via solar or similar it can reduce its scope 2 emissions.)
• Scope 3 Emissions: These are indirect emissions produced by a company or institution’s supply chain. Scope 3 for a large institution like the NHS would likely be scope 1, 2 and most likely 3 for a downstream business. The NHS would require its supply chain suppliers to demonstrate that they are reducing their carbon emissions as much as possible.This means that not only may an institution want to retrofit its premises to comply with its Scope 1 and 2 responsibilities, but it would also require its suppliers to retrofit or upgrade their premises and invest in green energy generation.The retrofit opportunity extends throughout the economy.

HOW CAN CONTRACTORS PROFIT FROM COMMERCIAL / INSTITUTIONAL RETROFIT?

There are 3 ways contractors and subcontractors can win commercial and institutional retrofit work.

• Larger contractors who are sub-tier-1 can win this work by demonstrating their retrofit and new build expertise. Because of the nature of retrofit experience in constructing new £3m projects is useful and relevant for executing £5m – £8m retrofit projects. As mentioned in our last blog about domestic retrofit opportunities, the key will be to position the firm as an expert in this kind of work.
• Smaller Contractors and subcontractors may be better placed to source these opportunities/ make these introductions because they’re on frameworks and will know the estate team. Larger contractors should leverage their subcontractor network and consider paying a ‘finders fee’ to subcontractors who introduce them to building owners in need of full building retrofit.

Conversely, subcontractors should use their relationships with building owners to understand what their retrofit plans and either offer to introduce them to trusted larger contractors or offer to join the team of the appointed contractor to serve as a ‘quality control’ / ‘inside man’ for the building owner.

ARTICULATING THE GREEN PREMIUM TO COMMERCIAL / INSTITUTIONAL BUILDING OWNERS?

Building owners of this scale are generally more sophisticated than domestic owners and are aware of the need to decarbonise and retrofit their assets.

However, they rarely understand how to initiate or execute a projects of this size safely and cost-effectively. This is where Contractors and Subcontractors can take the initiative and offer free consultation advice.

After April 2023, reaching out to building owners about ‘green retrofit services’ will be like ‘pushing on an open door’.

WHO IS TAKING ADVANTAGE OF THE RETROFIT REVOLUTION?

C-Link is working with leading construction businesses that are taking advantage of this once-in-a-generation opportunity.

If you’d like to discuss how C-Link can help you do the same drop us a note here.

If you’re not ready but if you’re intrigued, why not check out our platform?

 

Photo by Nastuh Abootalebi on Unsplash

About Martin Prince-Parrott

Martin is an ESG Real Estate Developer and former Award-Winning Architect. He’s spent the last decade designing and developing a billion-pounds worth of mixed-use institutional-scale real estate. He’s worked with and for market-leading companies such as Gensler, Microsoft, Barratt Homes, Legal & General and Barclays Bank.