Retrofitting is vital not only to net zero but real estate investment growth

It is a perfect example of profound changes that are taking place in the UK’s property investment market: retrofitting.

Retrofitting is vital because, as you might know, some 40 per cent of the emissions that cause climate change come from the buildings we live, work, learn and shop in.

Retrofitting buildings is now a very significant component of the investment approach taken by a real estate fund manager. 

Most of these buildings are still going to be around in 2050 – up to 80 per cent, according to some analysis.

Add these two realities together and there is a pressing need to upgrade the UK’s buildings to the required environmental standards.

Commercial property makes up around 13 per cent of the total in this country, and it is the sector our real estate fund members tend to specialise in. 

Building for the future

If we focus on that 13 per cent for a moment, what you have got there are offices, logistics (such as those huge sheds you see from the motorway), and a wide variety of retail – from high streets to out-of-town centres.

Retrofitting these buildings, with an eye on net zero, is now a very significant component of the investment approach taken by a real estate fund manager. 

They will focus on a wide range of tactics, from new cladding, heating, ventilation and air-conditioning to helping building facilities managers operate their buildings in the most effective and efficient manner.

Significant social and environmental gains are also there to be made.

Such work has been going on for well over a decade. Across the pond, the $13.2mn (£10.7mn) retrofit of the Empire State Building started as far back as 2008.

Closer to home, the old headquarters of former high street behemoth Woolworths is currently undergoing a vast refit, which includes best-in-class sustainability principles. 

Currently, hundreds of buildings in the UK will be having legacy materials ripped out, recycled and replaced with modern systems, materials and processes.

Investing for the future

Retrofitting is so vital to modern property investment, that part of any shares or units in a property fund held by your clients will almost certainly be used to fund such changes.

Moreover, and thanks to a whole-of-life approach by fund managers, your client’s investments will almost certainly already be reaping the benefits of lower energy expenditure.

But that is not all.

Such expensive changes are coming at a time when wage growth lags inflation badly.

The energy efficiency rating of any investable commercial building is now an essential part of the valuation process.

In simple terms, a retrofitted building with an energy performance certificate rating of A will be a far more attractive proposition than an untouched, legacy building glumly labelled G for inefficient.

Significant sums of money can be made by fund managers for their unit holders in retrofitting. 

At the same time, significant social and environmental gains are also there to be made.

Sustainable housing, Dutch style

As we have seen, the UK’s commercial buildings – giant though many are – represent a small proportion of the total. The bulk is housing and, according to recent figures, some 95 per cent of it needs retrofitting . 

This means better insulation, like that available through the ECO+ scheme, plus heat pumps, solar panels and other technology.

Fund managers who enter the housing market tend to have to build new developments and they are mostly for rent. With next to no access to legacy housing, they do not have the opportunity to unleash their retrofitting strategies. 

Do many owners or private landlords have the capital or incentive to retrofit their properties to the required standards?

Such expensive changes are coming at a time when wage growth (at around 6.1 per cent a year) lags inflation badly.

Spreading the cost over the life of a property, lowering the cost of green energy, and government subsidies are three ways to meet the retrofitting challenge.

One idea is a Dutch scheme called Energiesprong – translated as ‘energy leap’ – which works with housing associations in the Netherlands and several other markets. 

It borrows the approach taken by institutional fund managers by applying a whole-life model financing model.

This means up-front costs for retrofitting are met through energy savings and lower home maintenance liabilities over the long run.

The tenant then pays their association for energy usage, not utility providers, and the mark-up goes to pay for the retrofit.

All of a sudden, having better insulation, solar technology and an energy hub, such as a heat pumps, become more affordable. 

The Energiesprong approach is now being trialled in Nottingham and Maldon, Essex. The scheme may cover just a handful of homes, but hopes are high.

Show me the money

Spreading the cost over the life of a property, lowering the cost of green energy in relative terms, and government subsidies (which we might reasonably expect to grow) are three ways to meet the retrofitting challenge.

However, as is so often the case, innovative thinkers in the financial services sector are coming up with more. 

One you may already be familiar with is retrofitting mortgages.

Such products, like that provided by the Saffron Building Society, tie the rate you pay as a borrower to the energy efficiency rating of your house. There is an indirect incentive to use the money you save to upgrade. 

It is likely that retrofitting will become a bigger conversational staple over the years.

There are some 52 such and similar products on the market. You would like to think more will come.

Perhaps we will eventually see some sort of link between energy efficiency and interest rates in every product, including the commercial mortgage financing used by fund managers.

At the same time, banks are starting to securitise green mortgages into fixed income instruments – to the tune of £75bn a year. So, it is possible that any fixed funds held by your clients may already have such bonds tucked away in their portfolios. 

It is likely that retrofitting will become a bigger conversational staple over the years.

Get this right and the UK as a nation can look towards its 2050 environmental targets with more confidence.

Paul Richards is managing director of Association of Real Estate Funds