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Carbon CapEx and The Road to Carbon Net Zero - Part II

22 Feb 2022

by Nicole Lux

How to navigate this journey is complex and differs by asset and building type.

In the first article on The Road to Carbon Net Zero across Europe we looked at the benefits of upgrading (i.e. the cost of not upgrading) and how regulation is still not set in stone across Europe. The route of travel is clear, however. What is not clear is what exactly is required on the route to Carbon Net Zero, and what the impact on asset value and performance will be.

The journey to Carbon Net Zero will differ by asset type, building type and age, and country. Residential might have different requirements for upgrading to minimum Energy Performance Certificate (EPC) ratings by certain dates to allow an owner to let out a building than for commercial. Within commercial real estate requirements differ, for example for industrial assets vs an office building.

Exceptions requiring energy performance certificates exist

National regulations on the minimum sustainability of buildings will crystallise and are likely to tighten over time. Initially expect there will be instances in which certain minimum EPCs ratings are not required. This might sound like good news to some. However, many investors and lenders might feel less inclined to accept assets with EPC exemptions or with poor energy performance. Based on UK examples, Energy Performance Certificate exemptions (or the national equivalent) are likely for:

  • An industrial site, workshop or non-residential agricultural building that doesn’t use much energy
  • Buildings due to be demolished
  • Buildings that are listed or officially protected, for example a historic building where one cannot alter the external appearance and thus meeting the minimum energy performance requirements is not possible
  • A temporary building only going to be used for c. 2 years or less
  • A residential building that will be used for less than four or so months of the year
  • Churches
  • Where required upgrades are not cost-effective, f.e cannot be earned back within a certain time period

What can we expect?

Expect that regulation, aiming for a minimum EPC ‘C’ rating by 2027 and EPC ‘B’ by 2030 for commercial buildings, would stipulate that where an exemption is registered, property owners need to demonstrate that the building has achieved the highest possible EPC band that is cost-effective to implement. The length of the payback period will likely change over time, and at best will likely be 7 years.

Minimum energy efficiency standards are being implemented in stages by government regulation, so building owners can improve over time, or decide to do a major upgrade in one go. Most buildings, new and old, will require upgrades and a substantial amount of CapEx spend. Did you know for example that for example the whole of the UK, one of Europe’s largest office markets, only has 22 Carbon Net Zero buildings to-date? Yet 60% of greenhouse gas emissions come from buildings in urban areas.

Minimum Energy Efficiency Standards (MEES) matter, too

Even of those buildings currently under construction a minority have high sustainability credentials. Buildings new and old alike will require substantial ‘Carbon CapEx’ to strongly reduce the output of carbon emissions. Over time expect more stringent minimum energy efficiency (MEES) for non-domestic buildings in the private rented sector. Beware that the way an EPC is calculated could very well change, so the goal posts of what is required might move. It is sensible to be ambitious in targets to void having to retrofit in the future.