A case of jump or be pushed

THERE IS refurbishment and then there is refurbishment: one is a simple tidy up job, stick it back together and slather on the magnolia paint prior to re-letting, while the other is far more complicated, time consuming and expensive. But it is the latter, which is becoming far more commonplace. And for occupiers this is a bonus.

It was not very long ago that the majority of second hand buildings would get the former treatment and as long as the building was let, and an income came in then most investors/landlords were content.

But there has been a sea change in attitude not least due to the Paris Agreement on Climate Change. This has resulted in a focus both regulatory, from governments, and fiscally, among investors worldwide, to be seen, and to prove, to be furthering this agenda.

Like much of the commercial property market, many industrial and logistics warehouses are held as assets within a portfolio for a variety of investors, investment companies and pensions, either directly or indirectly through financial vehicles such as REITs. Each will have its own Corporate & Social Responsibility (CSR) agenda and will have targets for Environmental Social and Governance (ESG) as well as carbon net zero aspirations.

For a while it was up to individual companies to self-declare their ESG/net zero credentials making it difficult to judge who were genuine and who were just ‘greenwashing’. 

To tackle this governments around the world worked on various regulatory environmental reporting standards. In 2021, the European Union introduced its ‘sustainable finance disclosure regulation (SFDR)’. The SFDR, makes it law that investors, private banks and financiers in the EU must classify their funds based on how embedded ESG is within their investments, regardless of whether or not they have a specific ESG focus.

There are three levels known as Article 6, Article 8, and Article 9. Article 6 is the default category where funds need to show that they are addressing sustainability risks; moving up, there is Article 8 where funds must show that they are ‘promoting’ ESG – it is expected that minimum qualifying thresholds will be set in the future – then, there is Article 9, where the fund must demonstrate that sustainability is an ‘objective’ and this has to be proved.

The UK’s Financial Conduct Authority is implementing Sustainability Disclosure Requirements along similar lines to the SFDR. The FCA reports that global assets under management in ESG-orientated funds are expected to increase to $34trn by 2026 – its big business and investors must feel confident that what they are getting is in effect ‘guaranteed’. 

For the funds it is a case of the higher the ESG credentials the better with the highest trading more swiftly and at a premium. Simply put for fund managers, individual investment companies etc that means ensuring all properties held directly in a portfolio and indeed all properties held indirectly for example in a REIT, have to satisfy these criteria and that includes all standing stock.

Real estate Investment and development company Bloom co-founder and managing partner Tom Davies, says: “Effectively it won’t be long until funds will not buy [or invest in] buildings without the right credentials.”

He says Bloom is ensuring that its whole portfolio secures BREEAM Excellent and EPC A, even its refurbished properties. “As properties securing these high grades are thin on the ground securing these top ESG credentials will give us best value for our partners now and going forward.”

Some refurbishments undertaken by the developer seem extreme but in order to secure these highest ESG credentials Davies believes the measures are entirely justified. In its sixth project for its £250 million ultra urban joint venture with Angel Gordon which focuses on central London properties, it has completely overhauled the 36,885 ft2 Imperial Studios in Fulham. This has included re-configuring the whole layout of the property from 16 ragtag workshops into five modern units which saw the roof raised, mezzanine floors installed, the refurbishment of the entire façade, the installation of solar panels, EV charging points and cycle provisions. The property is due to reach practical completion later this year. Letting agents are Gerald Eve and Montagu Evans.

Tritax BIG BOX REIT assistant fund manager, Martin Shaw says: “Investors are relying more and more on asset with good ESG credentials therefore, we have to make our assets more sustainable to be more marketable and it is not just for the sake of our investors but also for our occupier base who have their own ESG agendas.”

There is a veritable trickle down effect. For some occupiers it will be driven by regulatory requirements for others it is seen as essential best practice.

“It is no happenstance that ESG has moved up the agenda for investors and occupiers alike,” says CBRE Investment Managers head of EMEA Logistics Operator Division Laurie LaGarde. She notes: “Companies such as GXO and DHL are now ring fencing funds to spend on building for ESG upgrades which were not available a couple of years ago.”

Logicor’s director of UK asset management Anthony McCluskie agrees: “The ESG environment is driven by stakeholders, but we are finding it is also driven by the occupiers we want to deal with; no longer can they just take on any old building. The ESG is right up there in the terms and underlying contracts. The building has to be sustainable; it has to have the right ESG credentials.”

Further regulatory impetus to upgrade the UK’s commercial property stock - which accounts for some 70% of the 23% of all UK carbon emissions from the built environment comes in the form of the Minimum Energy Efficiency Standards (MEES) regulation.

This applies to all privately rented property and makes it an offence to continue to let a commercial space with an Energy Performance Certificate (EPC) worse than an E, even in the middle of a lease term. By 2027 the minimum EPC needs to be rated C or above and by 2030 this needs to be a B or above.

Approximately 128 million ft2 of UK warehouse space, 18% of all units above 50,000 ft2, will fail to meet minimum EPC C by 2027 and this number triples to 404 million ft2, or 60% of warehouse space, when considering the minimum EPC B requirement by 2030 according to research by Knight Frank. Typically, those buildings that fail to reach the EPC standards are older buildings. Around 82% of the UK's warehouse stock was built before 2000.

It is not surprising then that there is a growing movement for high quality refurbishment of second hand units not merely swapping out old lighting systems and doing a deep clean but full on upgrades.

But what goes into those decisions? For Gerald Eve partner Charles Spicer: “The decision on whether a building is financially viable to refurbish is normally based on a costs and appraisal exercise and recognition of which option yields the best return.” 

Chancerygate’s head of investment and asset management Simon Cowley agrees: “Identifying what goes into the decisions to refurbish, including financial ones, will be based on underlying factors such as the age and quality of the building. However, many decisions are ultimately influenced on where the asset managers lie in the risk spectrum.

“This position on the risk spectrum involves finding the right balance between futureproofing an asset, making them more modern and maximising returns.”

SEGRO’s head of London asset management and development Bonnie Minshull says: “It is not a one-size-fits-all approach. We look at whether refurbishment is technically feasible and commercially viable as some older, poorer quality units will require significant CAPEX to be upgraded. We then consider the location, occupier-base and supply-demand dynamics to determine if there is a local need for the high-specification space.

SEGRO is in the process of completing two BREEAM ‘Outstanding’ refurbishments at Premier Park and Origin – which alongside its refurbishment at Auriol Drive, Greenford, will be the only industrial retrofits in the world to achieve this standard.

“Taking units originally built around 10 and 20 years ago and bringing them up to the very highest standards means incorporating more biodiversity and staff amenities and features to increase energy efficiency such as PV panels, intelligent lighting, occupancy sensors and electrification. Once delivered, we offer a ‘soft landing’ of the building to occupiers, so they understand how to get the most out of the unit and benefit from the occupational efficiencies.”

Around 40 million ft2 of Logicor’s European portfolio of properties is in the UK including properties built in the 1980s and 1990s. McCluskie notes that not all will be able to be refurbished. “When a building comes back to us we always look at refurbishment as an option but there are certain criteria that must be met. Firstly, if that building were refurbished including securing all ESG credentials what will we achieve rent wise? Will it let well and quickly? Is it in the right location, does it have the right bones? And we work back from there. Not all buildings will be institutionally acceptable or indeed financially viable for refurbishment. In those cases, it is more likely that they will be demolished and redeveloped.”

Where Logicor does decide to refurbish it will reverse engineer to provide the elements to ensure the property undergoing refurbishment achieves a minimum EPC A grade and BREEAM in Use Very Good. “We look at door, cladding and roofing specifications, introducing EV charging points and providing PV arrays. We will also look at the amenity space through the provision of canteens, kitchenettes for example and outdoor gym space as well as landscaping and enhancing bio net gain.

Recent refurbishment successes saw GXO take a 170,000 ft2 property in Wellingborough. The facility upgrades included enhanced insulation, providing LED lighting, replacing gas heating with an air source heat pumps adding in low capacity flushing toilets and introducing solar panels all this reduced carbon output of that property by 93%.

“We could have probably re-let the property without the refurbishment but that would not have been responsible from an environmental or from an investment point of view. It would have been let on worse terms and the investment value would have been knocked.”

Although Tritax Big Box REITs portfolio is almost entirely made up of assets with an EPC C and above where refurbishment is on the cards senior development director Tom Newton notes: “While EV and PV installation and rainwater harvesting etc get all the press, its the everyday aspects that are the smarter move like material choices, cladding with higher U values, improving air tightness, roof insulation improving M&E changing from gas to air source heat pumps – in effect the same approach as a new build. The only limitations on a refurbishment will be on the end value and how far it can be stripped back.”

Having completed and let one of the most innovative property overhauls in 2023 pulling in a BREEAM Excellent and EPC A + rating on refurbishment at its Solar120 building in Warrington, CBRE IM is undertaking a full audit of all its properties to get its portfolio to carbon neutral. Lagarde says: “We are looking at what needs to be done in order for those buildings to be carbon neutral in the future and checking where there is a strategy to implement changes on a more scalable basis.”

“Everything has a cost and some assets will be difficult to refurbish. Where we can, we will do so. It is important to note that the implementation, even if costly, will generate savings for occupiers not only in terms of in operational cost but also in more intangible ways.”

LaGarde is referring to the wellness initiatives pioneered at its Solar 120 scheme. “We are intending to duplicate what has been done [there] to other assets because it has been seen that enhanced amenities help retain staff and boost wellness -and in the long term productivity - we see ourselves in partnership with occupiers and we must work on a win/win basis.”

Wellness initiatives promoted at Solar 120 include a multi-use games area, changing hut, petanque court, cycle store, beehives, and a wellness garden.

The uptick in the number of properties being refurbished can also be traced back to the recent hiatus in the economy which has made funding speculative new build and build to suit more expensive. According to Naylors Gavin Black partner Keith Stewart this is particularly true in the Northeast and other non prime areas. “The cost of the building versus rental return is just not good enough and developers are unwilling to take the risk. However, properties that can be refurbished at a reasonable cost are hot property.”

Bloom’s Davies says: “There is a lot less risk on an existing building than constructing one from scratch. In most cases it is cheaper and quicker – this is an improvement not designing from the ground up and generally a lot less controversial as the use is already established.”

A lot of investors and developers are actively seeking these reversionary properties some inevitably will be redeveloped while others equally with be refurbished and enhanced.