Flight to quality gets underway as half of London offices set to be ‘unlettable’ by 2027
Changes to energy efficiency requirements mean that a majority of office spaces in the capital won’t meet the minimum standard for leasing within the next four years, making it a race to re-fit before 2027.
Minimum energy efficiency standards (MEES) currently require that rented commercial properties in England and Wales have a minimum EPC rating of E. This will increase to a minimum rating of C in 2027 and B in 2030.
The race is already underway: Recent data shows that demand for sustainable office buildings has been the main driver of office take-up in the city this year, with over half of lettings in buildings with excellent or outstanding environmental ratings.
Canada Corporation approved a record number of retrofit planning applications in 2023, which accounted for half of all permissions granted across London.
Grosvenor’s UK property business also announced a refit milestone – 1m sq ft in the capital earlier this year.
“There has been a clear flight to quality, with grade A rents in attractive locations reaching record levels,” Mike Hook, Executive Director at LMG, said.
This ‘flight to quality‘ includes energy-efficient buildings, smart tech, and (simply) nicer workplaces.
The change presents a “real shift in the commercial property landscape,” Graeme Dick, Principal Consultant from procurement consulting firm Proxima, adding that we’re approaching “milestone years” for the sector.
There is an “urgent need for landlords to invest in substantial upgrades to their buildings’ energy systems and insulation… [it will be a] significant challenge for landlords and property managers to mobilise the necessary resources and expertise,” he said.
Downsizing (and re-fitting) over expansion
The latest data from Savills has suggested that while the market as a whole may be ticking up amid an easing economic climate and a drive to sustainability, the trend is to smaller, higher-quality buildings.
“As pre-pandemic leases come to an end, tenants will be looking for more for their money: smaller spaces, higher quality.
Tenants are also reluctant to settle for older properties, as the flight to quality is real – meaning their expectations are higher when it comes to smart tech and modernised refurbishments,” Hook said.
Around 17 per cent of office tenants in London are looking to downsize, according to Savills.
In the first half of the year, 33 of the 45 assets acquired by UK purchasers were priced below £25m. These purchases accounted for 44 per cent of the market. There was only one deal for an asset above £100m in the quarter.
Stranded assets or a great opportunity?
Landlords without the spare cash to invest may soon be faced with the tough choice of whether to sell or wait for the government to – maybe – step in and help.
“Owners of B or C grade office space in unattractive locations will have to review whether they are able to afford repurposing or refurbishing plans, as their assets risk becoming stranded,” Hook said.
Despite the challenges, these “currently marginal buildings” have huge opportunities, Hook added.
For some landlords, the kind of right investment will create long-term growth: the rent per square foot for Grade A buildings sits at an average of £20 higher than Grade B rents, a price difference of around 30 per cent, according to Oktra.
The costs incurred to make an office more energy efficient, too, will also make it much cheaper to run. Improving air conditioning can reduce energy costs by up to 20 per cent, according to the International Energy Agency.
This is crucial: Savills estimates that most spaces will require moderations costing over £40 per square foot.
“Developers will have the business case to invest in smart building tech, which should be a core component of the project… it provides opportunities to facilitate new service-based relationships, green or social leases and reduce overall operating costs,” he said.