Retrofitting to Net Zero – an update on the changes and the challenges in the sector

Given the target under the Paris Agreement to reduce emissions by 45% by 2030 and to reach Net Zero by 2050, occupiers and existing building owners are swiftly committing to carbon and energy use reduction goals. Investors are also seeking projects which contribute to meeting this challenge. This has resulted in an increased emphasis being placed on how embodied carbon (carbon emitted during construction/ refurbishment of a building) and operational carbon (the carbon emitted during the in-use phase of a building) is reduced in new developments, be those new-build or retrofit projects. The sector's focus on this was clearly evident at Footprint +, the UK Property Event for a Zero Carbon Future, which was held in London earlier this month and which we were fortunate to attend to hear first-hand from a range of stakeholders on the issues the industry is facing and how the landscape is changing in response.

The need to reduce emissions in connection with development and the built environment can be driven by government regulation, such as planning policy (e.g. the City of London's Retrofit First policy) or building regulations requirements, or increasingly by the corporate social responsibility agendas of those in the Real Estate sector going beyond what regulators require. Around 40% of UK carbon emissions are linked to the built environment, and so it is critical that significant carbon emissions reductions are achieved by the sector for the UK to stand any chance of meeting its legally binding emissions reduction targets.

An example of this focus and how regulation is driving the need to achieve carbon and energy use reductions is the anticipated requirement under the MEES Regulations that by 2030 all commercial buildings will need to have a minimum Energy Performance Certificate rating of "B". It has also been previously indicated that an interim measure may be introduced to require that all commercial buildings will need to have a minimum Energy Performance Certificate rating of "C" by 2027. While subsequent government announcements have led to uncertainty on whether these target dates will in fact be introduced, the overall direction of travel to Net Zero is clear, meaning that the prudent approach is to act now to reduce carbon emissions and energy use in existing buildings.

Our article of January 2023 discussed the key considerations for landlords and developers on retrofitting properties at that time. In light of the matters outlined above, more than a year on, retrofitting existing properties remains very much in focus and is accounting for a much-increased proportion of activity in the development sector. In this article, we consider the changes and challenges we are seeing in the UK in respect of the delivery of sustainable, and in particular, retrofit developments.

There is no one size that fits all when it comes to retrofitting, and what type of retrofit is feasible will often be led by the existing building and how it can be adapted to perform a renewed role. It is with this in mind that we now see whole life cycle planning policy requirements focusing, among other things, on the adaptability of buildings now being developed, to safeguard retrofitting in the future.

Undertaking effective retrofit developments therefore requires a detailed understanding of the existing building, followed by complex considerations to identify the best solution. The process to consider this has significant cost and time implications, as developers now increasingly sequentially test their retrofit options to arrive at (and justify) development proposals. The feasibility documentation produced can sometimes run into 1000s of pages, being produced over multiple years, as planning departments seek to ensure that they have all of the required information so that they can be seen to be consenting schemes which are identified to be appropriate from a carbon perspective (even in some cases in the absence of planning policies requiring this).

Having navigated the planning system there is then often the need to obtain finance to undertake the retrofit developments, and in an increasingly difficult and competitive economic environment, this can be hard to come by. Lenders are now hyper-focused on the sustainability credentials of developments, as they seek to satisfy their own sustainability requirements, and there is undoubtedly a race to bring forward the best-in class to access funds.

While the Sustainable Finance Disclosures Regulation ("SFDR") is an EU regulation, since investment capital coming into the United Kingdom often comes from the EU, investors are often mindful of the SFDR framework and are therefore looking to assess whether targets are classified as Article 6 (i.e. no ESG focus), Article 8 (i.e. promoting ESG) or Article 9 (i.e. sustainable funds).

A pre-let, as ever, can also be key to obtaining finance, or to the decision being taken to commence a re-development altogether. It is also on this basis that the achievement of sustainable goals through development, and increasingly retrofit developments, will be dictated by demand, the strategies of occupiers and the ability of a landlord to align with those. It is also more frequently the case that the letting agreements will require certain sustainability criteria to be met in the carrying out of construction works and how the building operates once occupied, which can be carbon based or focus on other accreditations, such as high NABERS, BREEAM or other ratings.

Noting the above, we are seeing that due diligence checklists are becoming increasingly focused on matters concerning the energy efficiency and sustainability attributes of buildings.

We are also seeing that retrofitting existing buildings is introducing relatively novel challenges for contractors, the impact of which remain under consideration in the insurance market. For example:

• where retrofit developments re-use existing structures or materials or materials from other sites are recycled, as is increasingly common with developments now following a whole-life cycle carbon approach, it may be difficult to ensure that contractors are willing and able to take on the risk of working with the recycled materials, and that insurers will be comfortable with the proposed use of them and with new construction methodologies (often meaning insurers are likely to request increased levels of information and/or new surveys before being willing to provide insurance at acceptable rates); and
• green initiatives, such as roof gardens, electric vehicle charging points and green walls, may be seen positively from an environmental and energy efficiency perspective, but insuring buildings with those attributes may have an increased cost due to the increased fire risk.

In the race to transition to Net Zero, our expectation is that retrofit developments will continue to increase as a proportion of development activity and be a strategic focus of the sector – particularly given the focus on sustainability in the built environment is now driving the investment agenda and industry activity and is key to attracting the highest purchase prices and rents achievable in the market.

And with this there will continue to be novel issues to consider, as stakeholders seek to further improve on their own credentials and the performance of their assets and portfolios.

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