Refurbishment and the circular economy
The real estate sector seems to have undergone a genuine reflection of its contribution to carbonisation (the built environment accounts for 39% of global emissions) and now has a very real appreciation of the role the sector can play in the UK reaching its climate change commitments. With both current and potential future governments making clear that their respective future economic policy objectives have the environment and sustainability at the heart of their policy making, the ESG agenda is now firmly baked into most new UK developments that are being planned and undertaken.
However, a new emphasis is beginning to coalesce around what part existing buildings can contribute to the decarbonisation and sustainability of the real estate industry, and how retrofitting and refurbishment can contribute to decarbonisation. In 2020 refurbishments accounted for 70% of office real estate construction versus 30% new builds in Central London, rising to 75% refurbishment in the City of London versus 25% new build. More recently, it is reported that in May 2023 London has seen the highest number of office refurbishment starts in nearly 20 years.
The Urban Land Institute’s “C Change Initiative” is just one of a number of recent proposals by leading real estate industry bodies to seriously assess what the real estate sector can be doing to “greatly accelerate the path to decarbonisation, through identifying challenges and issues and developing practical solutions to assist the pace of progress”. The paper goes so far as to purport that “the broader goal of decarbonisation must be seen to far outweigh shorter term value protection”. It provides a stark warning that investors need to be alive to real estate’s role in the lowering of carbon emissions and highlights the importance of retrofitting to achieving EU emissions targets, given the prevalence of old stock across Europe.
By way of encouragement to onboard investors, the paper suggests that on a like-for-like basis, assets that are retrofitted to be close to net zero will have lower risk attributes and goes on to identify a number of benefits to net income including greater occupational efficiency (particularly lower energy costs) which in turn supports rental affordability and reduces non-payment and associated property management costs. The paper also suggests that such retrofitted assets might enjoy lower voids due to reduced marketing periods and speed of lease-up, an increased likelihood of lease renewal and improved tenant quality. The paper also notes the benefit that such retrofitted assets are future proofed with lower depreciation risks from the anticipated threat of future regulation, carbon tax, and future financing risks. In summary, the paper suggests that some short-term pain of funding refurbishment of assets could lead to long-term gain in terms of asset values.
The UK Green Building Council (UKGBC) has recently launched its “System Enablers for a Circular Economy” which aims to provide the real estate industry with a toolkit that looks at the barriers to a circular economy and what can be done to overcome them. Its view is that the economy is currently “linear” with a heavy focus on extraction and growth and is therefore “wasteful”. Instead, if we are to acknowledge that resources and labour are not infinite then we need to move to a circular, regenerative economy which balances the consumption of resources with our ability to regenerate those resources. The suggestion is that we move away from measuring the health of our economy in terms of GDP growth and look towards other matrices of what a healthy economy looks like, which might include environmental and social strategies as objectives and avoiding purely economic targets.
One of the eight industry “enablers” identified by the UKGBC as a strategy to move towards a circular, regenerative economy is the use of green contracts and leases in real estate. The report recognises that interests of owners and occupiers are not always aligned. For example, a building might be designed in accordance with circular economy principles but then the occupier might completely disregard such principles when they carry out their fit-out works. It also recognises that the nature of real estate ownership and occupancy is often short term and that these stakeholders do not often have a vested interest in the end of life of a building and what happens to its fit-out.
The UKGBC’s proposal to overcome these types of barriers is to use green contracts and leases to ensure that the developer’s aspirations in building or refurbishing the building are extended to the leaseholder. The suggestion is that by obligating both parties to co-operate on environmental issues and sustainability at the building, by holding parties accountable to an agreed set of sustainability clauses, and most importantly, by normalising such contracts in the marketplace, this will raise the bar for the industry and make it easier for the sector as a whole to refuse to engage in unsustainable practices.
In terms of practical examples of what green leases and contracts should include, the report suggests that these might include clauses on fit-out, waste avoidance, restrictions on material selection, responsibilities for deconstruction at the end of the lease and obligations on the tenant to notify the Facilities Manager of any changes to be made to the premises during the term so that any unwanted materials can be reused. The report also calls for developers and owners to work together to develop alternatives to CAT A fitout wherever possible, for occupiers to move away from the expectation of full autonomy on fitouts, and at the end of a tenancy for there to be a collaboration between the landlord and old and new tenants to see what of the previous tenant’s fitout can be re-purposed. For those looking for guidance on best practice for incorporating green lease and contract clauses, the Chancery Lane Project has already put substantial time into developing contracts that are integrated into sustainability objectives, and these are freely and publicly available on its website. These include clauses that deal with “Circular Economy principles in leasing arrangements for repairs and alterations” and “climate aligned construction waste management”. We have previously written on Green Leases and how the ambition might be practically delivered.
One of the final recommendations of the UKGBC is that the Government should use the announced review of the Landlord & Tenant Act 1954 to introduce a requirement that all new business leases include green lease clauses, the standard of which would be developed by industry. While this might at first glance seem a controversial proposal, there is already a lot of industry focus on what opportunities for improving the sustainability of the real estate sector might be afforded by the review of current legislation. The British Property Foundation has previously said that it will be “working closely with members and officials to consider whether there are elements of the owner-occupier relationship can also be leveraged to meet wider policy objectives, such as the targets around net zero.” It has also stated, in its February 2023 report “Towards Net Zero”, that it will be exploring how mandating green leases for new commercial leases might be considered as part of the planned review of the Landlord and Tenant Act 1954.
One suggestion is the introduction of a new ground of opposition under section 30(1) of the 1954 Act linked to retrofitting premises. Refurbishment and retrofitting is less carbon intensive than demolition and rebuilding however the landlord currently has to rely on existing ground 30(1)(f) to obtain possession for such refurbishment and is required to show that the landlord cannot reasonably carry out the work with the tenant in possession. The suggestion is that softening that ground or indeed introducing a whole new ground linked to retrofitting to make the premises more sustainable, could be a helpful carrot in incentivising landlords to refurbish their current assets.
It is not just commercial real estate that is increasing its focus on retrofitting and refurbishment as a way of improving the sustainability of its buildings. 38% of the UK’s carbon emissions come from the heating of existing homes and there are big challenges in terms of increased costs and skills shortages to address this. In the social housing sphere, the UK government has taken steps towards addressing this issue, with a £2.2bn social housing decarbonisation scheme, which will retrofit up to 50,000 social homes in England over the next five years. However, there are calls for more to be done to encourage retrofitting nationwide. This will involve both upskilling the real estate workforce in retrofitting, including architects, contractors and renewable heating engineers and coordinated funding which will incentivise retrofitting.
Proposals which may have been seen as revolutionary ten, or even five years ago are now increasingly recognised as being necessary steps for the real estate industry to take and play its part in developing both sustainable buildings and a sustainable economy. Refurbishment is just one part of an increasingly innovative strategy being proposed by industry leaders and investors, developers and occupiers will all have their contribution to make to the overall aim of reducing the sector’s emissions.
