Building a greener tomorrow: strategies for decarbonising the built environment in the UK

With approximately 40 per cent of carbon emissions arising from the built environment, countries across the world are coming together in a global push to accelerate change in the sector. The “Buildings Breakthrough” initiative was launched during COP28 in December 2023. Supported by 28 countries, including the UK, it aims to make near-zero emissions and resilient buildings the new normal by 2030. The initiative has led to the first Buildings and Climate Global Forum which will take place in Paris in March 2024 (the Forum). Ministers in charge of decarbonisation, as well as key figures in the buildings sector (including local authorities, NGOs and businesses), will attend.

We expect a key theme at the Forum to be how to accelerate collective action for building decarbonisation and resilience, as well as the role of financing in this area.

There is likely to be a range of perspectives at the Forum on what this collective action should involve, as well as different approaches towards achieving the end goal of building decarbonisation. The UK’s focus is likely to be on energy efficiency and retrofitting (the process of decarbonising existing buildings through energy efficiency improvements and renewable energy use). This reflects a growing trend in the UK for retrofitting fuelled by regulatory pressure, industry sentiment and market demand. We discussed the growing need for buildings to become “re-usable” in our September blog. Considerations for the UK commercial real estate market include:

• MEES: An immediate driver for retrofitting buildings in England and Wales is the need to comply with the Minimum Energy Efficiency Standards (MEES) designed to incentivise landlords to make energy improvements to sub-standard properties. The MEES regulations currently require commercial properties to have an EPC rating of E or higher before landlords are able to grant a new lease or continue to let a property (unless an exemption applies). This is set to get stricter – the government’s original proposal was that commercial properties would need to meet a C-rating from 2027 and a B-rating from 2030.  However, political influences have left the property sector awaiting clarity on the new regulatory targets. This has resulted in uncertainty surrounding the original timeline (although sponsors will be familiar with real estate lenders assuming the worst and requiring improvements to EPCs in line with the originally proposed timeline) and it will be interesting to see whether the Forum adds pressure on the UK government to clarify its position.
• Sustainability reporting: Following the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD), certain UK entities in scope (eg UK registered companies which have more than 500 employees and a turnover of more than £500m) must now make annual TCFD-aligned climate related disclosures. Mandatory disclosure requirements are set to increase further to prevent greenwashing and to help direct capital towards sustainable investment. For example, the UK government is expected to publish UK Sustainability Disclosure Standards (SDS) in July 2024, which will aim to decrease greenwashing and to unify UK sustainability reporting. These disclosure obligations will place increased pressure on companies to disclose how they are managing climate-related risks and opportunities, such as those relating to building decarbonisation.
• Green and sustainability-linked financing: “Private Finance supporting the net zero transition for buildings” is on the agenda of the Forum and is likely to intensify pressure on lenders to incentivise sponsors and borrowers. The two principal opportunities for sponsors are: 

(1) sustainability-linked loans where borrowers benefit from margin reductions contingent on satisfying ESG targets and/or improvements in environmental performance (eg BREEAM refurbishment and fit out ratings of “excellent” or “outstanding”) that are commonly already aligned to investor requirements; and 

(2) green loans (in which proceeds must be used for a green project), where borrowers may benefit from pricing incentives from day one if they commit to using capex proceeds for the purpose of retrofitting existing buildings.

• Industry sentiment: Industry bodies, such as the UK Green Building Council and the British Property Federation (BPF), are advocating for retrofitting over demolition and rebuilding as a way to minimise embodied carbon (carbon associated with the production of building materials), emissions associated with the construction of buildings, and energy consumption in building use through low cost and low disruption measures. The BPF has called for planning and tax reforms to encourage large scale retrofit projects. On the financing side, the LMA has already published general industry principles on green and sustainability-linked loans, and CREFC Europe has an existing ESG working group to support the sustainability agenda from the commercial real estate lending perspective. The Forum may generate additional specific guidance from these bodies and others so that market participants can more easily demonstrate compliance with the energy efficiency and retrofitting goals that result from the Forum (and so that they can benefit from more attractive financing pricing where they do).
• Market demand: Knight Frank recently found that “green” offices in central London can achieve a rental premium of up to 12.3% and we expect to see the UK’s transition towards net-zero increasingly reflected in pricing. The greenest buildings are also by far the most in demand. Tenants no longer want to rent buildings with poor energy efficiency or, if they do, they expect to pay a discounted price. This is no doubt fuelling the demand for retrofits, with the City of London Corporation approving 17 major retrofit planning applications last year.

Closing thoughts

The road to retrofitting is not linear and there will likely be discussions at the Forum as to whether this is the correct approach for all. Understandably, property owners are limited by various factors such as lease provisions, environmental, planning and title constraints. These will need to be checked carefully before retrofit projects are undertaken.

The Forum is the latest development to spotlight ESG in real estate, including the need to decarbonise building stocks. It will be interesting to see how it feeds into sentiment across the UK market regarding energy efficiency and retrofitting. Certainly the UK real estate market’s transition towards net zero will accelerate in 2024. Watch this space!