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In today’s ever-changing commercial property sector, developers, landlords and investors need to listen and respond to the needs of their client base or risk being faced with derelict, depreciating real estate behemoths that are more trouble than they’re worth.
Here, Solicitor and property law specialist Bee Gebhardt explores the trends and outlines the actions that property owners and investors could take to ensure a prosperous future.
Since the pandemic, we’ve seen a steady return of urban footfall to city centres — yet the commercial landscape will never be quite as it was. In the face of higher interest rates, persistent inflationary pressures and anaemic GDP growth, landlords and real estate investors can’t afford to stand idle.
The office environment has been an effective gauge of the wider trends affecting commercial property. At the height of the pandemic, thousands of office blocks stood barren and hastily abandoned. We’ve since seen many professionals return to the office, having missed the social and intellectual interaction of the shared workspace. Yet gone are the traditional office-based nine to five working weeks, with flexibility and work/life balance being the top factors for candidates in both recruitment and retention.
The disappearance of bustling offices isn’t necessarily a concern for landlords — many of whom will continue to receive rent from tenants locked into long-term leases — but come those break dates or term expiries office tenants may seriously re-evaluate what they get in return for one of the largest outgoings in their budgets.
It’s difficult for most office spaces to compete with the benefits of homeworking — no commute, more time with family, washing on the go. Commercial office spaces increasingly need to have that ‘wow’ factor that’s worth getting out of bed for — a premium experience that makes employees feel it’s worthwhile being physically in the workplace. While such refurb investment will involve a steep upfront cost for landlords, the long-term benefits in terms of attracting and keeping desirable tenants, demanding higher rents and holding premium real estate will soon be realised.
Rishi Sunak’s apparent decision to scrap plans for more stringent Minimum Energy Efficiency Standards will have been met with a resounding sigh of relief throughout the commercial property sector. Yet with or without the threat of enforcement action, energy efficiency is simply not an area that landlords and property investors can afford to ignore.
Who can forget the energy crisis of late 2022 — persisting into early 2023 — that caused energy prices to skyrocket beyond control. With energy bills doubling or tripling (if not quadrupling), the worst affected were low-income households — many of which could barely afford to switch on the heating in winter — and small businesses, which saw their electricity bills overtake annual rent outgoings. Many enterprises that somehow managed to scrape through the pandemic simply couldn’t deal with the final blow of exorbitant energy prices and were forced to shut for good.
While Russia’s invasion of Ukraine is slated as the key contributor to this latest energy crisis, globally we’re still far too reliant on finite energy sources that continue to cause irreparable damage to the environment. With energy bills linked to geopolitical economics and precarious fuel sources, landlords would be well-advised to protect themselves by improving the energy efficiency of their buildings.
Admittedly, this is far easier said than done — particularly for older buildings. According to a report published by the World Green Building Council in 2019, 39% of greenhouse gas emissions are derived from the built environment. 75% of that carbonisation is locked-in during construction. By the time a commercial building is completed, the capability to improve its energy efficiency is already limited. This is particularly the case for heritage sites — which are subject to restrictions on alterations — and buildings constructed during the 1960s to 1980s, where developers used the cheapest materials and designs available to get structures up as quickly as possible.
There is also the disruption that major energy efficiency works cause to existing occupiers, who may need to be moved around (or even out of) the building as alterations are carried out. However — particularly in the office environment — many employees are now capable of working from home if necessary and landlords may offer reduced rents in return for the inconvenience to tenants. Ultimately, it’s in tenants’ interests to lower their energy outgoings as far as possible. A further incentive will be the Non-Domestic Rating Bill (currently before parliament) which will introduce business rate relief for energy efficiency improvements.
While 'energy efficiency’ has been a buzzword in the commercial property sector for a decade or so, until recently it has only been paid lip-service. Contractors are now being instructed and hard investments made. This means that the energy efficiency construction sector is relatively young, with a consequent lack of experienced contractors. Without regulations in place, who will carry the risk of failing to deliver on energy efficiency savings — the landlord or the contractor? And how can this energy efficiency actually be measured?
The effective formula for measuring a property’s energy efficiency is comparing energy input with energy output. For example, how much energy does it take to heat a building? Just as importantly, how long does that building stay heated?
EPCs assist to some extent, yet research by CarbonLaces suggests that their mechanisms can overestimate energy usage for older properties and underestimate for newer builds, sometimes to drastic extents. Standard smart energy meters can also help, albeit their effectiveness is often limited to measuring the amount of energy that various appliances or activities use, as well as the cost of that energy.
Investment by landlords in modern technologies will become key as increasingly sophisticated solutions enter the market. By way of example, the heat pump — the first prototype of which was invented by Austrian scientist Peter von Rittinger in 1856 — continues to see extraordinarily low uptake in the UK despite its considerable energy efficiency capabilities. Modern heat pump systems work by extracting heat from the air from outside of a building and converting it into warm water, which is then used as a heating system.
According to MIT Technology Review, heat pumps can deliver 300 to 400% energy efficiency — meaning that they output three to four times more energy than the required input. The prohibitive upfront cost of heat pumps — which ranges from £6,000 to 18,000 — in addition to the increased time it takes for them to heat a property, have no doubt been the main hurdles to their widespread uptake. However, this will no doubt reduce as the technology advances and is offset by vastly reduced energy costs.
Solar panels are another example of a relatively well-established energy-saving measure that hasn’t been fully embraced by the commercial property sector. Similarly, this is likely to be due to their higher upfront cost and the length of time it takes for the return of investment to be realised. Yet the maths is improving and despite the relative lack of sunshine in the UK compared to parts of mainland Europe, solar panels can achieve energy savings of 15 to 25%, with the added potential for exporting excess energy.
Digital and software solutions are also shaking up the market. Oak Ridge National Laboratory in the US has developed wireless sensors that measure, analyse and control various elements such as room temperature, lighting and humidity. They can ‘sense’ when a room is unoccupied and make appropriate adjustments as necessary, reducing any outputs that aren’t required.
Ultimately, while the upfront installation costs of such technologies might be expensive, their longer-term benefits will no doubt pay dividends to the patient property investor.
As many of the more lucrative corporate occupiers seek to downsize in favour of aesthetic upscaling, inevitably those office spaces that cannot compete on value, visual appeal or green credentials will flounder.
Looking upwards at many heritage office spaces in the UK’s cities, you’ll often see piled-up desks, chairs and forgotten papers. Much of our abandoned real estate is nestled in prime city centre locations with fantastic amenities and high footfall. Tenants that have abandoned commercial spaces which are no longer fit for purpose won’t return. It’s up to pragmatic landlords to think about remodelling their properties to meet demand.
Property advisor JLL’s 2023 Big Six Residential Development Report revealed that the demand for city centre accommodation across the UK’s largest metropolises continues to rise sharply. Yet this demand isn’t being met by supply, leading to disproportionately high rents in cities like Manchester and Edinburgh. This presents an open goal for landlords sitting on empty commercial properties who are willing to make an upfront investment with guaranteed long-term returns.
Residential occupiers have historically been pushed ever further away from city centres due to the rising cost of (and high demand for) central real estate. Yet with so many commercial properties standing idle, it may be time for commercial landlords to consider a foray into residential. Of course, such a move would come with its own challenges — not least compliance with the recently enacted Building Safety Act — yet this may be a preferable alternative to finding a consistent supply of desirable commercial tenants.
One opportunity could be the retiree market, whose numbers are projected to increase by 29% before 2050, according to Knight Frank’s UK Healthcare Market Overview 2023. While there is a growing desire among retirees to locate within city centres for better access to shops, restaurants and entertainment, just 15% of the stock required to meet the needs of the later living residential market is currently being met in the UK — a clear case of supply being dwarfed by demand.
Another sector shaking the real estate tree is the growing emergence of ‘barber bars’, which — alongside their primary service — also offer an integrated space where clients can enjoy a drink before, during or well after their grooming session. These savvy barbers have found a way to simultaneously boost their income and keep customers happy. Such initiatives do hinge upon obtaining planning permissions as well as complying with the terms of the lease or superior lease in question — but where all parties are willing, these obstacles can almost always be surmounted.
Buildings that may be well used during the daylight hours need not stand empty at night. Get It Loud in Libraries, is one example of a unique community interest initiative that since 2005 has optimised the use of library buildings during closing hours to host live music events. While this is a non-profit venture, there is potential for commercial landlords to adopt a similar model and realise a considerable additional income stream in metropolitan areas.
Further options include granting short-term licences to ‘pop-up’ providers — which can range from smoothie stalls to Christmas grottos — or providing storage space for parcel deliveries. Here, landlords can realise decent returns for short periods of occupation at relatively low risk (assuming that the appropriate insurance is in place).
Also to be considered is the growing market for electric and hybrid vehicles and the associated demand for electric charging points. If landlords can reduce their energy outputs at the same time as developing wider income streams, the maths speaks for itself.
Sophisticated landlords are increasingly insistent on ‘green’ clauses within their lease precedents. Such provisions may place a range of obligations on the tenant, such as cooperating with the landlord to obtain an EPC, sharing data relating to energy efficiency or attending ‘environmental forums’ alongside the landlord and other occupational tenants.
These obligations can vary from ‘light green’ — soft-touch incentives, such as a tenant’s environmental improvements being disregarded on rent review — to ‘dark green’, where a tenant may be contractually prohibited from carrying out any alterations or using equipment that may worsen a property’s environmental performance. The latter can be especially problematic for manufacturing tenants that may need to install more advanced plant and machinery for their operations, which will achieve higher yields at a greater energy cost.
Tenants have generally been resistant to such green lease provisions — perhaps wary of veiled attempts by landlords to improve their property’s energy efficiency at the tenant’s expense. Yet ultimately energy-efficient properties may benefit tenants in the form of reduced energy outgoings, improved sustainability and better employee retention.
Energy efficiency is a long-term trend that will become increasingly regulated — notwithstanding the government’s recent backwards step in this regard. It’s in the best interest of landlords and tenants to collaborate and cooperate to achieve an outcome that suits all parties.
Not every landlord will have the deep pockets or risk appetite to make significant investments in reinvigorating their property portfolios. There is also the irony that renovations designed to improve sustainability will inevitably generate an embedded carbon footprint. Yet there is no faster way to depreciate the value of a property than letting it stand idle — whether due to dilapidation, adverse possession or vandalism.
There are options and opportunities for landlords of all budgets to maximise their portfolios.
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