Nearly 40% of Dutch CO2 emissions come from the built environment.
Companies are more aware than ever of the role that real estate can play in reducing their CO2 emissions, and with good reason. Sustainable offices also foster employee satisfaction and wellbeing, for instance. Moreover, legal obligations, such as SFDR, are forcing companies to think about sustainability.
This has resulted in a rise in the demand for high-quality sustainable offices. The demand for offices in the Netherlands with at least an energy label A has doubled in the past 10 years from 24% in 2011 to 53% at present, according to an analysis by Savills. This share rose even more rapidly for the five major cities in the Netherlands.
This is a positive development but more needs to be done. The actual energy consumption of offices will have to be reduced further to comply with the Paris Proof agreements. At present, one square metre of office space consumes approximately 115 kWh, while by 2050 this may be no more than 50 kWh/sq. m.
Background to Paris Proof
The Paris Climate Agreement adopted in December 2015 prompted the Dutch Green Building Council (DGBC) to draw up a Delta Plan for Sustainable Renovation. The objective of the Delta Plan for Sustainable Renovation is to make the built environment Paris Proof by 2050. This means that buildings must be extensively energy efficient and that the energy still needed by buildings then will be generated entirely from sustainable sources.
The demand for sustainable offices is rising, but the availability is failing to keep pace. Currently more than 11% of the office stock in the Netherlands does not meet the legislation criteria that will apply from 1 January 2023, while over 32% has no energy label at all yet. It is unlikely that the efforts needed to narrow the gap can be made before 2023, while an increasing number of companies will need sustainable offices. This means that shortages are a lurking danger, particularly in the five main cities where demand is highest. What impact will this have on the future supply-demand balance in the five main cities and can we draw a conclusion from this on the price development of sustainable and less sustainable offices?
Being more sustainably aware manifests itself in the demand for improved energy labels
ESG criteria (environmental, social, governance) are becoming increasingly important in real estate. Businesses are purposely reducing their environmental footprint and housing increasingly constitutes a part of this, in terms of location, accessibility and also layout, for instance. This is conveyed, for example, in a preference for an office with an energy label A.
There are however differences between types of companies and cities. The Randstad conurbation, for example, has many start-ups, scale-ups, and national and international companies that are more focused on sustainability than the SMEs located in the medium-sized cities outside the Randstad region. It therefore goes without saying that the largest take-up of sustainable offices can be seen in the largest cities such as Amsterdam, Rotterdam, and Utrecht.
The Hague and Eindhoven are the two cities of the main five that are relatively lagging behind. This not only applies to the take-up of sustainable offices, but also to the office stock itself.
Challenge to improve sustainability will lead to shortage
Approximately 1.8 sq. million. (11%) of office stock in the five main cities currently does not comply with the rules that will apply in 2023. Furthermore, more than 3.5 million sq. m. (21%) of the stock does not yet have an energy label. This means that the main cities face a considerable challenge to improve sustainability.
This raises the question of whether this challenge can be met given the current pace of sustainability.
Research by Kadaster shows that the speed at which these sustainability upgrades can be completed is not in line with the objectives of the central government. In the period from 2018 to 2020, the number of non-sustainable offices declined by just 12%.
As 1st January 2023 approaches, owners will be forced to act, which is why it is expected that the pace of upgrades will be higher than the depicted 12%. An additional incentive is that owners can benefit from a green premium until 2023. This premium can be included in the special provisions of the contract as Green Lease provisions, allowing tenants and landlords to make agreements about the steps needed to make their offices compliant with the energy label C requirement on time. After 2023 the responsibility will effectively lie with the owner so that the incentive for the tenant essentially ceases to exist.
Improving sustainability is expected to be a relatively slow process due to labour market shortages in the construction sector and also a shortage of raw materials. Moreover, companies will facilitate working from home more, and if investors are short of cash or have to contend with vacancies, there will be no slackening in the pace of increasing the sustainability of an office.
Roughly speaking, we expect the pace of sustainability to be between 10% and 30%. Even in the most optimistic scenario, i.e. assuming an immediate higher pace of improving sustainability of the existing stock, more offices are at risk of falling out of favour in 2023 than will be built in the same period.
In the optimistic improving sustainability scenario, which considers the already planned new construction, withdrawals, drop-outs due to the challenge to improve sustainability and the estimated relatively stable demand, it appears that in 2023 about 1.3 million sq. m. of the stock may no longer be let due to stricter legislation. This will result in a tighter market, which means that vacancy rates may well decline rather than increase. Based on this scenario, the vacancy rate may drop to 6.9% in 2023, as there is more demand than availability of offices with a sustainable energy label.
The outlined expected development pertains to all the five main cities. However, differences are to be expected between Amsterdam, Utrecht, and The Hague on the one hand and Eindhoven and Rotterdam on the other.
Amsterdam, Utrecht, and The Hague are expected to face the greatest shortage. This shortage will arise because there is already a relatively high vacancy rate of offices with an energy label D or worse (Amsterdam 14%, The Hague 18%, Utrecht 9%).
Eindhoven and Rotterdam have relatively few vacant offices with an energy label D or worse (Rotterdam 9%, Eindhoven 8%). As a result, vacancy rates in cities are increasing, albeit very slightly.
These expectations are largely driven by the regulations that will apply from 2023. It is vital that sustainability upgrades do not grind to a halt in 2023, but that this is the starting point.
Players in the challenge to improve sustainability
The Dutch government is already anticipating that offices will become more sustainable as offices must have at least an energy label A by 2030. Investors and banks are thus increasingly being forced to be prepared for this because non-sustainable offices are becoming increasingly difficult to lease and therefore difficult to finance. This is mainly due to increasingly strict government legislation and regulations, but of course also due to the wishes of companies.
How will this affect the price that tenants are prepared to pay in the future for sustainable but also less sustainable office buildings? And what will this mean for investors?
Non-sustainable offices are at risk of becoming stranded assets
To answer this question an analysis was made of more than 12,000 occupier transactions in the Netherlands from 2011 to 2021YTD. Although past performance is no guarantee for future results, this analysis gives a clear picture of the situation.
The analysis shows that over the past ten years companies in the Netherlands have been increasingly willing to pay for a sustainable office (at least energy label A) and less so for a non-sustainable office (energy label B or worse). The rental price that tenants are prepared to pay is an important element of how much an office is worth. After all, it is likely that the value of sustainable offices will increase and that of non-sustainable offices will decrease. There is a logical explanation for this: tenants are generally less willing to pay for offices that are or are at risk of becoming economically obsolete. It is therefore essential for investors to look ahead and, above all, to take action to make their offices future-proof. In addition to the increasingly stringent regulations, there are also other reasons why the outlined price trend will continue in the coming years.
Five reasons why the outlined price trend will continue in the coming years
- Energy efficient modifications to an office will result in lower operating costs, lower absence due to illness and higher productivity and can therefore command an important premium in rental income.
- The benefits of operating sustainable offices is good for the brand awareness of the company or investor. That is because in the near future all stakeholders in office real estate will come from environmentally conscious generations. Millennials will make up 75% of the global workforce by 2025, for instance.
- ESG due diligence has clearly become a trend in the past year, with an increasing number of investors balancing not only market or economic risks, but also considering climate or social risks.
- Companies have experienced the benefits of sustainable offices and are demanding that sustainability provisions be included in lease agreements (green leases), while owners of obsolete offices will give ‘brown discounts’ in a dubious attempt to bind companies.
- The ‘green bonds’ market has grown exponentially, among financial institutions as well as governments that fund environmentally friendly projects in office real estate.
Companies are increasingly willing to pay for a sustainable office and less so for non-sustainable offices. This means that the value of non-sustainable offices is under pressure and investors will therefore have to be prepared for increasingly stringent sustainability requirements if they want to prevent the depreciation of non-sustainable offices.
Step-by-step plan for investors to make offices more sustainable
The sustainability criteria for companies, public authorities, banks, and investors of office property will become increasingly stringent.
Offices that no longer meet the stricter sustainability criteria will be more difficult to let. If investors do not make offices more sustainable, there will be a danger of depreciation of their asset value. An important component of value development is, after all, what companies are prepared to pay for an office.
The past decade has shown that companies are increasingly less willing to pay for non-sustainable offices. It is expected that this difference will increase at an accelerated pace in the coming years as companies, banks and public authorities impose ever more stringent sustainability criteria. Sustainable offices are therefore no longer a trend but the norm. The Dutch government is thus providing incentive to force investors to make their offices more sustainable. Investors may perhaps have the most important role to play in making Dutch offices more sustainable and Paris Proof.
Demand for label A offices
The share of energy label A in the demand for office space in the Netherlands more than doubled between 2011 (24%) and 2021YTD (53%). The demand is primarily concentrated in Amsterdam, Rotterdam, and Utrecht. This demand will continue unabated in the coming period.
New government rules
The demand for sustainable offices will increase in the coming years, partly as a result of increasingly stringent government sustainability criteria. As of 1 January 2023, it will be prohibited by law to occupy an office building with an energy label D or worse. In 2030 this will be stepped up to energy label A.
The office market in the main cities faces a considerable need for sustainability upgrades as 1.8 million sq. m. of office space currently does not comply with the requirements that will take effect in 2023. Even the most optimistic scenario for sustainability upgrades, in which the speed at which these upgrades are performed is almost three times as high as in recent years, shows that 1.3 million sq. m. will become unlettable in 2023 as a result of more stringent legislation.
More willingness from tenants
Over the past ten years, companies in the Netherlands have been increasingly willing to pay for a sustainable office (at least energy label A) and less so for a non-sustainable office (energy label B or worse). This difference in willingness will polarise further in the coming period due to stricter sustainability criteria of the Dutch government.
In the coming period it is likely that the value of sustainable offices will increase and that of non-sustainable offices will decrease.
Sources Brainbay Database, BAG, Vastgoedmarkt, RVO, CBS, DGBC, Kadaster, IPCC
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