There is a clear opportunity for investment in green retrofits in Europe, supported by both the legislative and corporate environment.

A retrofit of Deutsche Bank’s Frankfurt
headquarters enabled the group to cut its
energy supply by half, water consumption
by over 70 percent, and carbon dioxide
emissions by almost 90 percent.

The market for commercial green retrofit projects in Europe is growing, propelled by climate change regulations, as well as investor and tenant demand and corporate social responsibility. In parallel, the program of grants and incentives aimed at facilitating this work is evolving. But the market has yet to cultivate a viable financing model that will provide acceleration for the sector. The recession also has instigated a lower tolerance for risk and forced some landlords to reevaluate their plans for capital expenditures.

Investment of €102 billion ($144 billion) is required between now and 2020 if the European Union is to meet its carbon reduction target, according to a calculation by Barclays and Accenture, a global management consulting, technology services, and outsourcing company.

The latest iteration of the European Performance of Buildings Directive, which took effect in June, specifies that all renovations of commercial buildings meet minimum national government standards for energy performance. The continuing evolution of Part L of the U.K. building regulations is also forcing the real estate market to embed energy efficiency in its activities, as is the Carbon Reduction Commitment (CRC) Energy Efficiency Scheme, which effectively is a 10 percent carbon tax on electricity consumption, designed to capture those industries outside the E.U. cap and trade scheme. The respective 2020 and 2050 emission reduction targets of the E.U. and U.K. parliaments are driving this focus.

Worth £10 billion ($16 billion) per year in the U.K. alone, according to project development and construction group Skanska, the environmental upgrades for buildings are likely to face no shortage of capital because of interest on the part of major international investors with a long-term view, such as large pension funds.

“There are people out there with money to invest, and there are people out there with money willing to lend. The trick is to configure that with the right projects in the right way so the capital can reach those projects,” says Chris Jofeh, a director at Arup, the engineering firm that delivered the large-scale retrofit of Unilever House on London’s Embankment in 2007. The company has recently teamed with Skanska and GE to tackle the retrofit of U.K. commercial building stock.

Nick Gibbins, a Jones Lang LaSalle Upstream sustainability consultant, believes retrofits are an item on everyone’s radar. “Putting green to one side, landlords are used to undertaking improvements on buildings within their portfolios on a periodic basis. These investments frequently include upgrades to mechanical and electrical plant and buildings’ fabric, all of which have a bearing on the environmental performance of a building and its running costs,” he says.

Green retrofits involve going a step further in terms of improving a property’s performance at a time when investment may already be required, depending on where the asset is in its life cycle. Such initiatives include the improvement of lighting, as well as insulation of walls and windows, in conjunction with a better building management system and the installation of enhanced heating and cooling equipment.

Landlords must ask, “Is the property at the point of a major refurbishment? Has the facade failed, and does the glazing need replacing, regardless?” says Gibbins. From there, investment decisions can incorporate considerations of sustainability and performance at a time when improvements are being expensed, not as a separate exercise.

There are always degrees to which investors are willing to take retrofits beyond what would be needed to comply with government standards, however. “It comes down to the relationship between the length of the existing tenancy and ownership arrangements, which together with the rental income will determine how much the building’s owner is willing to lay out for improvements,” he says.

At the same time, the landlord must make a judgment about whether it wants to appeal to the likes of a blue-chip occupier—often a firm that says it is only prepared to take a high-quality space—by making investments over and above what it typically would have made on a building.

Deutsche Bank is one such owner/occupier committed to energy efficiency. A retrofit of its Frankfurt headquarters, which reopened this year, has enabled the group to cut its energy supply by half, water consumption by over 70 percent, and carbon dioxide emissions by almost 90 percent. With the “green value” of real estate becoming more important, Holger Hagge, Deutsche Bank’s global head of workplace and building development, believes investments in efficiency will pay off. “In the future, the sustainable buildings will become the asset category with highest marketability,” he says.

Yet, as ever, some areas of the market are experiencing weak demand, and investors are simply looking to get properties back on the market. Therefore, they may not be interested in doing as much as possible in engineering terms to improve the building. “The cost equation is always something that is going to have to be thought through carefully and central to any refurbishment project,” Gibbins acknowledges.

Asset selection also plays an important role because some properties do not lend themselves to being upgraded. “There has to be some sort of evaluation process from a financial perspective, ultimately driven by how much a landlord could gain from a future tenancy,” Gibbins says. “Some classes of nonprime building warrant the discussion of whether or not it is justifiable to demolish it and start again.”

Large investment funds are better positioned to tap internal resources to finance retrofits, whereas other companies need to obtain loans, grants, or low-interest loans. All landlords are focused on overhead now more than ever, and it is those that can weave together lower operating costs with green refurbishments that will come out on top.

With capital investment programs scaled back, particularly in the public sector, and spending also being scrutinized on the corporate side, increased emphasis is being placed on getting the basics of green retrofits right. This may rule out use of some innovative technologies that cost more than less-complex approaches. However, “there’s no need to chase shiny new solutions such as building-mounted renewable energy, when actually there are simple things you can do to an existing building to improve performance,” asserts Gibbins.

A further challenge can be to know when an investor is spending just the right amount of capital on a project rather than throwing money at it unnecessarily. “To get the best balance, it’s crucial to remember that in the end it’s about people and business just as much as it’s about energy,” says Jofeh. “Green means reducing energy and water consumption, reducing generation of waste and CO2 emissions. But equally important, it means making it a better, healthier, and more pro­ductive place for the people that work there.”

Although each European country takes its own approach to funding retrofits, they are all working toward the same goal.

“Germany has got a fairly forward-thinking approach: it’s a mainly grant-driven system,” Jofeh says. Both Germany and Spain have long operated feed-in tariffs—schemes designed to encourage the adoption of renewable energy sources. The feed-in tariff schemes guarantee structured payments over a defined period—15 or 20 years—based on the size of installed capacity of a renewable generating plant, and also on the amount of green energy that can be sold back to the electricity grid. Payment rates vary, but they are designed to incentivize investment in renewables. The scheme transformed Germany’s embryonic solar industry, making it a world leader. Now that the country’s domestic emission reduction targets are close to being met, the scheme’s effectiveness has been substantially reduced.

In the U.K., the government in the next year or two is implementing the Green Deal initiative. Under the Green Deal, which is designed as a “pay as you save” scheme, the capital cost of the refurbishment is offset by cost savings realized through the energy efficiency retrofits. “That’s a mechanism by which the government thinks landlords can bring forward improvements in performance through building retrofits,” Jofeh says. “The golden rule is that the savings will equal or exceed the cost of capital for the improvements.”

The large-scale retrofit of Unilever
House on London’s Embankment
by Arup in 2007.

Other nascent models, based on financing strategies in the United States, are also being implemented. The London Development Agency’s RE:FIT scheme is based on performance contracting: a property owner enters an agreement with an energy services company that guarantees energy savings on the building through implementing energy efficiency retrofits. If the services company does not deliver those savings, it agrees to return to the landlord the difference between what it promised and the actual savings, thereby largely insuring investors against the risk that the energy saving will not be realized.

This approach can be problematic in the commercial building stock it is applied to, however, because there is a danger that the asset could be perceived as less tradable given the energy or refurbishment financing attached to it.

Also in the U.K., vehicles such as the Bridges Ventures Property Fund, Climate Change Capital Property Fund, the Igloo Regeneration Fund, and, most recently, the Threadneedle Low Carbon Workplace Trust have been launched to invest in the upgrade of existing buildings.

There is a clear opportunity for investment in green retrofits in Europe, supported by both the legislative and corporate environment. Regulation, incentives, and reputation are driving governments, utility companies, and large investors in this arena, with various schemes in the pipeline aimed at injecting more capital into the undertaking.

Yet the retrofit sector is not one that evolves quickly, notwithstanding the fact it has had to contend with the recession. The financing model that will ignite the market is still in the making.