COMMENT There is no doubt that the future of Scottish real estate will be shaped by increasing commitments towards sustainability and ESG as awareness grows of the impacts of climate change, air quality, biodiversity, waste and the circular economy. In addition, we are seeing the government expanding its expectation on organisations to meet environmental requirements and do their part to build back responsibly.
We have already seen proposals come out for England and Wales from the UK government in its 2021 Net Zero Strategy for offices across the UK to meet the minimum standards required of a grade B Energy Performance Certificate by 2030. While this doesn’t apply to Scotland, it could inevitably have a knock-on effect for the Scottish office market as EPC ratings move up the scale in terms of importance for occupiers and investors.
Survival of the most sustainable
Arguably, offices are ahead of other real estate sectors in terms of improving energy performance, predominantly due to the fact that obsolescence is not a new thing and has been factored in by many of the institutional landlords who own large proportions of the office stock across Scotland and have their own ESG strategies. In order to ensure their assets are future-proof and continue to remain lettable, many will have factored in the costs of financing and undertaking larger-scale improvements. For this reason, there will be a proportion of stock that has been refurbished or redeveloped over the last 20 years, meaning that it has largely kept pace with changing regulatory requirements.
However, there is still a substantial percentage of offices in Edinburgh, Glasgow and Aberdeen that require significant improvements where landlords are unable to raise rents to cover the upfront costs of improvements. As a result, it is inevitable that there will be a rebalancing of stock in the Scottish office market that will see a proportion of the buildings that fall within the lower EPC rating potentially going to other uses.
We have already witnessed a flight to quality from office occupiers in Scotland this year which have been drawn to those spaces offering a best-in-class specification. This has generated an acute current shortage of prime office accommodation and the development pipeline is not substantial enough to address this. The knock-on impact of this upward pressure on pricing for quality stock, which is a trend that will become even more evident as the distinction between prime and grade-A offices that are more sustainability conscious and what is essentially ‘the rest’, becomes even more apparent.
While this has raised questions of a ‘green premium’, the reality is that it will be those offices that offer the most value in terms of quality, facilities and sustainability that will reap benefits in terms of higher occupancy rates as tenants look for the best performing space, particularly in terms of lower energy bills, reputational benefits and lower costs in having to off-set any residual carbon emissions.
Flight to quality still has wings
Given that the transactional market is generally dictated by what is happening in the occupier sector, we will also inevitably see this flight to quality filter through to the investment market in Scotland. Buyers are already looking for buildings that offer the full package in terms of perceived rental growth, location, quality, sustainability, future-proofing and value-add and they are paying prices that reflect this.
Furthermore, as we have mentioned previously, investors across the board have their own ESG strategies that will impact the category of office that fits their buying criteria and it will ultimately be those at the upper end of the spectrum that preserve and increase value.
Nick Penny is head of Savills Scotland
