The Celtic Tiger Office Glut Takes A Bite Out of Ireland’s Sustainability Ambitions

Before the recent push to add space to house Dublin’s tech giants and pharma pioneers, there was a previous office development gold rush, one that built the fortunes of many developers in the city. But a quarter of a century on, it is becoming a major headache for the current owners of Irish offices.

Much of Dublin’s stock built during the Celtic Tiger boom of the late 1990s and early 2000s is not up to modern standards, and will need an expensive makeover if it is not to see huge falls in value.

The big question facing Dublin’s landlords is how to turn the city’s older grey space green. Because a raft of new regulations, coupled with the needs of tenants in an increasingly tough market for office owners, will give landlords and developers little option but to upgrade their stock or be left with stranded assets on their hands.

"There is an ever-widening gap between older, less energy-efficient buildings versus new space in terms of tenant preferences as companies opt for the most sustainable buildings to reduce costs, carbon emissions and align with ESG targets," HWBC Director Paul Scannell said.

The problem is that much of Dublin’s legacy office sector stock may fall into that category, meaning landlords and tenants will need to be collaborative and creative about finding solutions.

A look back in time shows that landlords are facing a reckoning from the Celtic Tiger boom that saw Ireland's economy advance rapidly from the mid-1990s onward.

From the mid-1970s to the mid-1990s, Dublin office development completion figures were fairly consistent, at around 600K SF a year, data from Lisney in a 2008 research paper showed.

That jumped to almost 2M SF in 1999, as developers rushed to build to house companies expanding rapidly, and peaked at almost 3.5M SF in 2001. In the debt fuelled run-up of the early 2000s, 2007 saw almost 2.5M SF completed.

Those offices are now being vacated and aren't seen as fit for purpose by tenants who want the highest ESG standards in the buildings they lease. 

"Changing occupier demands regarding how the office is best utilised will continue to heighten the appeal of the best-quality buildings, namely those with top ESG credentials in core locations," Savills Ireland Director Andrew Cunningham said.

"As older stock becomes vacant due to poor energy performance metrics, there may be opportunities for owners. This has brought forward the discussion on retrofit versus demolition with councils likely to encourage the retention of existing structures where possible and sensible."

As well as tenant requirements, regulation will force the hand of owners too. Among a raft of new regulations affecting the energy-efficiency of commercial buildings in Ireland set to be introduced, the most pertinent is that all nonresidential buildings must have an E rating for energy-efficiency by 2027 and D rating by 2030. All public and commercial buildings need a minimum performance of E or better by 2027 and D or better by 2030.

In addition, the use of fossil fuels in heating systems will be phased out by 2035 for new buildings, buildings undergoing a major renovation, or renovation of heating systems, while their use will be fully phased out by 2040.

Realistically, while the expenditure necessary to secure top sustainability ratings can be justified in the case of a prime city-centre office building that can command a higher rent, there will inevitably be far more challenges for suburban locations with a much lower rent ceiling, TWM Director and Head of Professional Services Ken Noble noted.

“Given the often significant costs involved in more significant retrofitting, long-term secure income will be needed for a landlord to justify the level of investment and the level of payback required. Each case will have to be taken on its merits,” he said.

HWBC estimates that with suburban Grade A rents at €30-€35 per SF, compared with €60 per SF and above for Grade A in the city centre, the comparative attractiveness between prime city and the rest will continue to diverge. That means the economics of retrofitting are widely different.

And if the issue isn't addressed, it will affect the owners of better-quality office buildings too.

“Despite rising overall vacancy, headline rents for prime, new, ESG-compliant buildings are holding firm whereas headline rents for older stock are under pressure in nominal terms," BNP Paribas Director and Head of Research John McCartney said. "This is even more evident in net effective rents which incorporate the de facto discounts of increasing rent-frees, and when we adjust for generalised inflation."

“The most obvious thing for owners of older stock to do is cut the rent. This will have a knock-on impact on owners of slightly better stock, who will have to counter-cut to remain competitive. This is turn passes the problem up the chain until, eventually, prime rents will be affected,” he added.

Pressure is also set to come from lenders, notably banking giant AIB, which recently announced that commercial and residential developers will need to adhere to strict sustainability rules to access finance, after it issued ambitious new sustainability targets.

AIB has set carbon reduction targets for around €43.5B of its customer loans, representing three-quarters of its lending portfolio, as part of wider plans to reduce carbon emissions significantly for its commercial real estate, residential mortgages and corporate loan books by 2030.

For real estate, the bank is aiming to achieve a reduction in emissions intensity of 58% per SF on homes funded by €29.4B of residential mortgages and by 67% per SF on commercial real estate funded by €5.6B of loans.

“AIB’s new green lending grew by 65% to €3.3B in 2022, accounting for 26% of all new lending, while our green mortgage products represented 28% of new mortgage lending. We are now further aligning ourselves with the global sustainability agenda,” AIB Chief Sustainability and Corporate Affairs Officer Mary Whitelaw said.

Many markets also have too much office space and too few homes, an issue especially acute in Dublin. JLL speculated that repositioning buildings will become more common, retrofitting to improve the energy footprint while converting a building to higher value classes like living space, multi-use, student housing or even urban logistics.

“For owners of well-located older buildings, particularly those with good slab-to-slab clearances and narrow floorplates, refurbishment will be an option. In time, greater recognition of whole life carbon and embodied carbon may become reflected in higher values for refurbs than new developments. This would obviously assist in the break-even arithmetic," BNP's McCartney said.

“Given the structural challenge of hybrid working, less well-located offices may be suitable for repurposing as residential or hotel and leisure and we are likely to see both refurbishment and reuse strategies come to the fore," he added.

For those that get retrofitting buildings right, the opportunity to make good returns exists.

Although it’s early days, there is already evidence that higher-sustainability buildings are beginning to trade at a premium. Last year, adviser JLL estimated that a 20% premium could be applied to high ESG offices in the UK and a similar effect is starting to be felt in Dublin.

“Anecdotally, properties that are classified as ‘Dark Green’ benefit from lower yields, higher values, shorter void periods and strong demand. As the market becomes more developed we expect there will be more evidence and research that highlights the value gap between green buildings and older stock,” Savills Associate, Offices Conor Egan said of the market situation.

And that is bringing opportunistic investors to this part of the market. Global real estate investment company Kennedy Wilson was one of the first to take part in AIB's Irish green loan programme, securing €77M in financing for The Cornerstone mixed-use development in Stillorgan last year.

More recently it secured €110M from AIB to fund more than 140K SF of recently developed office space at Ten Hanover Quay, 20 Kildare Street and 94 St Stephen’s Green in Dublin.

The new loans follow attainment of LEED Platinum certification at 94 St Stephen’s Green. Ten Hanover Quay and 20 Kildare Street are targeting several sustainability credentials including LEED Gold and Platinum, WELL Gold and WiredScore Platinum.

The company said that the green loans “strengthen the link between decarbonisation and financing strategy”, and the three projects were designed to align with the key principles of EU taxonomy, a classification system for sustainable activities that was established to boost sustainable investment as part of the European Green Deal.

“The creative reuse and repurposing of older existing buildings is one of the keys to a lower carbon future. The letting of these projects ahead of our initial business plan and the long-term green financing support from AIB shows the market is increasingly aligned on these key ESG issues,” Kennedy Wilson Global Sustainability Officer Peter Collins said.

The mix of regulations and rental adjustment is likely to have a deep imapct on Dublin's office stock, yet modernisation is not going to be easy or quick.

Dublin may be on the path to sustainability, but there is a tough road ahead.