The World Needs More Retrofits. Making Them Work Requires Money, Brains And A Stomach For Risk

The numbers couldn't be starker when it comes to retrofitting buildings: Private equity firm Clearbell’s retrofit of The Kodak in Midtown produced about 240 kilograms of carbon per square metre.

Developing a new building of the same size from scratch? About 800 to 1,000 kilograms of carbon per square metre. 

Retrofitted buildings produce a lot less carbon than new developments. And no matter how energy efficient a new building is, it’s typically not enough to counteract the effect of the carbon emitted in construction.

If the real estate industry is to hit its net-zero targets and do its bit to fight the climate crisis, it needs more retrofits. The trouble is, they're hard. 

“Inherently, these projects come with a lot of risk,” LS Estates CEO Mark Swetman told the audience at Bisnow’s Retrofitting for the Future event, held at Nuveen’s 7 Devonshire Square, a retrofitted building in the City of London. 

Finance is scarce for office retrofits, the sustainability accreditation system pushes occupiers away from retrofitted buildings, and taking old buildings and improving them comes with a lot of uncertainty.

These problems are all solvable, though, and panellists argued converting offices to other uses like rented residential or life sciences is in some respects easier than trying to create new offices from old.

But it will take a change in attitude from developers, financiers and occupiers as well as a shift in the macroeconomic environment before the retrofit revolution can get going at scale, experts at the event said. 

“You look at retrofit as part of the bigger sustainability agenda, which is really important,” Amro Partners co-founder and head of venture investments Ami Kotecha said. “But looking at retrofit just by itself, you’re missing a trick. The commercial viability of a project has to come first.”

Amro typically takes older offices or retail properties and repurposes them to living uses, like student accommodation or co-living. Debt and equity for such schemes is relatively plentiful given the underlying strength of rents in these markets, Kotecha said. 

Panellists said converting offices with the right internal structure and access to water and power to urban life sciences schemes was finding favour with investors and developers. 

Trickier, given the mood around the sector, is retrofitting older offices to create new space that is fit for purpose for discerning modern office occupiers. 

“If you’re looking at new deals, there’s not a lot of capital out there to buy offices and retrofit them because most investors already have too many of them,” Clearbell co-founder and partner Rob West said.

That means a lot of the retrofitting being undertaken is by investors looking at problems in their existing portfolios. And the fact is, the price of older, obsolete offices hasn’t come down sufficiently to reflect the construction risk new owners are taking when refurbishing older buildings.

“It’s all about what happens post-acquisition, when you peel back the skin,” Swetman said, adding that even buildings that were relatively recently constructed have building information that is unavailable, obsolete or just plain wrong. 

Even those getting ahold of equity are finding debt equally difficult to source.

“Debt funds are the only game in town. The German lenders and UK high street banks that have traditionally funded UK development aren’t there,” Swetman said. 

Some debt funds are incentivising owners and developers to produce the most sustainable buildings possible, Clearbell’s West said. Clearbell is in the process of refinancing The Kodak, and the asset’s debt fund lender put in place a ratchet that meant the interest rate margin would rise by 200 basis points if the scheme did not win BREEAM Excellent accreditation — it did.

“That really incentivises you,” West said.

Those debt funds typically have return targets in the low double digits, so for owners to justify borrowing from them, they need to believe they will produce returns of 18% to 20% from the scheme, panellists said. Achieving that depends on what an occupier is willing to pay for the space once a retrofit is completed. 

If the building has the right bones — good floor-to-ceiling heights and columns and machinery in the right place — it is possible to make a building as aesthetically pleasing and amenitised as a new building. 

But when it comes to operational sustainability, or the carbon emitted in operations, it can be more expensive to reach the same level in a retrofitted office as in a new build designed with sustainability in mind from the start, Swetman said. 

If owners scrimp on operational sustainability, occupiers won’t choose their building. Even though carbon is being saved during the construction process, occupiers are mainly looking at operational carbon emissions, a problem that is exacerbated by the sustainability accreditation system. 

“What [sustainability accreditations] fail to do, and I still think they're failing to do, is consider embodied carbon in that story at all,” Nuveen Director Andy Booth said. “I think that will change, but at the moment, they’re really focused on onward [operational] performance. So actually a new building, ground-up development with of all the bells and whistles in terms of ESG accreditations, is going to sit very well.”

Because occupiers still primarily use accreditations to gauge the sustainability of a building, tweaks to the system giving higher certifications to retrofitted buildings would change the incentives for occupiers, panellists said. If that happened, retrofitted buildings could carry a premium above new developments, the inverse of the current situation.

Panellists said tax incentives from the government could make retrofits more financially viable, adding that such carrots are preferable to the stick of tougher regulation.