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Real estate investors already battered by high interest rates now face the prospect of significant writedowns triggered by new European regulations.<\/p>\n
Property owners across the region will need to invest vast sums in renovations to ensure their buildings aren\u2019t emitting illegal levels of carbon dioxide or consuming excessive amounts of energy, according to lawyers advising the sector.<\/p>\n
The situation \u201cis causing huge problems,\u201d said\u00a0Rory Bennett<\/a>, a managing associate at the real estate practice of\u00a0Linklaters<\/a>\u00a0in London. Portfolios containing energy-inefficient buildings face \u201cthe task of expending a huge amount of capital to bring that up to scratch, together with refinancing or redeveloping at the highest interest rates we\u2019ve seen in decades.\u201d<\/p>\n This month, lawmakers in the European Union\u00a0passed<\/a>\u00a0the Energy Performance of Buildings Directive<\/a>. The rollout will be gradual \u2014 lasting more than a decade \u2014 but property owners that fall too far behind risk being saddled with assets that can no longer be sold or rented.<\/p>\n The directive is intended to force property owners to embark on large-scale renovations to improve the environmental credentials of buildings across Europe, and ensure the bloc meets its commitment to\u00a0the Paris Agreement<\/a>. For now, refurbishments in the region only reduce annual energy consumption by 1%, according to the European Commission. To meet its climate requirements, the EU says property owners need to raise spending on renovations by\u00a0\u20ac275 billion<\/a>\u00a0($300 billion) a year.<\/p>\n \u201cIt\u2019s huge sums of money,\u201d Bennett said. \u201cThe reality is there will be some who simply can\u2019t afford or would choose not to comply with the legislation directive on the basis that paying a penalty is, at least in the short term, easier than having to spend a huge amount of your reserves on bringing your stock up to grade.\u201d<\/p>\n For real estate investors, the new wave of green requirements adds to the fallout from higher interest rates. The situation has started to attract short sellers, who are now targeting the weakest links in a global property market that\u2019s struggling on multiple fronts.<\/p>\n Europe\u2019s new energy-performance law is likely to affect tens of thousands of buildings across the region. By 2033, property owners will need to have renovated a quarter of the EU\u2019s biggest energy-guzzling buildings. Fossil-fuel boilers are out and solar-panel-ready buildings are in. And by 2030, all new buildings must be emissions-free.<\/p>\n The directive is part of a package of first-ever initiatives adopted in recent years to green the EU economy, and includes legal liability for failing to address environmental harms, as well as the mandatory disclosure of energy, emissions and water-use data.<\/p>\n The UK also is planning rules that will force property owners to embark on environmental upgrades. Mount Street, a London-based company managing \u20ac65 billion of European real estate loans, estimates that about 70% of Britain\u2019s commercial property currently has an\u00a0energy performance certificate<\/a>\u00a0(EPC) grade of C or lower. That implies major upgrades ahead as the UK plan gives all building owners until April 2027 to reach a grade of at least C. By April 2030, a building\u2019s grade can\u2019t fall below B for it to stay operational.<\/p>\n Jim Gott<\/a>, who manages the asset surveillance team at Mount Street, says the current proposal implies an investment need as high as \u00a3150 billion ($189 billion).<\/p>\n \u201cIn a lot of places, you\u2019re going to struggle,\u201d Gott said. \u201cIf you don\u2019t hit those EPC targets, it becomes effectively illegal to rent the space. It will affect the capital value of the building.\u201d<\/p>\n About 60% of UK warehouse space is on track to fall short of a B rating by 2030, according to law firm\u00a0Ashurst<\/a>, which cited data published in Logistics Matters.<\/p>\n Stricter EPC rules are becoming a potential \u201cregulatory cliff edge for unrentable European offices,\u201d said\u00a0Kim Politzer, head of research for European real estate at Fidelity International. \u201cPoorer quality buildings in secondary locations need expensive capex renovations\u201d and \u201cthe sums are getting more difficult to add up.\u201d<\/p>\n In the EU, about 85% of buildings were constructed before 2000, according to the\u00a0European Commission<\/a>. Because of poor energy performance, they are the single biggest users of power at a time when fossil fuels constitute two-thirds of the energy sources for heating and cooling. The EU wants the sector\u2019s emissions cut by 60% by 2030.<\/p>\n Such considerations have taken on growing importance in investment negotiation and decision processes, said\u00a0Jean-Fran\u00e7ois Vandenberghe<\/a>, a real estate specialist at\u00a0Baker McKenzie<\/a>. Some asset owners and managers are embracing the new trend, while others are focused on mitigating the obligations, he said.<\/p>\n On the flip side, buildings that are already green are more in demand than ever. In major EU markets, 22% of the office stock was certified sustainable as of mid-2023, up from 15% in 2019, according to CBRE, a real estate adviser. Other CBRE research found that when the effects of a building\u2019s size, location, age and renovation history are accounted for, green certified buildings command a 7% rental premium.<\/p>\n Demand for green properties by the EU\u2019s biggest companies currently exceeds availability by more than 50%, according to a November\u00a0report<\/a>\u00a0by\u00a0Jones Lang LaSalle Inc.<\/a><\/p>\n Bennett at Linklaters said he\u2019s regularly called into meetings at which \u201cwe spend hours talking about what to do.\u201d<\/p>\n For now, real estate investors are just hoping the wider economic situation improves and softens the blow of the regulatory shock ahead.<\/p>\n \u201cIf the economic environment picks up, interest rates will come down and that\u2019s going to really help with the decision-making,\u201d Bennett said. It would give real estate investors \u201ca little bit more breathing space.\u201d<\/p>\n<\/div>\nSubscribe to the new Fortune CEO Weekly Europe newsletter to get corner office insights on the biggest business stories in Europe. Sign up<\/a> for free.<\/div>\n