Balancing responsibility and viability
The current construction and real estate landscape presents significant challenges – but also great opportunities. The recovery across the south east office market is gaining traction, with headline metrics on demand moving further into positive territory with each passing week. With supply still tight in many locations, this is fuelling anticipation of rental growth and an uptick in development activity.
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Uncertain times
Brexit, Covid-19 and the Ukraine conflict have heightened uncertainty, however. Manufacturing and supply chains have been disrupted, whilst shortages of labour, products, and inflated energy prices are making vital components more expensive. The impact is being felt most acutely in construction: the BCIS All Work Material Price Index rose 21.5% in 2021, the highest annual increase on record.
Price fluctuation clauses now form part of contractual negotiations for many larger projects, leading to reduced cost certainty on projects that may be reaching their viability point anyway. With forecasts indicating further annual increases of between 4% and 5%, the viability question is here to stay, at least for the short term.
Environmental legislation on the rise
It’s not just geopolitics and the legacy of Covid fuelling cost pressure. Major tenants are seeking commercial buildings with strong sustainability credentials, and legislation continues to ratchet up. By 2023 all existing tenancies will need to achieve at least EPC E, and landlords must prepare for a minimum EPC B rating from 2030. Prospective tenants must now seriously consider the implications of future EPC upgrades.
Furthermore, as part of the UK’s drive to achieve net zero carbon, from April 2022 large investors must now report publicly on their carbon emissions. This in turn will require everyone in the property value chain to provide accurate carbon data. Research found that 40% of green claims currently made by businesses could be misleading, with the Competition and Markets Authority publishing its Green Claims Code in November 2021. Now, by law, all claims must be backed up by robust, credible and upto- date evidence.
This puts a greater onus on certification of real estate. An interesting and very timely addition to the UK’s current certifications list is NABERS, which seeks to close the energy performance gap between design intent and real-life operation. Accreditations in the UK, though, are plentiful, and assessment varies widely. Inevitably, all come at an additional cost.
“Nice to have” is the new norm
The past five years have seen a growing trend for the provision of amenities within office buildings of scale. Best practice now extends beyond end-of-trip facilities such as showers and changing rooms to include smart technologies, healthcare and spaces that support mental wellbeing.
Post-Covid, expect to see new forms of amenity emerge that reflect changing business agendas and the new contract between employee and employer, for example, sanctuary and learning spaces, to support up-skilling and re-skilling. These will be particularly important in a future workplace which puts the emphasis on collaborative over personal space, as employees’ relationship with the office becomes more fluid and flexible.
What does this all mean in practice?
To fully understand the impact of these pressures, Knight Frank’s Building Consultancy team compiled a case study comparing costs of a hypothetical office refurbishment project in 2017 vs 2022.
The subject building spans ground, first and second floors, measuring 50,000 sq ft net (62,500 sq ft gross). It features a brickwork façade, three lifts, and a four-pipe fan coil heating/cooling system and mechanical ventilation. The building has an EPC rating of D with no current environmental accreditations. In 2017, the cost of refurbishing to modern standards equated to £104 psf. But by 2022, this cost has risen +66% to £175 psf.
This is because in addition to the +16% increase in tender prices, an additional £3.4m of costs were identified to achieve newer 2022 standards. These included:
- £1 million of improvements enhancing the EPC rating from D to B. Key upgrades include transitioning boilers from gas to electric, and installing VRF heating and cooling systems.
- £650,000 worth of ESG enhancements, including replacement of the building management system to better monitor energy consumption, and development of a smart app to enable interaction with building amenities.
- £1 million for development of quality amenity space in line with current occupier demand, including provision of outdoor and wellbeing space.
- £700,000 in consequential fees due to extended scope of works.
| In 2017 £104 per sq ft |
| Tender price (2017–2022) +16% |
| EPC conformity £1.1m |
| ESG upgrades £650,000 |
| New amenity £1m |
| Fees and other costs £700,000 |
| In 2022 £175 per sq ft |
Assessment against capital values in the key markets of the south east indicates that only a third of the key markets have registered capital value growth higher than the 16% rise in tender price.
Conclusion
While our example is theoretical, the incorporation of enhancements to specifications and the use of new suppliers is undoubtedly increasing costs.
Design teams will be under pressure to deliver more for less, particularly post novation when contractors look to value engineer schemes to drive cost savings. Increasingly, the allocation of risk will move away from the contractor and on to the employer, with shorter acceptance periods for bids. The need to create a narrative to market schemes will require more studies, data collection and reporting throughout the design and construction process in order to show how ESG requirements have been met.
Price certainty and economic viability are coming under increasing scrutiny from investors and lenders who want greater due diligence and transparency on procurement and supply chains. From a development perspective, land prices remain high, construction costs continue to increase and occupier and lender demands around ESG are growing. It will be interesting to see what gives first.
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