Compression of cap rates for the best performing multifamily housing stock to become increasingly visible across the region, says Dragana Marina, Sustainability Research lead, Continental Europe, CBRE.
The European council has recently announced that it has formally adopted the revised Energy Performance of Buildings Directive (EPBD), with new rules aimed at reducing energy use and emissions from buildings across the EU. This includes targets for all new buildings to be emission free by 2030, and to phase out the use of fossil fuels in building heating systems by 2040.
Currently, 75% of the EU’s building stock has poor energy performance and buildings are responsible for 40% of final energy consumed across the region. Investment in energy efficiency and clean technologies in buildings has increased, but still falls far short of levels needed if we are to achieve net zero.
The emphasis has been placed on getting residential buildings fit for the future, with requirements outlined for residential buildings to reduce primary energy use by 16% by 2030 and 20-22% by 2035, with at least 55% of the decrease to be achieved through the renovation of the worst-performing buildings.
The impact of the decision on the multifamily housing market will vary across Europe, depending on the overall energy composition of the multifamily housing stock within each country, as well as the share of the rental market on a national level, which varies from 5% in Romania to 58% in Switzerland.
However, the make-up of European building stock means it has large potential for renovation, with approximately 126 million buildings fitting the criteria set out. Of these, 90% are residential. Within the EU, around 40% of residential buildings were built pre-1970, before the gradual adoption of energy efficiency measures. The age of this stock suggests that to reach the agreed targets, a significant level of renovation will be required.
With the legislation now agreed, the importance of addressing this risk has now come to the fore, to avoid assets suffering write-downs in value and becoming obsolete. And whilst the introduction of regulation could result in the write-down of value of inefficient buildings, on the other end of the scale, efficient buildings could see an increase in value which also enhances the business case for renovation.
However, there are a number of challenges related to the investments into the improvement of a building’s energy profile. These include the CapEx requirements, the cost of capital and the lack of consistency around energy labels in European markets, all of which are causing issues for investors, property owners and lenders. Current low renovation rates could well be the result of investors pursuing short-term cost-benefit strategies, rather than focusing on long-term ESG compliance, something that will need to change if we are to meet the targets set out. Furthermore, the relatively higher cost of debt the European real estate markets have experienced in 2023 and into 2024 has halted ESG initiatives.
At CBRE, we have undertaken a comprehensive analysis of residential stock in Denmark to help us better understand the implications for investors. Having analysed 18,000 lease agreements between 2019-2023, we have found that dwellings with higher energy rating have a premium compared with lower rated dwellings and that that premium is increasing, the higher the EPC label is. We have also been able to identify a positive correlation between dwelling size and rental premium, with the largest units commanding the highest premiums.
However, the dynamics are more nuanced than first meets the eye, as the balance between the rental premium that can be achieved, and the CapEx required to perform the energy efficiency upgrade does not necessarily result in an uptick in value and points to the need to run due diligence on each specific use case. The analysis shows that it is difficult to build a robust business case around moving a multifamily asset’s energy profile from EPC B to EPC A but moving a building from EPC C to EPC B on the other hand results in a 9% asset value uplift.
Ultimately, as higher energy performance leads to higher rents and/or increased asset values, this should also be reflected in higher collateral value. This is an important consideration for financial institutions and should provide the required support to property owners and investors looking for financing to perform the required energy efficiency upgrades. Furthermore, compression of cap rates for the best performing stock will increasingly become visible across the region. This is already recognised in several European countries, including The Netherlands and Germany.
What is clear is that investors who address the energy efficiency agenda early, with both coherent and credible due diligence at a property and portfolio level, stand to benefit from greater economic gains in the future. However, this road will not be without its challenges and detailed analysis is needed to identify the right initiatives at a property level, as it is not a one-size-fits-all model. Going forwards, the balance between the challenges and the opportunities and how investors navigate these, will define the roadmap.
Read more:
https://www.cbre.com/insights/reports/energy-performance-and-multifamily-housing-asset-value
