WHAT IMPLICATIONS DO EPCS HAVE ON RETAIL’S RESPONSE TO THE CARBON CHALLENGE?

WHY ARE EPCS IMPORTANT?

British shops currently emit over 8MtCO₂ (million tons per annum) more than new build standards. The Minimum Energy Efficiency Standards (MEES) provide legislation and timescales of how leased buildings need to improve their energy efficiency in the coming years, via their Energy Performance Certificates (EPCs). EPC gradings range from A-G and are the same system we’re familiar with when buying a fridge, with G being the worst performing. In order to optimise a building’s efficiency there are severe consequences for a landlord who fails to climb the EPC ladder. Properties that fail to meet the MEES Standards can no longer be leased and could become ‘stranded assets’.

As from April 2023 it will not be permissible to continue to rent commercial buildings with an EPC of Grade F or G. Furthermore, the Energy White Paper 2020 confirmed the Government’s intention that all commercial rental buildings must be EPC Grade B before April 2030 (with an interim step to grade C in 2027). These regulations refer to England & Wales, with Scotland bringing regulations through earlier. However, to simplify matters in this discussion we group all UK stock together because the underlying message remains the same.

A substantial proportion and quantum of UK retail real estate needs to improve its EPC grade before the end of the decade, something that will challenge the commercial property market and regulators alike in the coming years. The benefit is that this would reduce our national emissions by 5.4MtCO₂ per annum.

SO WHAT ARE THE IMPLICATIONS AND HOW MUCH RETAIL IS AFFECTED?

By 2023, 185,000 million sqft of EPC F&G grade retail space is at risk of being unlettable unless urgently improved.

By 2030, 1.4 billion sqft of retail space needs to reach EPC grade B; equivalent to 83% of all UK retail real estate.

This global figure is quite worrying and a lot for any of us to get our heads around. There are significant differences in how these ratings vary across different asset classes, unit sizes, geographies, and different parts of our town and city centres. However, no sub-sector is clear of the challenge. Questions remain about how implementable the legislation is given the scale and cost involved.

RETAIL ASSETS DIFFER IN PERFORMANCE

For landlords with a significant exposure to retail property the EPC cliff edge can be seen as an insurmountable challenge. On the one hand, they are increasingly led by ESG drivers that invariably align them with the need to reduce property emissions. On the other it can be difficult to know where to start given wider environmental concerns across large estates. Properties could be modified in incremental steps, which may be more expensive in the long run as well as more disruptive to tenancy, or upgraded in one go at a greater upfront cost and with the possibility that the technology available will be quickly surpassed.

Looking at the main retail asset classes of shopping centres, retail parks, and supermarkets (i.e. stripping out high streets etc), these core retail assets account for 1.1 MtCO2 pa compared to ‘new build’ standards. It’s worth noting that this is not even reaching a net-zero position.

Of these asset types, by 2023, 35m sqft can no longer be leased unless improved above F&G grade and by 2030, 335m sqft will have needed to be improved to grade B. Critically, 4m sqft retail parks and 12million sqft shopping centres could be ‘unlettable’ within the next 12 months.

Put another way, 80% of institutional retail stock needs improving by 2030 – 8% before 2023. However, a considerable number are already heading towards the 2030 goal, with 20% of the total floor area already at Grade A or B.

There are different degrees of exposure to the regulations. Retail parks are the sub-sector most advanced towards reaching Grade B for 2030 (35%) and a further 36% at Grade C. The unit size and configuration is generally seen as being easier to retrofit improvements on a cost per sqft basis, although the large floor areas do require considerable heating and cooling. This sector also has the fewest poor performing assets.

While two thirds of retail park assets don’t currently meet the 2030 target, that’s far less than shopping centres where 94% of the space will need to be addressed across all EPC bands.

Supermarket units also appear to be performing relatively well, with 25% already at a B standard and just 8% at risk of 2023 stranding. However, refrigeration is a significant problem and one that is not measured by EPCs, which is why many in the industry consider an ‘actual usage’ certification (e.g. NABERS) more useful than the current MEES regulation in addressing a unit’s emissions.

THE REAL CHALLENGE IS HIGH STREETS

For large institutional and private landlords, investor obligations and lettability of space will be key drivers in reducing outlet emissions. The size of their individual investments and access to capital will increase viability. However, most retail property emissions are not associated with shopping centres, retail parks, and large high street blocks, which only account for around 25% of retail property emissions and 40% of the floor area. The rest is the responsibility of smaller investors, largely in fragmented ownership, widely dispersed, under multiple ownership, often in marginalised trading locations, and where occupational challenges also persist.

What then, does this mean for the other 60% of retail stock in towns, cities, villages, and parades up and down the country where there is limited access to funding, advice, and a common strategy on what needs to be done, by when, by what means and with what consequences?

By 2023, 150million sqft (20%) of this ‘forgotten stock’ can no longer be leased and is at significant risk of becoming redundant. By 2030, around 1billion sqft (93%) will need to have been improved.

Property EPCs are simply more difficult to improve if they do not reside within institutional ownership, with two major side issues bookending the market. Polarisation is occurring from shrinking retail demand; resulting in higher voids in off-pitch and tertiary locations. These same areas are seeing a reduction in investment, which means converting units to higher standards of efficiency is either lacking or unviable with a significant risk of further stranded assets.

While many town centres don’t typically need the amount of retail space they currently have this doesn’t mean we can afford to lose more shops solely because they fail to meet MEES regulations.

It also raises the predicament of how we improve retail units that are sitting empty. UK voids have now surpassed 150 million sqft, with 40% of this space being redundant. For context, the average amount that retail buildings need to reduce emissions by to reach the 2030 target is 7-10 kgCO2 for every 1,000 sqft of retail space. Therefore, UK retail voids account for 1.1-1.5 MtCO2 e of emissions each year. There is a considerable potential missed opportunity to reduce a town centre’s carbon footprint if we can’t unlock and make improvements to these sites.