Building renovations and the ghost of green premiums
Reducing energy consumption has a direct positive impact in the form of reduced energy bills, however, when selling the asset, at the moment, there is no evidence that buyers would recognise this value. In-depth research shows that although buildings with A or B energy labels are valued higher in some markets, it is not related to the energy performance of the building but rather an indicator of buyer preference for modern and comfortable buildings.
by Maarja Meitern & Rolf Bastiaanssen
It is often presumed that better recognition of the energy efficiency quality of dwellings would lead to a higher valuation of real estate, driving sustainability and building improvement ambitions. On a larger scale, this economic incentive would trigger lenders to make financing available at low-risk interest rates and for investors to engage in deep renovation.
This logic has led many policymakers to base their policies on the assumption that financial institutions, rather than strong regulation can incentivise the uptake of retrofits in Europe. Policymakers have founded their analysis on academic and market reports that market value premiums of label A or B dwellings command up to 8% higher valuations than their label C counterparts. While these are seemingly positive results, a deeper dive into the methodology dissolves many of the claimed results.
For example, many buildings with a higher energy label are either new or recently refurbished. Due to a lack of both data and analysis of the impact of energy labels, it is hard to say if buyers appreciated the energy label (or the insulated windows) as much as the well-equipped modern kitchen. Interviews carried out as part of the REVALUE project among dozens of valuers across Europe indicate that they didn’t. In the context of regression analysis, the energy label is quite likely a better indicator of a buyer appreciating a building’s general quality, rather than its energy efficiency.
Regression analysis can only break down values for known building characteristics such as location, size, number of bedrooms. Especially in academic research that focuses on the value of energy efficiency, the number of known variables for sizeable samples of real estate is very limited. An international effort to plug this gap led by real estate advisors Savills, within the framework of REVALUE project, found much willingness among affordable housing providers to participate in research but struggled to obtain datasets that included at least 10 basic data points on buildings that they often owned for decades.
Moreover, the studies with limited data have disclosed that the regression analysis can typically ascribe only 1% of the total value to energy efficiency – while failing to explain a full 20% of an asset’s building value (Maastricht University). With so much uncertainty, making bold claims about green premiums is risky business. Asked for specifics by RICS, lenders and valuers also confirmed they currently do not recognise any values for energy efficiency in residential buildings.
So, unfortunately, the benefits of higher energy quality buildings such as lower energy bills do not currently translate into higher building values.
On a positive note, financiers and professional valuers do indicate that they foresee a potential value differentiation between building with higher and lower energy quality:
Short to medium-term value differentiation will be driven by regulation, not by consumer preferences.
Most consumers are simply not ready to invest more for components contributing to the energy efficiency of the building (e.g. non-visual upgrades). This will likely change over time, and some markets in north-west Europe are already moving in that direction.
At this rate, the process would take a couple of decades; much longer than politicians and policymakers can afford, given their stated ambitions to complete the building energy transition and meet international climate goals.
The value difference is more likely to be negative.
Markets currently do not recognise energy efficiency as a significant value component in pricing, largely due to the limited availability of high-quality housing. As new buildings meet higher standards and some existing stock is refurbished, there may be a temporary premium attached to energy features. Once many buildings boast high energy qualities, that premium will disappear, and brown discounts will become more prevalent for non-refurbished dwellings. More properties will be viable for redevelopment; but the danger is that the costs become prohibitive unless capped.
An overview of expected impact of building energy performance on building value over time
Phase of market transition: <1% dwellings with EPC A
Expected impact on value: Currently retrofitting for better energy performance does not for increased value. Some green premium is observed in specific markets.
Phase of market transition: ≈10% of dwellings EPC A
Expected impact on value: Once there is some choice of high EE dwelling on the market, a positive value compared to the similar dwellings with lower EE is expected.
Phase of market transition: Equal distribution
Expected impact on value: When there is significant share of EE dwellings in the market the green premium will go down, while brown discount will become more evident.
Phase of market transition: ≈75% dwellings EPC A or B
Expected impact on value: Changing standards (through regulation or market expectations) will make some dwellings unlettable without major upgrade.
We can conclude that although markets currently do not generally recognise energy efficiency as a significant value component in pricing, there will be a short period when green premiums will be relevant. However, as refurbishment and new build shift the median from an E/C rating to an A/B level, the green premium will disappear and brown discounts will be more strongly visible on the market, leading to the worst-performing buildings becoming stranded assets.
Such insights are important not only for building owners but also lenders and policymakers using statistical evidence for building policy or taking investment decisions. Policymakers should continue working to promote energy efficiency financing but the policies and decisions should be made while taking into account the customer preferences, as buyers prefer new double glazed window frames for aesthetics and comfort but not for impact on their energy efficiency.
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