Heading into the second half of the 2020s, commercial real estate continues to exist in a rapidly evolving environment. Shifting preferences for how space is used to where development takes place are converging with tightening sustainability requirements and severe shortages of housing, quality office and retail product and spiking climate mitigation costs, all under the umbrella of strained national and local finances and infrastructure.

As a result, heightened attention is being placed on the scale of potentially obsolete assets across the real estate spectrum. The current discussion around obsolescence, however, does not reflect the multifaceted opportunities found in turning challenges into value and returns. Importantly, the decision tree and investment journey for a given asset will vary depending on the type of product, spatial considerations, changing market preferences and viability constraints, amongst other factors.

A more holistic perspective shows that there are three overlapping factors – age and design, regulatory pressure and locational effects – whose convergence points inform the strategic direction for both owners and cities. Creative and proactive engagement between owners, developers, capital partners and public entities will enable necessary investments to take place not only faster, but also in a manner where the result is greater than the sum of its parts.

Pressure on owners to extensively retrofit their buildings is also coming from both private and public forces with respect to sustainability and decarbonization. Although the share of emissions sourced directly from buildings is beginning to flatline, they still comprise upwards of 39% to 42% of global emissions on an annual basis. In order to reach impending net-zero targets, the scale of retrofitting will need to accelerate markedly. The top eight markets for regulatory stranding risk have more than 86 million square meters of office product in need of near-term capex due to tightening compliance standards alone.

The upfront expense of necessary capital expenditures, however, comes with longer-term benefits to operating costs over the life cycle of a given asset. Whole-building retrofits involving a reduction in energy usage of between 40% and 65% have an average saving of US$31 per square meter. If applied under a medium scenario for global at-risk office product in the eight highest-risk markets for stranding, this would yield US$2.7 billion in annual energy savings alone for institutional office owners. These opex benefits are coinciding with sustained growth in tenant and investor demand alike for low-carbon buildings across asset classes and intensifying emissions reporting and benchmarking mandates from national and local governments. As a result, owners who are proactive about bringing product up to and above sustainability expectations will find greater return on investment and minimize the incidence of stranding.

The geographic concentration of aging product and places in cities with higher shares of emissions coming from buildings means that the rewards from decarbonization scale rapidly. Under even a moderate scenario, more than 52 million square meters of current office product in Boston, Washington DC, Paris, London, Seoul and Tokyo is likely functionally obsolete, but more than 60% of emissions in these metro areas originates from the built environment. Similarly, European and Asian cities with strengthening regulatory regimes also have more than half of their emissions emanating from buildings, meaning that the risk of stranding is now an impetus to accelerate wholesale retrofitting and meeting net-zero targets.

Sustainability and regulatory changes will also affect the spectrum of asset classes at highly variable rates, with significant implications for capital costs, portfolio optimization and stranding risk. Most sectors have a typical site energy use intensity of 800 to 1,550kBtu per square meter, although this rises above 2,400 for data centers and approaches 3,500 for lab space. On the other hand, warehouses fall below the 500kBtu per square meter threshold and the broader industrial and logistics segment skews near the bottom, creating significant opportunity for a 100-200bps rise in returns in stringent compliance regions such as Europe. 

There are four core pathways to avoid stranding risk, each with requisite market, financial and political considerations