ESG warehouse retrofitting: Finding the cost/benefit sweet spot

More lenders, investors and occupiers acknowledge that ESG and energy efficiency need to be a priority.

Some 61% of Europe’s warehouses are older than 10 years old, according to our Retrofitting warehouses: Connecting the dots between legislation and shareholder action points report. Such a vintage means some level of refurbishment is needed to stay competitive.

Beyond just age, as green legislation across Europe tightens to meet Net Zero Carbon targets, reporting requirements, and taxation are putting pressure on all stakeholders.

Not only is Europe’s logistics stock aging, but the growing obstacles to building new space mean that retrofitting is often the most realistic solution. While each ESG upgrade cost can be substantial, retrofitting is only feasible if the cost to achieve energy efficiency and carbon emissions targets is significantly below that to demolish the building and redevelop the site.

At the same time, to be included in carbon emissions and efficiency calculations, the required ESG reporting for a stakeholder paying for such upgrades must include transparency at all levels, from material sourcing through to installation, which can also drive-up costs.

Against a backdrop of weaker demand and higher financing costs, retrofitting is not yet happening on a large scale. For this reason, a lack of evidence and data has made it difficult for investors, lenders, and valuers to quantify whether there is a premium for improving energy efficiency and maintaining a property’s competitiveness. And if so, what form premiums would take in both leasing and investment markets.

At JLL, a collaborative team from valuation, capital markets, sustainability, and research set out to identify premiums observed in both leasing and investment transactions and then input these into a DCF analysis to calculate the IRR premium range for retrofitting a hypothetical 10-year-old, 25,000 sqm warehouse in a prime location. Identifying three upgrades considered essential for occupiers and investors (LED lighting, HVAC conversion from gas to electric, and solar panel installation on the roof), we established a range of costs, from adding only one of these upgrades to including all three.

Impacting the value differential between ESG retrofit and no improvement to a building are market-based assumptions including rental premium, shorter void periods, lower exit yields, and IRR premiums.

ESG capital expenditures vary considerable beyond an estimate €50 per square metre for basic refurbishment.

Our analysis shows that IRR premiums of 100bps to 200bps are achievable in scenarios where upgrades focus on one or all three of the upgrades noted above as essential to occupiers and investors.

No ESG upgrades or excessive ESG capital expenditures equal to 60% to 75% of the average site redevelopment cost produce significantly lower IRR ranges. Therefore, the right ESG spend, or sweet spot is between €100 and €350 per square metre. Our view is that you will see a rental premium average on that basis of circa 12.5%.

While the outstanding questions are around how much to invest - and in what type of upgrades, it’s good to see that we have reached an inflection point in terms of where capital is best spent.