Is the rise in office refurbs a blip or a trend?

Evolution in London’s office market is constant; but are we now witnessing a revolution? Deloitte’s London Office Crane Survey (LOCS) has recorded a decided market shift towards refurbishment – or refurb – of existing stock rather than brand new development. Refurb volumes reached record levels in the two 2023 surveys since we first started tracking them nearly two decades ago, back in summer 2005*¹. Indeed, refurbishment activity has outstripped new build in each of the past eight (six-monthly) surveys, compared to just twice in the prior ten, as shown in figure 1 below.
 

Figure 1: Deloitte’s London Office Crane Survey Summer 2024 – volume and number of new starts – new build vs refurbishment

The push and pull of refurbs
 

Behind this shift are both ‘push’ and ‘pull’ factors. Chief among the ‘push’ factors is the expectation of continued tightening of Minimum Energy Efficiency Standards (MEES) – which we termed, in our Summer 2023 LOCS, “the spectre of obsolescence”. In 2021, the UK government outlined policy that would ban commercial landlords from letting office buildings with an Energy Performance Certificate (EPC) rating lower than grade ‘B’ from 2030². The former, Conservative, government had delayed some milestones on the path to meeting Net Zero by 2030. Since the recent Labour win, it seems that Sir Keir Starmer’s intentions are good, and that Labour is fully committed to both green politics and industrial strategy³. Legislation states that any office – or other non-domestic property – that has an EPC rating of below E became lawfully unlettable as of April 2023. Of course, exemptions exist based on technical and/or financial feasibility, but buildings that don’t qualify for an exemption (or indeed those that do but still struggle to attract occupiers) are exposed to “stranding” risk. Many so-called “stranded” assets are simply written down in value, at least until capital is invested to meet anticipated or actual MEES regulations. The risk for commercial real estate is that, unlike, say, bonds or equities, there may continue to be costs associated with buildings (e.g., rates, maintenance, security), even if there is no income. In other words, a building’s value may be exposed to the risk of an accelerated rate of value erosion through obsolescence. 

The “pull” factors for refurbs include climate, heritage, cost and time considerations. Many occupiers have made their own climate commitments, of which the carbon emissions from their building and overall environmental performance are key components. These market preferences are leading to a bifurcation in the market where higher rental levels are being achieved for more sustainable buildings. 
 

Framing the question: what makes a refurb?
 

Such is the interest in refurbs that Deloitte compiled the table in Figure 2 listed below to articulate the distinction between refurbishment and new build. First up, there are improvements that we don’t include in our London Office Crane Survey either because they don’t meet our 10,000 sq. ft. size threshold or because the scope of the improvements is merely superficial, e.g., painting, electrical works, minor external alternations without strip-out.

In differentiating between a new build and a refurb, the key question is what happens to the frame. Refurbs retain the frame, while new builds replace the frame, even if the façade is retained, (generally because it’s of historic importance). 

What this means is that what can appear like refurbs of heritage buildings, e.g., the current construction of Westminster House (7 Millbank)⁴, are actually new builds.

By contrast, some refurbs involve such huge changes that they appear like a completely different building. A recent striking example of such a refurb is 6 Bleeding Hart Yard. Edwin Heathcote, architecture critic of the Financial Times, summarises it: “A so-dull-it-was-invisible 1970’s office on Greville Street, just off Hatton Garden in central London, has been wrapped in a complex layer of modelled mesh to recreate an approximation of a historic structure”.⁵

On the face of it, one may think that refurbs constrain the developer’s ability to re-imagine the building, as they must work within the existing frame. Nonetheless, as the Bleeding Hart Yard example shows, this constraint can spur the architect’s imagination. Moreover, given that many refurbs strip right back to the frame, changes can run the gamut from cycle facility upgrades through new, and more sustainable, window treatments to fresh interior design.
 

Should refurbs be categorised by scope?
 

A refurb, at least for the purposes of our London Office Crane Survey, was defined as: upgrades made to existing developments where the original frame of the building is retained. But with refurbs now comprising the majority of new office development, we realised that more nuance was required. For the first time, we propose to categorise refurbs based on the scope of activity, whether that be minor, major or comprehensive. 
 

Figure 2: Deloitte’s Internal Classification Parameters*

*Classification parameters are subject to change to meet the evolving nature of the refurbishment market trend
 

To illustrate what each type of refurbishment looks like in practice, the following new starts from our LOCS are examples of each type:

10 Spring Gardens in St James’s, part of our West End submarket, would constitute a minor refurbishment. The planning permission allows for restoring of the building’s exterior, reconfiguring the internal spaces to offer modern office space and general improvements to the public spaces.

13 Fitzroy Street, in Fitzrovia, which is part of our Midtown submarket, is a prime example of major refurbishment. According to the projects’ website⁶, a 2-storey extension will be added, as well as improvements to the primary entrance. The internal offices and amenity areas are to be fitted out with new mechanical and electrical finishes.

76 Upper Ground, in the Southbank submarket, meanwhile, is an example of what we would designate a comprehensive refurbishment. While the scheme is designed to retain 80% of the existing structure the developer aims to achieve a 200% improvement in biodiversity value and targets BREEAM Outstanding (the previous building did not qualify for a BREEAM rating), as well as a NABERS certification, per the architects’ website⁷.
 

Are refurbishments always greener? 
 

Central to the shift to refurbs is the presumption that refurbs are ‘greener’ than redevelopment when considering the whole carbon lifecycle of the building, as is shown in Figure 3 below. This remains the subject of intense, and evolving, debate as the balance between embodied carbon and operational carbon efficiencies rises up the agenda. Some, such as co-working operator Second Home, have championed how green it is to refurbish, as they did with their original site in Spitalfields (68-60 Hanbury Street). Second Home suggests how, by choosing “forgotten buildings” they “drastically reduce” their carbon footprint across their co-working portfolio. A 2021 report from the UK Green Building Council (UK GBC) pointed out that whole life-cycle assessments need to be carried out to accurately assess the embodied carbon in the existing building . The typical scenario of higher embodied carbon and lower carbon in operation involved in redevelopment is exemplified in the Climate Emergency Design Guide by the London Energy Transformation Initiative (LETI) and the Net Zero Carbon Pathway Framework from the Better Buildings Partnership in Figure 3 and 4 below. Further to this, at the time of writing, the UK Net Zero Carbon Building Standard continues to develop with formal adoption eagerly anticipated.
 

Figure 3: London Energy Transformation Initiative, Climate Emergency Design Guide

(Source: LETI, Climate Emergency Design Guide, 2020)
 

Comprehensive refurbishments can involve the decarbonisation of building services, thereby producing operational carbon levels as low as those of new builds. Such refurbs are often considered to be the quickest, most efficient and cost-effective way to hit required regulated sustainability ratings. Given occupier ESG requirements – including but not limited to carbon – such improvements can re-base the asset in terms of its ‘leasability’, secure higher rental levels and potentially enjoy a trajectory of improved rental growth. 

When interviewed in connection with Deloitte’s Winter 2021 Crane Survey Alastair Moss, then Chair of the City of London’s Planning Committee boldly declared: “Our emerging policy is that we have a presumption against development. This is because we are looking at embodied carbon and the whole life carbon cycle. Everything will have to up its game. Everything is in play.” 

Despite this forthright statement from a planning authority arguably at one of the most challenging market interfaces, the debate still rages. This is best exemplified by the ongoing row over Marks & Spencer’s plans to redevelop its landmark Marble Arch store. Both the retailer and Secretary of State Michael Gove, who ruled against demolition, (a decision itself later overruled by the High Court) cited environmental concerns in support of their positions. 
 

Figure 4: Net Zero Carbon Pathway Framework

(Source: Better Buildings Partnership, June 2022)
 

Are refurbs always cheaper?
 

Historically, refurbs were thought to be smaller scale, simpler, quicker and cheaper. This is largely because, per the LETI chart above, both demolition and (re)construction are significant contributors to budget and time as well as the building’s embodied carbon level. Nonetheless, this is not always the case, especially as refurbs have become more commonplace and now encompass very large buildings. 

The costs associated with refurbishment are inevitably challenging to plan for, with each building presenting its own individual nuances. Seaforth Land’s founder and CEO, Tyler Goodwin, who is nearing completion of the refurb of Grade II-listed Space House near Holborn said:

“I think it is now clear that customers and indeed policy makers have come to the realisation that the choice of refurbished over new build is both better for the environment AND offers the promise of a more fulfilling tenant experience. Done right, there really is no discount for refurb over new-build, and there shouldn’t be. Great quality refurbishments can be just as costly as new build – and often can cost more as refurbs can present surprises during enabling works that offer the opportunity for value uplift, but at a cost to the programme. While policy makers consider forcing developers to refurb over demolish, they should also consider adding an additional 20% margin to construction costs of refurb in their viability process. This will encourage developers to embrace the new policy and attract much needed capital to this exciting sector of the market that urgently needs reinvestment.”

While certain refurbs can be more cost effective than redevelopment, as Tyler Goodwin mentions above, contingency planning typically needs to be thorough to mitigate the risks of what may lie beneath the proverbial skin. Listed buildings present particular challenges from both timeline and budget perspectives. 

The UK GBC showed the impact of various retrofit measures as of Q4 2023, (figure 5 below) in a recent report¹¹. Retrofit works typically involve more than one of these interventions, and there may be economies of scope¹² if undertaking more than one measure. The figure below lists the average value of each retrofit measure’s impact on the reduction of Energy Use Intensity (EUI)¹³ from the office buildings current baseline.
 

Figure 5: UK GBC 2024, table indicating the costs of individual retrofit measures and associated consumptions

(Source: UK GBC Retrofitting Office Buildings in the Case for Net Zero)
 

By avoiding some, or all, of the demolition and frame construction, refurbishment timelines are generally shorter than those of new builds. Moreover, the time savings are not just in the construction phase. Given the shift among many local councils, such as the City of London and Westminster, in favour of refurbs, the UK government’s Net Zero targets, and the environmental objectives laid out in the new National Planning Policy Framework¹⁴, refurbs are arguably less likely to be ‘called in’¹⁵ if permission is granted. M&S’s Marble Arch redevelopment application – first approved by Westminster Council in July 2021, and then called in by the previous Secretary of State in June 2022 – it is still awaiting a verdict from the now new Secretary of State. Unfortunately, this demonstrates the sorts of delays that can assail wholesale redevelopments. 

Delays are especially costly at a time when construction costs continue to increase for example, average fit out costs per sqm across EMEA (Europe, Middle East, Africa) have risen by 5.2% in the year to €1,708, according to JLL’s recent market analysis¹⁶. A key contributor to cost increases is changes to legislation, in particular new requirements that developers provide higher quality mechanical and electrical services when fitting out existing offices.

Thankfully, the high levels of inflation experienced throughout 2022 and 2023 are starting to show signs of fading. Nonetheless, overall refurbishment costs are likely to remain high due to the large proportion of labour costs associated with fit out. High fit out costs are, in part, related to construction labour shortages which are further exacerbated by a general scarcity of specialist trade skills in EMEA. 

In addition to material inflation, and the scarcity and higher wage costs for construction workers, money is no longer cheap. Many applications or approved schemes were envisaged during the decade or so after the Global Financial Crisis when interest rates hovered at around 1%. With the Bank of England base rate now at 5.25%, and commercial lending rates substantially higher, delays are much costlier than before. 
 

Refurbish, rebuild or (get) rid?
 

We have outlined above the reasons for the recent spike in refurbs over new builds. Some of the factors driving refurbs – construction cost inflation and high interest rates – will abate. On the other hand, we anticipate that other concerns, notably climate change and the policies, regulations and legislation introduced to tackle it (e.g., MEES) will only grow in importance. We feel that, on balance, the shift towards refurbs is a trend, not a blip. 

Even with greater letting potential following refurbs, some owners and developers will not want to undertake them, especially with a high degree of uncertainty around environmental upgrades, and the costs thereof. 

For such owners, the choice is not as simple as hold or sell. With the proposed tightening of MEES regulations, looming Net Zero deadlines as well as broader ESG and occupier expectations, the problem for many office owners is that the market for sub-prime, low EPC stock is moribund. To tackle this complex and changing environment, owners will need to explore the full range of asset management options, including a spectrum of refurbishment alternatives. What this spectrum of alternatives includes, and what various options are likely to cost, in time, carbon and money, will have to be the subject of another blog.