The Peculiar and Dynamic Marriage between the Energy Performance of Buildings and their Market Value

Assessing the Value at Risk in the Energy Performance of European Buildings

Buildings are responsible for 40% of the EU's final energy consumption and 36% of its greenhouse gas emissions. EU GHG emissions must be reduced to net-zero by 2050 and by at least 55% by 2030 under a legally binding target in the European Climate Law. To achieve this, in its July 14th “fit for 55” regulatory package, the European Commission has increased its target to reduce final energy consumption by 36% in 2030 versus a modelled baseline, and to put a carbon price on the supply of gas and heating oil to buildings from 2026. In addition, it is expected that a minimum energy performance criterion will be introduced to accelerate buildings renovation in an update of the Energy Performance of Buildings Directive later this year.

Europe has decided to tighten regulation in the face of the climate crisis, because postponing coherent climate action is both expensive and unfair to future generations. This regulatory tightening will have increasing impact on the value of buildings. In fact, in annex 3c of its new Sustainable Finance Strategy the Commission already states that measures to enhance energy efficiency of a mortgage collateral can be considered as unequivocally increasing property values. This article develops these trends.?

Two ways of looking at value and energy efficiency

Energy efficiency upgrades are designed to reduce operational costs, they can improve a building’s image and cut its use of primary resources. For the European Commission’s Joint Research Centre (JRC) this provides the rationale for an increase in a building’s value, and improved marketability. In 2018, the JRC offered “a rule of thumb” pointing to an observed increase of 3-8% in the sale price of residential assets resulting from energy efficiency improvements, as well as an increase of around 3-5% in residential rents compared to similar properties. It also reported that this premium was over 10% in commercial real estate, all subject to country, region and building type.

The 9th edition of the European Valuation Standards “Blue Book” (EVS 2020), published in November 2020, takes a more conservative view. While it states that highly energy-efficient buildings with low energy consumption, or properties with a recognised green certification, may begin to attract an additional value in some markets, it notes that any such “green premium” for efficient buildings may be replaced by a “brown discount” for inefficient ones as the market begins to expect such standards, or regulation requires them. In valuation, timing is everything and guidance fit for the market of the 2040s, may not work as well in the 2020s.

EVS 2020 standard 6 also requires TEGOVA’s 70,000 valuers to be aware of any future legal deadlines and inflection points, and when they will appear, to estimate the cost of a renovation deep enough, at that future time, to meet the required new level of energy efficiency then, and how these future costs will affect the building’s Market Value at the date of valuation.

Buildings’ energy transition risks and opportunities must be more visible to owners and valuers

Each building has a unique transition trajectory, depending upon its physical attributes and local environment. For larger buildings, the Carbon Risk Real Estate Monitor (“CRREM”) offers a way for commercial buildings owners to see when its makes economic and regulatory sense to renovate, and identifies and reduces stranding risks at the building level. CRREM is already being used by asset managers owning over €300 billion worth of property covering 5 million square metres.

Funded by the EU’s Horizon 2020 Programme, CRREM provides science-based, location-specific carbon reduction pathways for individual buildings. The calculations are valid for all buildings, and CRREM’s mathematics could also sit behind a tool to help homeowners plan when a renovation will be needed to increase home efficiency to comply with upcoming EU Regulation and increasing carbon prices.

A combination of minimum energy performance standards, carbon prices and taxes will exert growing pressure to conduct net-zero aligned renovation works, which will be the economically rational decision at or before the “stranding point”. The following diagram shows a typical asset (eg. building) decarbonisation pathway to 2050, horizontal lines show current and future emissions intensities which are stranded as the regulatory environment gradually tightens emissions intensity requirements in line with a pathway dictated by Paris agreement aligned regulations:

So is the “value” glass half full, or half empty?

Is value simply being redistributed between energy efficient buildings and inefficient ones in a zero-sum game? Is the sum of all green premiums equal to the sum of brown discounts, or is the overall market value of all European buildings increasing, or decreasing, due to energy efficiency improvements and lower bills?

EVS 2020 suggests that while “energy efficiency may be a virtue, a cost saving, allow a higher quality of working environment and be an aspect of a modern building which, as such, has lower maintenance costs, less need of refurbishment and may be in a more attractive location. Taken on its own, energy efficiency might not be the decisive factor in value.”

A powerful way to answer this question is to see if the aggregate value of the cost savings resulting from building renovations is greater than the aggregate cost of those renovations.

In 2019, Europe consumed some 11 billion MWh of energy (990 Mtoe[1]), of which 4.4 billion MWh (40%) was used in buildings. One third of residential buildings’ energy use is gas, a quarter is electricity and the remainder is split between renewables, biomass, district heat and oil-based products[2]. European electricity has an average wholesale cost of around €50 per MWh, and an EU-average retail cost of €200 per MWh. Gas has EU-average retail price of €70 per MWh, and a historic wholesale price of around €25 per MWh. For approximation, assuming an even split between “gas priced energy” and “electricity priced energy”, Europe has an annual buildings’ energy bill of €594 billion[3].

Ignoring inflation, tax and carbon price increases, the present value of saving €594 billion per annum for ever, at a discount rate of 3% (the approximate average long-term mortgage rate for the last few decades[4]), gives a maximum EU renovation budget of €19.8 trillion. If two-thirds of the buildings’ energy bill is allocated to Europe’s 220 million households, the break-even energy renovation budget to upgrade these 220 million European homes is €13.2 trillion, or €60,000 per home. This per home budget will also increase when spread across just those homes which need deep renovation in their transition.

Extensive work commissioned by the European Commission in 2019 [5], revealed that real deep home renovations (those saving some two thirds of energy use) cost on average 219 euros per m2. With an average EU27 home size of around 100m2, this gives a deep home renovation budget of €21,900. This is a very long way below €60,000, in fact it suggests that the present value of all future energy cost savings alone delivered by deep renovations is more than double the cost of renovation, assuming a discount rate of 3%. This calculation does not consider the multiple benefits of energy efficiency, nor the very likely increased carbon prices for domestic gas use in Europe, which both improve the economics of home renovation.

Good value, but for whom?

If long-term, low cost financing (below 3%) is available for deep home renovations, they are great value. Yet, when their benefits are discounted at 10% (the discount rate used by the European Commission in its impact assessment of the recast of the Energy Efficiency Directive), the estimated break-even maximum deep home renovation budget comes down by 70%, leaving just €18,000 per European home.

Many homeowners “don’t see the economics” of deep renovation, as their implied discount rates used to assess the benefits are much higher than 10%. Yet this paradox can be rationally resolved by guaranteeing access for all European homeowners to cost-effective, long-term funding for deep home renovations. In fact, aside from neutralising the social impacts of the energy transition on the energy poor through providing grants to support their home renovations, the EU can work with retail banks to offer millions of unified EU Renovation Loans backed with public guarantees and linked to the buildings’ value. EU Renovation Loans can work as the carrot when combined with mandatory energy performance standards and increasing retail carbon costs.

In conclusion, while EVS 2020 upgrades energy efficiency valuation to “Standard status” and advises valuers to integrate future regulatory costs (mandatory renovations) into their determination of Market Value, it is less firm in its view of the market’s assessment of the future cost savings delivered by those same renovations. This conservative approach is somewhat reflective of the pre-2015 accounting treatment of energy performance contracts by Eurostat which insisted public authorities reflected all the service payment costs of energy performance contracts without accounting for any of the value of the delivered energy savings. It’s as if Eurostat and EVS’ standard require accountants and valuers to assume respectively that neither local authorities, nor building owners are able to contract for the delivery of energy savings. This could be construed to be a serious criticism of the European building renovation industry, and shows how important it is to prove the delivered cost reductions through energy efficient renovations, and not rely on deemed or design-estimated savings calculations.?

Sustainability, energy efficiency and green features should indeed only be reflected in a building’s valuation where there is observable market evidence. Yet markets are fickle and the impacts of property features vary over time, and between different sectors, cities and regions. Nevertheless...

...with a present value of up to €20 trillion of future energy savings at play in moving to net-zero energy buildings, a €3 trillion renovation wave investment by 2030 will surely provide the evidence that valuers need to reflect efficiency premiums or discounts in EVS edition 10.

This article first appeared in the European Valuer's Journal - September 2021 issue with thanks to Michael MacBrien, editor and his team at TEGOVA.

[1] Eurostat. (2020). Energy consumption in 2018: Primary and final energy consumption still 5% and 3% away from 2020 targets.

[2] Eurostat. (2020). Energy consumption in households: Energy products used in the residential sector.

[3] 4.4 billion MWh multiplied by (average of Euro 70 and 200 = 135).

[4] Euro Area Statistics. (2021). Bank interest rates – Loans. [Database].

[5] European Commission. (2019). Comprehensive study of building energy renovation activities and the uptake of nearly zero-energy buildings in the EU.