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Stricter energy-efficiency requirements potentially a costly affair for office property owners

If the energy upgrade of existing Danish office buildings becomes mandatory as seen in England and the Netherlands, as much as 42% of the Danish office stock requires retrofitting. However, much depends on the year of construction, location and ownership structure of the individual building.

The green transition is accelerating across Europe these years, with the property industry becoming an ever-more relevant topic for political debate.

England and the Netherlands have decided to introduce energy-efficiency requirements for existing buildings, and against the backdrop of mounting political focus on reducing greenhouse gas emission it is not unlikely that similar requirements will become a reality in Denmark in a matter of years.

In this article, we therefore zoom in on Danish office buildings, examining how energy efficient they are, and if factors such as year of construction, ownership and location make a difference, along with the likely consequences should energy-efficiency requirements of existing buildings be introduced in Denmark.

In 2020, the Danish Parliament, Folketinget, passed the Danish Climate Act, the primary objective of which was a 70% reduction (relative to 1990) of Denmark’s greenhouse gas emission by 2030.

According to the Danish Energy Agency, some 40% of Denmark’s aggregate energy consumption takes place inside buildings. It may therefore be highly relevant to factor in energy-efficiency improvements of the building stock when con-templating how Denmark is to meet the targeted reduction of greenhouse gas emission.

In terms of newbuilding, reconstruction and refurbishment, construction works are required to meet the minimum energy performance standards in the building code. However, no minimum energy performance standards apply to existing buildings in Denmark – yet.

Amended rules for residential buildings

In terms of raising the energy performance of rental properties, the problem is that the tenant and the landlord are not necessarily equally incentivised to carry out improvements. It is typically the landlord that carries the cost of introducing energy upgrades, whereas the tenant reaps the benefits in terms of lower energy costs, better indoor climate and comfort.

As a result, landlords may be holding off on energy upgrades.

One solution to this problem is new legislation. In 2020, this was the case for residential properties when section 5(2) of the Danish Housing Regulation Act was amended, in-troducing a green incentive and a green energy-efficiency requirement.

The green incentive implies that a new owner of an old-stock residential rental property may circumvent a five-year qualifying period, starting when the landlord takes control of the property, during which the landlord is not entitled to raise the rent to utility value even if the landlord has carried out comprehensive improvements.

The incentive lies in the fact that the qualifying period does not apply if the energy-efficiency rating of the residential rental property is raised by at least three grades, or if energy-efficiency measures are carried out in the amount of not less than DKK 3,000 per sq m.

The green energy-efficiency requirement implies that the landlord is only entitled to raise the rent to utility value subject to comprehensive improvements when the property’s energy-efficiency rating is C or higher (A-B) or raised by two grades since 1 July 2020.

Although we have yet to see similar regulations of office rental property in Denmark, other European countries have decided to introduce energy-efficiency requirements of existing buildings – even if the building owner in question opposes reconstruction or refurbishment.

In the Netherlands, for instance, office buildings are required to qualify for energy-efficiency rating C or higher by 2023. Failure to comply in principle means that the office building must close.

In 2018, England and Wales made it illegal to enter into new lease agreements or renew lease agreements on premises in buildings that do not carry energy-efficiency rating E or higher. Effective from 2023, this will also apply to existing lease agreements in England and Wales.

Current energy-efficiency standards of Danish office buildings

Owners of office buildings do well to ponder how their portfolios would hold up if Denmark were to introduce energy-efficiency requirements of existing office buildings in line with the requirements introduced in other European countries.

Figure 1 focuses on Danish office buildings with a valid energy performance certificate (EPC), showing a breakdown of the office building stock in terms of energy efficiency.

The largest share of floorspace in Danish office buildings is registered with energy-efficiency rating C, and more than half (58%) of the floorspace has energy-efficiency rating C or higher.

However, the analysis also shows that 16% of the floorspace in Danish office buildings is registered with the poorest energy-efficiency ratings E to G.

Supposing it becomes mandatory for Danish office buildings to hold an energy-efficiency rating of D or higher, this would imply that 16% of office space would require retrofitting to allow for lawful use.

However, if office buildings were required to hold an energy-efficiency rating of C or higher, like in the Netherlands, it would imply that all of 42% of the Danish office stock (Note 1) would require retrofitting. This would impose quite substantial retrofitting costs on the property owners in question.

[Note 1: EPC assessment methods vary from country to country. As a result, there is an element of uncertainty involved when comparing energy-efficiency ratings across borders.]

 Figur1_UK_BetragteligandelafkontorejendommeiDanmarkharlavenergieffektivitet

Many office tenants prefer location over energy efficiency

Leaving aside the disparate incentives of landlords and tenants when it comes to carrying out energy upgrades, it is fair to assume that the landlord may also benefit from an energy-optimised building in terms of happy tenants, a potential for upping rents, a diminished risk of tenants moving out and a lower vacancy rate.

All other things being equal, an office tenant will prefer an energy-efficient lease to a lease with high energy consumption. But all other things are not equal: In the cities, the best located office leases are situated largely in older buildings that are less energy-efficient than new buildings in more secondary locations.

According to a breakdown of office vacancies in terms of EPC, prepared by the Danish Property Federation, the office leases in the City of Copenhagen that are the most energy efficient (ratings A or B) suffer the highest vacancy rates, whereas the premises that are the least energy efficient (ratings E to G) are associated with the lowest vacancy.

This could therefore indicate that many office tenants consider location a weightier parameter than energy efficiency when deciding on an office lease.

For the same reason, we advise against jumping to the rash conclusion that the sustainability certification (e.g. DGNB) of newly built office buildings per se translates into a higher rent level.

The location of a new property is often correlated with the quality of the building, including the emphasis on sustainability.

A higher rent level in DGBN certified properties may therefore be explained by the tenants’ willingness to pay extra on account of sustainability but also by the prime location.

Newer office buildings are the most energy efficient

Figure 2 shows the percentage of Danish office buildings registered with various energy-efficiency ratings according to the construction year of the buildings.

As the figure illustrates, there is no clear correlation between year of construction and energy-efficiency rating in office buildings constructed before and in the 1970s.

The energy efficiency of these office buildings has been improved to largely the same performance standards, irrespective of construction year. This may be due to the fact that the most obvious retrofitting of e.g. ceilings, external walls and windows/doors raise the buildings to more or less the same energy performance standards, whether the building dates from year 1900 or from 1970.

In terms of office buildings constructed in or after the 1980s, however, the most recently completed buildings tend to have achieved the best energy-efficiency ratings.

For instance, office buildings dating from the 1980s outperform office buildings dating from the 1970s in terms of energy efficiency, and so on. This could tie in with the fact that the oil crises of 1973 and 1979 served to sharpen the focus on the energy efficiency of the Danish building stock, followed up by stricter energy-efficiency requirements of newbuilding.

Figur2_UK_Energieffektivitetenstigermedopfrelsesrforkontorejendomme 

Public sector lagging behind in terms of energy upgrades

How is the EPC rating status of office buildings in a comparative analysis across types of ownership? Figure 3 groups Danish office buildings according to ownership, showing how big a portion of the office building stock carries a specific EPC rating.

It is remarkable that three categories of public-sector building owners – the Danish State, regional authorities and local authorities – have the largest share of office floorspace with the poorest energy-efficiency ratings (E-G). In this analysis, the public sector is therefore hardly a frontrunner in terms of reducing greenhouse gas emission.

The “Organisation, foundation or self-governing institution” ownership category accounts for the lowest share of office space with energy-efficiency ratings E-G, probably because owner and user in this category often are one and the same, with the above-mentioned disparate landlord and tenant incentives to carry out energy upgrades therefore not applying.

As for the remaining two, non-public sector, ownership categories – corporations and private individuals – the office buildings in question are mostly rental properties where the landlord pays for energy upgrades, while the tenant reaps the benefits.

Figur3_UK_Detoffentligehardenstrsteandelafkontorejendommemeddrligenergieffektivitet  

Aalborg heading the field, with Odense falling behind

It is also interesting to examine if the energy efficiency of office buildings differs across Denmark. Figure 4 shows the breakdown of office building EPC ratings across the four largest office markets: Copenhagen (including Frederiksberg), Aarhus, Odense and Aalborg.

Here, the Odense market stands out by having a large share of office space with the poorest energy-efficiency ratings (E-G) and a small share of toprated office space (A-B).

Of the four office markets, the City of Aalborg accounts for the smallest share of E- to G-grade office space and the largest share of A- and B-grade space.

Figur4_UK_Storvariationienergieffektivitetptvrsafbyer04 

In addition, it is possible to examine if the energy efficiency of office buildings differs within each of the four largest office markets. Figure 5 includes a panel illustration of each office market, showing the share of the office stock in each postal district that carries EPC rating D or higher: The darker blue the colour of the postal district, the higher the portion of buildings rated D or higher.

The trend is clearly that postal districts with the largest share of office space with energy-efficiency ratings D or higher are situated in out-of-town locations.

This could be ascribed partly to the generally older date of centrally located office buildings compared to those slightly less centrally located, partly to the weaker landlord incentive to carry out energy upgrades in central locations as office occupational demand is high here – even if an office building does not have a good EPC rating.

Figur5_UK_Omrderudenforcentrumharenlavereandelafkontorejendommeidrligeenergiklasser04 

In Denmark, energy-efficiency requirements so far only apply to newbuilding as well as the reconstruction and refurbishment of the existing building stock. From a financial perspective, this makes sense as energy-upgrade measures in connection with planned construction works typically are less costly than is otherwise the case.

However, as buildings are characterised by long life spans and long renovation cycles, and as annual new construction accounts for only a small part of the overall building stock, it cannot be ruled out that Denmark will see the introduction of energy-efficiency requirements of existing buildings in an effort to speed up the energy upgrade of the building stock.

We have seen that such energy-efficiency requirements have already been implemented abroad. The introduction of energy-efficiency requirements of existing buildings would help to reduce greenhouse gas emission, enabling Denmark to reach the ambitious climate targets high on political agendas.

Investors owning older office buildings should therefore be aware of the energy-efficiency ratings of their current portfolios, taking into account energy-upgrade costs if investing in older office buildings with low energy efficiency.

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Gregers Nytoft Rasmussen

Head of Research

Copenhagen

Gregers is responsible for Colliers’ Danish research function. He has a strong track record with project management of data-driven research, and his primary tasks are related to preparing statistical and econometric analyses.  

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