Andrew Mercer, Office Sector Lead at Legal & General Investment Management (LGIM), says that while there is a plentiful supply of less attractive office space as a result of the pandemic, the high end of the market is proving competitive.
“Occupiers are starting to realise that the quality of space is really important,” says Mercer. “We have already seen record rents set for really high-quality offices. For example, we recently set new record rents in 3 office development schemes completed during the pandemic in Windsor, St Albans and Watford.”
Meanwhile, LGIM and Mitsubishi sold their Central Saint Giles joint venture in the centre of London to Google for $1 billion in January 2022.
So what sets these offices apart? “It’s about quality and having a future-proofed asset with ESG credentials,” says Mercer.
While every occupier has a different definition of quality and ESG; health and wellbeing, sustainability and amenity are increasingly important factors in the office property market for attracting and retaining staff.
Central Saint Giles, for example, has an in-use BREEAM Excellent rating, showing its strong sustainability performance. One Victoria Street in Windsor is a wellness-focused Grade A office building that incorporates an indoor wellness and relaxation garden, roof terrace and entertainment space. The Hyde building in Watford has AirRated Platinum and Ska Gold ratings for its air quality and sustainability good practice, which includes electric vehicle (EV) charging points in the basement car park.
While strong ESG credentials were appealing back in 2019, since then, the pandemic, the gradual prioritisation of net zero and a highly competitive employment market have focused minds.
“As a result of the pandemic, people are now looking for much more health and wellbeing,” says Mercer. “They want to see a lot more plants in the office, they expect a lot more transparency around things like air quality. We were putting air sensors into our spaces long before COVID, but that’s now grown in popularity. We put iPads on the wall, and people can see what the air quality is in their space.”
Even before the pandemic, LGIM noticed more HR people coming on building tours to make sure spaces are chosen not just for their functionality, but to support health and wellbeing, from cycle facilities to proximity to gyms and the safety of the walk to work.
“I do think that there will be more HR people coming on viewings,” says Mercer. “In this period of high employment, businesses will be thinking about how to retain and attract staff. They want to listen to their staff and make sure that what they’re able to offer will be competitive in the market.”
The density of offices is one way this trend could manifest, as people have become more aware of how viruses transmit and the importance of air quality. “Over time, people have been packed into offices at greater densities, with one person to every 40 to 50 square feet in many serviced offices when air conditioning is typically designed 1 person to every 80 to 100 square feet. That will now start to push out,” explains Mercer. “People will expect a better experience from their work environments.”
New modes of working are also putting space at a premium. As many workers return on a flexible basis, there is a greater focus on collaboration when people are in the office, which drives up demand for meeting spaces.
“The amount of space that we’re going to need will probably increase,” says Mercer, who thinks it unlikely many occupiers will go back to five days a week in the office. “Employers recognise that to retain and attract staff, there needs to be an element of flexibility.”
With people spending time on video calls even when in the office – speaking to clients or colleagues working from home – noise is increasingly an issue. “Having somewhere you can go to reduce that noise is really important,” says Mercer. “So ‘zoom rooms’ and smaller rooms where you can take calls, for example.”
With at least 60 of the UK’s FTSE100 companies and many more smaller businesses having set net zero targets, the sustainability of office buildings will play a role in turning those commitments into action.
“We’ve been looking at sustainability for a long time,” says Mercer. “It’s growing in momentum. Two years ago when we spoke to occupiers, most were inquisitive, but very few were really engaged on a productive basis. Now, it’s split. The bigger corporates are really engaged. Then at the other end of the spectrum, you’ve still got the occupiers that are trying to figure out what it means for them and what their journey is.
“Most will realise in time that to attract customers, investors and staff, they will need to get on the journey and have a strategy that addresses people’s concerns. Most occupiers we speak to understand that, but don’t quite know where to start. So we see our role as helping our occupiers on that journey.”
The developer or operator of a building has a big impact on its sustainability credentials.
LGIM is one of the UK’s biggest investors in real estate, developing, owning and operating office space. Having set a 2050 deadline for our real estate portfolio to reach net zero carbon emissions, we are now working towards our interim 2030, science-based targets.
In new builds, that means things like using clean energy sources as alternatives to gas for heating systems and aiming for high BREEAM ratings, which assess factors such as carbon emissions reductions, design durability and biodiversity protection. In existing buildings, it can mean retrofitting spaces for energy efficiency and removing gas boilers, while striving for high operational performance, benchmarking against BREEAM In-Use or NABERS ratings, which measure things like energy, water and waste.
“Embedded carbon is a greater challenge,” says Mercer. “One way we’re addressing that is to look at where we can refurbish rather than renew without significantly impacting on quality or health and wellbeing.”
However, occupiers are responsible for a lot of the emissions once a building is in use. LGIM has been supporting the occupiers of its buildings to be more sustainable through smart meters and remote data analysis. “We put the technology in place to enable occupiers to manage their utility consumption properly. We saw a recent example in an office on Strand where an occupier was experiencing a spike in energy usage because a timer was incorrectly set switching on a bathroom fanat three o’clock every morning .”
In addition to its fitted offices product, Capsule (the image above is of Capsule, 120 Aldersgate Street, London), LGIM launched a managed concept in 2021, whereby it provides property management for occupiers, looking after factors such as operational energy efficiency for an all inclusive cost. This has enabled companies with short term leases that do not have the time horizon needed to invest in an ESG-friendly office to improve their sustainability credentials by paying LGIM a premium to amortise the cost over a longer period.
While employee wellbeing is a big part of the ‘S’ in ESG offices, social value is also important for those concerned with ESG investing.
“The social value side is more difficult to measure than sustainability. But with 245 Hammersmith Road, which we developed just before the pandemic, we were able to show that we had generated £650,000 of added value for the local community through things like using a local workforce in the building,” says Mercer. The project used the Social Value Portal to measure the value of the development to society. “So there are ways that you can do it. But it is more challenging to come up with those ideas, especially in a smaller building.”
ESG-friendly offices are already proving popular and valuable. “What we have at the moment is a market where the supply of really good quality assets is quite low, in every city across the UK. So there is already a low supply, growing demand imbalance for good ESG-type buildings,” explains Mercer. “And you can see the link between increased rents for those assets.”
The low supply is primarily due to two factors. “If you go back to the Brexit referendum, a lot of developers stopped developing, and that shortage of developments hasn’t really caught up,” he says.
The situation was compounded by the pandemic. “Some parts of the office market froze when we went into lockdown – no one really knew how long the pandemic was going to last.”
In addition to the low supply of ESG-friendly offices, demand is likely to increase over time. “the pandemic will bring a realisation for occupiers that they do need better quality ESG compliant offices,” says Mercer. “If they’re going to hit their ESG targets, which they may not have set yet, they will realise that the quality of their asset will need to improve.”
Government pressure is also being brought to bear on the market, with a target of EPC C for non-domestic private rented properties in England and Wales by 2028 and B by 2030. . It is now considering how to enforce these targets.
“Those buildings that may never hit the EPC B by 2030 target might become stranded,” says Mercer.
At Legal & General we recognise the long term benefits of socially responsible investing and we are committed to sustainable impact investing through our inclusive capitalism agenda.
“All our real estate assets have a net zero roadmap in place, so that even if they’re not hitting those targets now, there is a plan mapped out for compliance.,” explains Mercer.
As well as benchmarking our assets against ratings such as BREEAM, we are measuring our progress towards interim targets. However, as even the 2030 targets are a long way off, we are taking steps to ensure accountability at a senior level within our organisation today.
“All of our offices have science-bases targets in place and the asset and fund managers have renumeration attributable to that. So even now, you will be rewarded or not rewarded based on whether you’re hitting those targets,” says Mercer.
There has been much debate about how cities will be changed by the pandemic, but the urban regeneration that will take place as a result of greater focus on ESG and technology could be the real driver of this change.
We’ve been looking at sustainability for a long time. It’s growing in momentum. Two years ago when we spoke to occupiers, most were inquisitive, but very few were really engaged on a productive basis. Now, it’s split. The bigger corporates are really engaged. Then at the other end of the spectrum, you’ve still got the occupiers that are trying to figure out what it means for them and what their journey is.