There is value in UK home energy efficiency renovation
The UK residential building space has significant energy renovation requirements. The valuation uplift from improving the energy efficiency, measured by means of the EPC, seems less pronounced for UK properties. Still, the high savings on energy cost from renovation still make such renovations attractive, despite the lack of subsidies and a high financing rate.
In previous research we showed that energy efficiency renovations in Dutch residential property made sense, despite the high cost of capital
The UK residential building space also has significant energy renovation requirements
The valuation uplift from improving the energy efficiency, measured by means of the EPC, seems less pronounced for UK properties
Still, the high savings on energy cost from renovation still make such renovations attractive despite the lack of subsidies and a high financing rate
In our previous Sustainaweekly (see ) we illustrated that there should still be strong incentives driving the market for energy renovations in the Netherlands, as external research by NVM/Brainbay had shown considerable valuation differentials between various EPC (energy performance certificate) in property sales (see below).
The reason behind such valuation uplifts (or discounts depending on how you look at this matrix) are quite straightforward. Firstly, energy renovations drive a lower utility bill, which especially matters a lot in a high energy cost environment and enables buyers to pay more for such properties. Furthermore, decarbonization targets are ambitious and in order to meet these targets government might possibly impose a higher cost of carbon on weaker energy label properties in the future or other regulations, especially since the built environment remains responsible for a high share of emissions. The potential cost of renovation to be consistent with such regulations could also drive a valuation discount.
Such EPC driven valuation differences should be stronger in the UK…
Given the pan-European issue of higher energy prices and ambitious carbon reduction plans, one would expect such valuation differences between property EPC labels to be also visible elsewhere. We shift our focus to the UK, especially since UK residential properties tend to use even more energy, i.e. heat, in comparison to the Netherlands as shown in the chart below, taken from the CCREM decarbonisation dashboard. The chart illustrates that there should be more effort to get the UK residential sector on track of a 1.5 degree pathway, which should make already strong EPC properties in the UK a sought after investment.
...but studies reveal a diverse outcome
There have been multiple studies on the relationship between EPC labels/home energy efficiency and the effect on property values as measured in transaction prices. One of the earliest studies for the UK goes back to 2015 when Fuerst et al revealed a premium of 5% on A/B labelled properties against the UK median of D. A 2013 study commissioned by the UK government (see here) highlighted a 14% premium between a G labelled and a A/B labelled property. More recent studies, continue to point towards premiums assigned to high EPC labels and we shall take the lowest 5.4% premium from the Nationwide study as outcome as input in our analysis on the next page. The Nationwide paper actually flags a 3.5% discount for a G labelled property and a 1.7% premium on a A/B labelled property against the median D label, which boils down to a 5.2% difference between the G and A/B label. With an average UK property price of £3.2k per square metre (psqm) assumed to apply on the Dlabel, the gain from jumping from a G label to an A/B label is roughly 5.2% or £166 psqm.
Value uplift close to required investment
The property obviously needs renovation to improve energy efficiency before one could capitalize on the aforementioned £166 psqm gain. We looked at various measures such as loft- and cavity wall insulation, triple glazing and installing a highly efficient boiler. Each measure has energy (i.e. heat consumption) reduction potential and the cumulative of the featured savings would result in an 80% reduction. Perhaps as a set of combined measures the reduction potential would slightly dilute, but an upgrade from an EPC label G to a label B should be feasible through these measures. These measures together would require roughly £170 psqm in upfront investment. Although this £170 psqm is considerably lower than the €500 psqm of energy efficiency refurbishment for assumed in our earlier piece based on research done by residential real estate bond issuer LEG Immobilien, it just about covers the envisaged price appreciation. Also, further retrofits could still apply if natural gas used for heating is phased-out, as for now we have only switched to a high efficiency boiler. This would imply that the required investment would be higher, perhaps even as close to the €500 psqm as expected by LEG Immobilien.
The immediate energy savings would suggest a higher valuation uplift than 5.2%
But why should one focus purely on price appreciation, when direct savings on the energy bill are also up for grabs, especially if one decides to keep on inhabiting the renovated property. As we explained earlier, the reason behind the price appreciation on better EPC label should chiefly be driven by a lower cost to operate the property and should therefore theoretically reflect a discounted value of these savings over the lifespan of these investments. While the Nationwide paper implies only £166 per sqm gain, the annual savings on the utility bill are close to £27.5 per sqm, based on October 2022 prices for gas and electricity. We also found average theoretical savings of £30 per sqm per annum when upgrading from an EPC G to a B label from the EPC database (see chart below). Such savings would imply a 6 year pay-back period and since the underlying renovations have a much longer lifespan the valuation uplift could perhaps be estimated too conservatively.
There is value to be found in UK’s energy efficiency renovation
Assuming that the cost of utilities and the £166 per sqm envisaged valuation gain stay steady for the foreseeable future and the cost of the energy renovation is financed through a 5y mortgage (a green mortgage rate by UK banks is quoted as cheap as 5.2%) with the idea to sell the renovated property in 5 years, the renovation would still be value accretive from a discounted cash flow perspective, as shown in the table below. Importantly, such a decision should not depend on the general state of the property market. Even in the unlikely situation that the less tangible valuation premium would suddenly disappear (for example because of a massive renovation wave and therefore less price differentiation) the investor would still be able to recover the investment purely from savings on utility bills in as little as 7 years.
