Will the investment case for sustainability sustain?

While the jury is still out on both the duration and depth of the UK’s expected economic downturn, one thing is certain – the recessionary clouds will lead many clients to reassess the business case for their capital programmes.

With tender price inflation set to remain high even as the economy shrinks, the danger of stagflation looms large. As a result, private sector clients are likely to revisit the revenue assumptions on which their investment decisions are based – as nothing is more damaging to returns on investment than rising capital costs just as demand falls.

The coming months could therefore see some clients pause, defer, or scale back their projects – or, at the very least, look aggressively for cost savings before deciding to proceed.

Given that the most modern, energy-efficient technology and materials are rarely the cheapest, there’s a danger that this desire to cut costs now may lead the construction industry – and its clients – to rein in their sustainability ambitions. This will likely become a serious consideration, even as the upcoming COP27 summit returns our climate to the forefront of minds.

Will clients’ appetite for sustainability wane as they seek immediate cost savings?

In some cases, yes. But the picture varies by sector and from organisation to organisation, due to differences in public scrutiny, legal requirements, and funding models.

Public sector clients are the least likely to change course on sustainability. The UK Government, along with many local authorities and other public bodies, has committed to progressively reduce net carbon emissions to zero – by cutting a significant proportion of total emissions and offsetting the remainder.

While the deadlines they have set themselves vary (2050 for the UK Government and 2030, or even earlier, for some councils), backtracking on such high-profile, public pledges would cause considerable reputational fallout. The blowback would be particularly acute for central Government, which has enshrined in law both its 2050 net zero target and an interim target of a 78.0 percent reduction in carbon emissions by 2035.

Many private sector clients have made similar net zero commitments, albeit ones that are not legally binding and subject to less public scrutiny – so there is greater scope for these pledges to be watered down. Nevertheless, the sharp rise in businesses’ electricity costs, even with the temporary cushion provided by the Energy Bill Relief Scheme, will keep energy-efficiency at the top of many boards’ lists of operational priorities.

Meanwhile the tighter Building Regulations introduced in June will keep carbon emissions front of mind for real estate decision-makers. Under the new rules, new non-domestic buildings must produce 27.0 percent lower carbon emissions than were required by the previous standards. The bar has been raised even higher for new-build homes, which must now produce 31.0 percent lower emissions. While these more stringent regulations won’t come close to achieving net zero by themselves, they are an important step forward.

These measures come on top of the regulatory requirements placed on Registered Providers of social housing, who between them own around a fifth of England’s homes. The 2014 Fuel Poverty Regulations require them to upgrade their housing stock to at least an EPC C rating by 2035, but many are aiming to reach this target earlier.

Significant Government funding has been made available to help them achieve this goal, with the Social Housing Decarbonisation Fund (SHDF) due to disburse £1bn across England in the current parliament alone.

Similar funding is available to mitigate the carbon impact of public buildings, through the £2.9bn Public Sector Decarbonisation Scheme. It is due to dispense £1.45bn between 2023 and 2025.

Such long-term funding arrangements, which also tend to be the norm on infrastructure programmes, are less prone to being blown off their sustainability targets by medium-term market volatility and inflationary pressure.

Different route, same destination

A number of public sector clients have shown it is possible to apply downward pressure to capex while keeping their built assets firmly on track to achieving net zero.

The highest profile shift in investment focus has been in social housing, where the retrofitting of better insulation and superior energy-efficiency to existing stock has been given a major boost by the SHDF. Registered Providers are together spending as much as £1.6bn a year to improve the energy-efficiency of the UK’s social housing stock.

Two other factors are improving the returns delivered by retrofit investment:

1. A quantum leap in technology has the potential to slash unit costs. Energiesprong, introduced to the UK in 2018, is a revolutionary building performance standard and funding approach for whole-house refurbishment and new build. It is a combination of offsite manufactured components to create warmer, more desirable places to live; financed by energy and maintenance savings. Turner & Townsend is working with Energiesprong to increase productivity and drive down the cost of ultra-energy-efficient, modular home retrofits over the coming years.
2. Public sector retrofitting programmes have also become more sophisticated, pooling resources, sharing best practice, and delivering economies of scale. London has been a trailblazer in this regard, with the Mayor of London’s two Retrofit Accelerator schemes making it easier for public bodies, from borough councils to universities and housing associations, to install energy-saving technology across both residential and non-domestic estates.

Redefining ROI

Meanwhile, the re-examination of business cases has prompted some corporate clients to rethink what they want from their capital programme – and what success might look like.

The 2022 energy crisis has had a galvanising effect on attitudes to investment in energy-efficiency and sustainability. The prospect of energy prices remaining high for months, or even years, to come provides a compelling argument for organisations to ‘invest to save’.

Even commercial organisations that previously made only modest nods to sustainability now see in it the potential to achieve immediate, and enduring, opex savings, not to mention the prospect of improved performance and greater revenue-generating potential for their operations.

The intangible benefits of investing in the sustainability of an organisation’s built assets can also be considerable. Companies with modern premises that fully reflect their brand – and their ambition – can secure a reputational boost among a range of key stakeholders, from shareholders and clients to potential recruits.

Boards are increasingly viewing the built assets in their portfolio that have not, at a minimum, been made net zero ready as a long-term liability. Buildings that cannot easily be made net zero compliant when needed risk becoming ‘stranded assets’ that may reduce in value, become less attractive, or attract lower rental income, that then makes them harder and more expensive to finance.

Public sector decision-makers are also recalibrating their view of the benefits offered by investing in sustainability. Social housing providers see in it a way to achieve a societal payback, in which better insulated homes reduce fuel poverty, improve public health and create new job opportunities – not to mention the maintenance cost savings achieved by preventing damp, mould and condensation.

Those planning capital programmes are increasingly realising that they need not choose between improving sustainability and delivering maximum value. The latter can be the product of the former; and when a programmatic approach is used to keep activity aligned, both goals can be achieved together.