Aging office buildings in Dubai and Riyadh present a unique investment opportunity as occupier expectations start turning increasingly green, according to a new report, The ESG Imperative – The View From The Middle East – https://bit.ly/3ehxPwC, by global property consultancy, Knight Frank.

As sustainability issues take centre stage globally, environmental, social and governance (ESG) considerations are growing in importance. With 40% of global greenhouse gas emissions traced to the buildings we occupy, the imperative to go green has never been stronger. Furthermore, ESG factors can have a significant impact on the attractiveness of commercial assets to occupiers, as well as investors.

Knight Frank says ESG rated commercial assets are increasingly being sought after, especially by international blue-chip businesses.

WINNING THE WAR FOR TALENT

Faisal Durrani, Partner – Head of Middle East Research, Knight Frank, explained: “Occupying best-in-class office space is no longer a nice-to-have, but a need-to-have. Businesses are quickly discovering that to win the battle against the global talent shortage, a key tool is occupying world-class office space that effectively doubles as a showroom. This allows a business to showcase itself to potential clients as well as future talent, while offering a workspace that employees are proud to work in. This will be critical as we emerge from the pandemic.”

Knight Frank’s report points to Dubai’s office market, where there has been a sharp return to rental growth for locations that have higher concentrations of new, or relatively modern stock. Submarkets such as Business Bay, the DIFC and the Dubai Design District have all seen rents surpass pre-COVID levels, while older parts of the city where there is a higher concentration of older, more secondary stock are still struggling to return pre-pandemic lease rates. This is not necessarily due to a lack of demand in the market, says Knight Frank, but a lack of demand for older offices.

Durrani continued, “The flight to quality and sharpened focus on Grade A space is reflected in the fact that Grade A buildings in Dubai have occupancy levels in the high 80’s to low 90’s per cent, while in Riyadh, Grade A occupancy levels are hovering around the 97% mark.

“While the DIFC retains its position as Dubai’s financial heart and commands the highest office rents in the city, its buildings are rapidly aging. Indeed, 51% of the precinct’s 6 million square feet of office space was completed before 2010. The same is true for some other popular locations such as Dubai Internet City and Dubai Media City, where the average age of office buildings is 15 years across the 10.3 million square feet of office space in these areas. Similarly, in Riyadh 50% of office space on King Fahd Road and 84% of office space on Olaya Road is over 5-10 years old.”

ESG-LINKED REFURBISHMENT

Inevitably there will have been some refurbishment activity across these markets, but without extensive refurbishment that is ESG compliant, some buildings may start to see increasing voids and falling rents as occupiers gravitate towards more modern and green buildings.

Ben Walker, Partner – Head of Project and Building Consultancy, said: “All is however not lost for older buildings. Grade B buildings are often better located in that they are completed communities, with supporting infrastructure already in place. Clearly it will not necessarily be financially viable to refurbish all Grade B buildings, but the traditional demolish-and-rebuild approach in the region may soon be difficult to achieve as banks scrutinise the carbon footprint of new schemes before awarding development financing. Indeed, the carbon footprint of a refurbishment is far lower than the demolish and rebuild route”.

According to Knight Frank, average renovation or refurbishment costs for office buildings in Dubai currently range from approximately AED 280 psf and can be as high as AED 580 psf.

Walker added, “For refurbishment projects, a 40-50% uplift in the cost of the contract is the norm when attempting to achieve a LEED Silver rating. Clearly it may not always be possible to achieve a Platinum LEED rating as the cost may far outweigh any expected benefit and some older buildings may not be suitable to accept the retrofit needed.

“Overall, however, the message from businesses is clear: ESG credentials are quickly becoming a must have, especially for international blue-chip businesses. And this is not necessarily just LEED. It also includes WELL certification, which is focused on the experience of the occupants of a building, but also WiredScore Certification.

“Landlords may view this as lost cap-ex, but we have evidence from mature cities such as London where we have evidence to show clear rental premia associated with ESG-badged office buildings. There is no reason why we cannot expect to see the same in Dubai, particularly while internationally accepted, green-rated buildings remain in short supply”.

INVESTOR APPETITE

Knight Frank also highlights the investor appetite for green-rated buildings, with over US$ 120 trillion worth of real estate assets managed by funds that are signed up to voluntary climate-change disclosures.

“The region is yet to successfully attract global institutional capital in a meaningful way. The key reasons have been around the lack of assets of scale and market transparency. All that being said, investors are abandoning brown assets in favour of green-rated buildings. So, we have a clear opportunity to create these assets, attract strong covenants and deliver these green assets right into the hands of ESG-hungry funds.

“A significant test will come in the form of the US$80 billion 2024 IPO planned by the US$500 billion Saudi super-city NEOM, which has placed sustainability at the heart of its development objectives”, concluded Durrani.