CMBS: European Net-Zero Targets and the Rising Demand for Green Office Space

The intensity of focus on climate change and the need to commit to a carbon-neutral world has increased noticeably over the past years. In this commentary, DBRS Morningstar analyses the main challenges the European commercial real estate (CRE) sector is facing to cope with tightening regulatory requirements and market expectations regarding decarbonisation, with particular attention to the office market.

Key highlights include:
-- DBRS Morningstar sees a threat of significant value erosion for carbon-intensive assets, due to both increasingly stringent regulations and greater pressure from market participants.
-- Increasing attention to sustainability features and net-zero commitments will shift occupiers’ demand towards more energy-efficient office space.
-- DBRS Morningstar expects the bifurcation between Grade A or green-retrofitted office space and secondary old-fashioned alternatives to increase, with good assets attracting new financing and legacy, and carbon-intensive assets facing accelerated obsolescence and distress.

“In our view, a large part of the European CRE sector is heavily exposed to stranding risk in the next few years, as more stringent environmental regulations are implemented at the country level. In particular, this will affect non-complying assets, which will struggle to attract new financing and thus face declining market values. In turn, this might trigger future breaches in loan-to-value ratio financing covenants and a potential increase in CRE loan delinquency rates. While higher energy costs as well as the establishment of hybrid working models might trigger occupiers to cut back or convert their occupied office space, thus leading to a general decline in demand for office space, DBRS Morningstar expects the demand for more sustainable and flexible premises to remain strong in the medium term” said Andrea Selvarolo, Senior Analyst of European CMBS at DBRS Morningstar.