The case for refurbishment

In late 2023, we established a split of our non-residential building forecasts into consents for new buildings and consents for alterations and additions (A&A). At the time, we noted the long-term trend in non-residential construction towards new building, and predicted that this trend would continue, albeit with a pause during 2024 and 2025 as weaker economic conditions saw large new projects less likely to progress.

The drop-off in new non-residential building work has turned out to be more marked than we expected and, at the same time, consents for A&A work rose. Between June 2023 and June 2024, A&A as a proportion of all non-residential consents lifted from 21% to 29%, reaching a 10-year high. Put another way, the volume of new non-residential consents in the year to June 2024 fell 18% to a nine-year low, while the volume of non-residential A&A consents lifted 14% over the same period to its highest level since 1996.

Although we expected A&A activity to withstand the economic downturn better than new building, its growth during 2024 has been unexpected. New non-residential building is likely to start rebounding by 2026 as economic conditions improve, but our updated forecasts in Chart 1 show that we expect some of the recent gains in A&A consents to be sustained.

Chart 1 also includes older consent data from the 1980s, which suggests that the very low proportion of new non-residential consents during the 1990s was more of an anomaly than we had previously thought. The very high proportion of A&A work, which peaked at 55% in the year to June 1993, was effectively due to an exceptionally low level of new building work, following a 62% collapse in prices for Auckland prime office buildings between 1988 and 1991.

Why has there been a material lift in non-residential A&A? Part of the reason is likely to be due to a need to refurbish buildings to make them attractive and competitive in the current environment. Vacancy rates for non-residential property have risen across the board over the last two years as the economy has weakened, with the largest increases occurring for lower-grade space – as is usually the case. However, there is arguably more pressure than ever on employers and retailers to provide prime space for their staff and customers.

For employers, providing an attractive and enjoyable working environment is important to encourage staff into the office, given that working from home has become a more accepted and viable option in the wake of the COVID-19 pandemic. For retailers, shopping is more about the “experience” than ever, due to the increasing options for customers to purchase online. Furthermore, environmental targets of the public sector and many businesses, particularly large multinationals, mean an increasing emphasis is being placed on the environmental credentials of the buildings they are operating in, across areas such as initial carbon footprint, energy efficiency, and water usage.

These factors mean that lower-grade space is arguably becoming even more difficult to lease, over and above the usual cyclical weakness we would expect during an economic downturn. Some commentators don’t expect vacancy rates for lower-grade offices in Auckland and Wellington to start declining again until 2027.

For owners of lower-grade buildings, this outlook is problematic given substantially higher operating costs, particularly in terms of insurance premiums and local government rates. The seismic performance of older buildings, and uncertainty about the benchmark against which those buildings are measured, has also led to significant costs for some building owners.

In this environment, the business case for major refurbishment or retrofitting of existing buildings can be difficult. Building owners are likely to face significant upfront costs to try and meet market demand for more modern space, better environmental outcomes, and a higher safety rating – with the risk that the refurbished building will still fall short of what can be incorporated into a brand new building. In many cases, the value of work required to meet greater demand standards is likely to be high compared to the building’s apparent current value, meaning a write-down of the asset’s value (or a sale to a new owner at a significant capital loss) will be required.

In a recent piece of research, Jones Lang LaSalle (JLL) highlighted the mounting pressures related to building obsolescence around the world. Although JLL’s work was globally focused, the issues are just as pertinent for New Zealand given the age of our non-residential building stock. The large volume of new offices constructed between the late 1970s and early 1990s means that a substantial proportion of our buildings will reach the end of their expected serviceable life over the next 15 years. Many of these buildings, particularly in more earthquake-prone areas, are likely to have received substantial upgrades in recent years. This investment to date will stand them in reasonably good stead for additional refurbishment to take place, enabling them to meet greater environmental standards, for example. However, there will be many other buildings where the decision between refurbishment or complete replacement is less straightforward.

In the 1990s and early 2000s, we saw the problem of obsolete office space in New Zealand lead to the emergence of central city apartment living in Auckland and Wellington. Seismic considerations and other more intensive regulatory requirements mean that going down the “conversion” pathway is now less simple than it was in the past. And even with housing affordability at considerable worse levels than it was 20 years ago, buyers are probably more discerning than they were in the apartment market’s early days, when apartments were something of a novelty and less attention was arguably paid to the quality of a building or the conversion work that had been done.

JLL’s research shows that New Zealand is certainly not alone in facing increasing obsolescence in its building stock. However, the lack of scale in the New Zealand market, relatively high cost structures, and an increasing sense that New Zealand’s incomes are failing to match our aspirations on the global stage, raise questions about how effectively we will be able to address the issue in this country. There are signs that, over a 15-year horizon, alterations and additions of non-residential building should experience something of a renaissance. But it remains to be seen whether the funding or willpower to achieve that renaissance is there.