ESG (Environmental, Social and Guidance) is at the forefront of everyones minds, as an industry commercial real estate owners, tenants and the whole supply chain must act together. It’s not easy to actually measure ESG but for commercial property owners the easiest and most simplistic metric is an EPC Rating (Energy Performance Certificate).

When a home is built, sold or rented in the UK, it needs an Energy Performance Certificate (EPC). This shows you how much a building will cost to heat and light, what its carbon dioxide emissions are likely to be and what improvements you can make to improve its energy efficiency. Properties are rated from 1-100 SAP points (Standard Assessment Procedure) and then grouped into bands from A (most efficient 92-100 points) through to G (least efficient 1 to 20 points) and the EPC is then valid for 10 years from the date it’s issued.

Making a property more energy efficient won’t just make it warmer, more comfortable place but it can improve its value. Here are some of the ways in which a residential property could improve its score.

• Double glazing. Upgrading your windows and doors won’t just improve your home’s energy performance, it can reduce noise too;
• Loft insulation. It’s easy to install, inexpensive and can make a huge difference to your bills. Install loft insulation that’s at least 270mm thick Wall insulation;
• Whether your home has cavity or solid walls, insulating them can improve your EPC rating and you might qualify for help with the costs;
• Replace your boiler. You can cut your energy bills with a new, energy-efficient boiler;
• An efficient secondary heating source. Installing a wood-burning stove instead of an open fireplace can give you greater fuel efficiency and reduced costs in the long run.

In Commercial property, the EPC indicates the energy efficiency of building fabric and the installed heating, ventilation, cooling and lighting systems (building services), but it does not take into account how the present occupier or tenant uses these systems. From 1st April 2018 it has been unlawful for a landlord to grant a new tenancy of commercial property with an EPC rating of ‘F’ or ‘G’ (two of the lowest ratings).

This guideline was just the start, there is more to come for commercial property landlords through something called

EPC B 2030.

In 2019, the Government has confirmed that all privately rented non-domestic buildings (i.e. commercial) will need to meet Energy Performance Certificate (EPC) Band B by 2030 and are seeking views on a proposed framework to implement and enforce this requirement.

This change will result in almost 1 million non-domestic buildings being cheaper to run, more energy efficient, and able to accept low-carbon heating systems. It is estimated to cover around 85% of the non-domestic rented stock, deliver up to 10.3TWh in energy savings by 2030, and 4.1MtCO2e of carbon (non-traded) over Carbon Budget 5 (2028-2032).

The Government currently estimates that around 10% of non-domestic let buildings are below the ‘E’ rating. As from 1 April 2023, a landlord can only lawfully continue to let a non-domestic building if the building has an energy rating of ‘E’. It is possible that in the period after 2023, the landlord’s building does not have a valid EPC because, although one was obtained when the lease was granted, it has expired. EPCs only have a 10 year lifespan.

As part of its package of measures, the Government intends to alter this so that a building must always have an up-to-date EPC during the whole time that it is let. This would cover cases of lease renewal where current guidance suggests that an EPC is not necessary where an existing tenant is renewing its lease.

The Government is proposing two ‘Compliance Windows’ in the second half of this decade, which are as follows:

First Compliance Window: EPC C (2025-2027)

• 1 April 2025: Landlords of all commercial rented buildings in scope of MEES (Minimum Energy Efficiency Standard) must present a valid EPC;
• 1 April 2027: All commercial rented buildings must have improved the building to an EPC ≥ C, or register a valid exemption.

Second Compliance Window: EPC B (2028 – 2030)

• 1 April 2028: Landlords of all commercial rented buildings in scope of MEES must present a valid EPC;
• 1 April 2030: All commercial rented buildings must have improved the building to an EPC ≥ B, or register a valid exemption.

This may be an incremental pathway but landlords be aware because at each enforcement in 2027 and 2030, landlords will need to demonstrate that the building has reached the highest EPC band that a cost-effective package of measures can deliver. In addition, the Government intend to introduce the necessity for landlords to present a valid EPC two years before the relevant enforcement date for each EPC target. In essence, this will involve submitting the current EPC to an online PRS (Property Redress Scheme) compliance and exemptions database. This will trigger a clear time period within which landlords will be expected to undertake improvements if they have not done so already.

This approach is a move away from enforcement at the point of letting.

Dispensing with compliance at the point of letting will assist with the ‘shell and core’ problem. In new ‘shell and core’ lettings, where a landlord lets a unit in a stripped-out condition, with the tenant to fit out (including installation of heating and lighting), at the point of letting, an EPC for the building is likely to give an ‘F’ or ‘G’ rating, thereby making it unlawful for the landlord to let.

Options for compliance would include either the tenant obtaining early access to fit out, or the landlord installing items which the tenant then replaces. While the proposed new framework for compliance would still require a landlord to hold a valid EPC at the point of letting, for the purposes of complying with the MEES Regulations, the building would simply need to achieve a ‘C’ rating by 2027 and a ‘B’ rating by 2030, regardless of when it was let.

For those lettings occurring close to a compliance date, a specific exemption could be introduced. Hence, the Government is proposing to enforce MEES only once a unit is fully operational and has been occupied for at least six months. However, the tenant’s fit out may have a significant impact on the final EPC rating, and thus on compliance. The Government is therefore considering ways in which tenants can take on a share of the legal responsibilities in relation to MEES by imposing duties upon them.

DOES MEES APPLY TO LISTED BUILDINGS? Unfortunately this is unclear. The Historic England website tells us that “From January 2013 there has been an ‘exemption’ for listed buildings. However, the exemption is qualified, it states: “Insofar as compliance with certain minimum energy performance requirements would unacceptably alter their character or appearance”.”(EPC Regulation 5). We also know that MEES only applies to buildings for which an EPC is required and so on the premise that EPCs are not required for listed buildings, this would mean MEES will not apply. In its March 2021 consultation, the Government proposes to catch listed buildings and those in conservation areas – which are to be rented out – to have an EPC (unless a valid exemption is registered).

EXEMPTIONS: It is proposed that the current exemptions available will continue to apply. This will mean (amongst others) that:-

• Standalone buildings less than 50 sq m
• Short term lettings (6 months or less), lettings over 99 years and licences

In addition:

• Landlords will only be required to carry out works that are cost-effective under the 7 year payback test. Broadly speaking, this means that the expected value of savings on energy bills over a 7 year period is equal to, or greater than, the cost of the measures;
• Landlords may continue to let if they can show that the building has reached the highest rating that is possible after undertaking a cost-effective package of measures;
• If third-party consents are not available despite reasonable effort;
• If consent to undertake work to install the required energy efficiency improvements is denied by a tenant, lender planning authority or higher landlord, this will make the landlord exempt from MEES for five years (unless the tenant who denied consent vacates the property);
• Recommended Measures devalue the property by greater than 5%;
• Where a chartered surveyor (RICS registered) advises that installation of specific energy efficiency measures would reduce the market value of the property by more than 5%. This exemption would also last 5 years.

Exemptions last for 5 years (some are as temporary as 6 months) and are personal to the owner of the building. The exemption does not run with the land and so if the building is sold, the new owner must apply to register the exemption and all exemptions must be validly registered in order to be effective. After the exemption expires, landlords will need to reapply with evidence that the exemption continues to apply.

Where someone has become a landlord unexpectedly, it is deemed unreasonable and inappropriate to expect them to comply immediately with the standard. A temporary six month exemption may be used in this case.

ENFORCEMENT:The consultation proposes that letting agents and online property platforms should only be able to advertise and let properties compliant with the MEES Regulations. It is hoped that this will strengthen the existing enforcement regime and encourage greater compliance. Changes are also envisaged to the enforcement period for penalty charge notices. In addition, it is intended that current PRS Exemptions Register be expanded to capture all properties that should be in the scope of the MEES Regulations, so as to enable local authorities to more easily police compliance.

PENALTIES: In addition to the current £5,000 (plus publication penalty) that can be imposed on landlords for registering false or misleading information, or failing to act on a compliance notice, the consultation proposes fines of £5,000 for the following breaches:

• A landlord failing to register its property on the proposed PRS exemptions and compliance database;
• A landlord failing to present a valid EPC by the required dates;
• A landlord registering false or misleading information;
• A landlord failing to provide a post-improvement EPC to demonstrate compliance.

The current fine of up to £150,000 for letting a property in breach of the MEES Regulations would remain.

POTENTIAL LANDLORD AND TENANT ISSUES

COSTS: Landlords may need to install measures in order to bring the premises up to the required minimum standard before they can let. Can the landlord pass this cost on to the tenant? Certainly, in the grant of new leases, landlords will look to pass the cost on to the tenant by way of an enhanced rent and given that the more energy efficient its building stock is, this should reduce tenant outgoings. However, with existing leases, the question of whether costs of energy efficiency works can be passed on to the tenant will invariably be a question of what the lease says about recouping this expenditure under the service charge.

Parties are advised to review their leases as landlords could argue that the tenant would be benefiting from reduced energy bills once the works have been carried out. However, the tenant (depending on the residual length of the lease term) could argue that the works would improve the value of the asset and therefore increase the landlord’s prospects of letting the premises at the end of the lease term.

REINSTATEMENT & DILAPIDATIONS: Many leases require that the tenant reinstate the premises at the end of the term. However, if the tenant has improved the energy rating during its period of occupation, the landlord will want to continue benefiting from such energy rating and so reinstatement may not be necessary. Similarly, if the landlord is required to undertake works on expiry of a lease, in order to lawfully let the premises to a new tenant, the outgoing tenant should think ahead and negotiate with landlords to see if any repair work it must undertake pursuant to the lease is actually necessary.

LANDLORD ACCESS RIGHTS:If the landlord requires access to the tenant’s demised premises in order to carry out works to increase the energy rating, unless the lease reserves a right of access, the landlord will need to rely on the tenant agreeing to grant such access. This could be a problem where the relationship between the parties has deteriorated and thus could be a good opportunity for tenants to renegotiate their position, such as agreeing to grant access in exchange for a rent free period whilst works are being carried out.

SHELL & CORE LETTINGS: Issues arise when commercial premises are to be let in a shell and core state, where it is only the tenant’s fit out that will increase the EPC rating. However, if a shell and core unit does not meet the minimum standard, the landlord cannot lawfully let, and so almost inevitably transactions will require the additional complexity and cost of conditional agreements for lease. In its March 2021 consultation, the Government highlighted this as an issue and stated that for a shell and core property, where the compliance deadline has been missed, that a tenant must have occupied the property for a minimum of six months before a local authority can take action against the landlord for failing to meet MEES.

There needs to be an increased contractual requirement for collaboration between landlords and tenants in leases and landlords must ensure that sufficient drafting is included in order to protect themselves contractually, including obtaining a tenant commitment to complete energy efficiency works within a relevant timeframe (if the EPC rating rests on the tenants fit out), and step-in rights to complete the works (at the tenant’s cost) should the tenant fail to do so. The March 2021 Consultation also addressed a potential amended to the Regulations in order to give tenants of commercial property some duties regarding compliance with MEES, and to add duties of cooperation for both landlord and tenant.

VALUATION: Owners need to consider the existing ratings of properties that they may be planning to sell in the short to medium term. Even if such properties are MEES compliant now, potential buyers will be conscious of the changes coming down the tracks, and this may have an effect on valuation. Only time will tell whether tenants will pay more rent for a property with higher EPC and effectively ESG credentials.

This could be because the tenant believes they must play their part in climate control or the tenants ESG policy dictates that they can only lease a property with a specific rating. Higher rated buildings will attract higher rents and in turn attract higher valuations.

What seems strange to understand is that an old building today could actually become a higher rated building than one with high credentials today. Over the next 5 years, the newer building will deteriorate and potentially fall behind the curve, whilst the older building which is upgraded over time will benefit from newer and newer technology and will be hitting the 2030 deadline at its peak.

Whatever happens, Landlords and lenders show be keeping a watchful eye on these dates and look to spend what has been termed, “Defensive Capex”, in order to ensure that their properties fall within regulations as and when they fall due.

Photo by Li-An Lim on Unsplash