Landlords beware! Katie Somerville assesses the significant potential impact on commercial property of the new minimum energy efficiency standards recently approved by Parliament.
In one of its final sessions before the general election, Parliament passed the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015, bringing into force the long-awaited minimum energy efficiency standards (MEES).
The Energy Act 2011 is the legislation that enacts minimum energy performance standards. As landlords have been waiting for the timings and details of the proposed Regulations since this Act, the certainty of the final Regulations is likely to be a welcome development.
The Regulations apply to both domestic and commercial premises. In the last edition we outlined their application to residential property, so this article only considers the implications of the new Regulations for commercial property.
The compliance burden imposed is significant.
The Government proposes to introduce an online PRS Exemptions Register, which will be operated by the Department of Energy & Climate Change to act as a centralised database to monitor exemptions. The register will be open to public inspection and will require notification and supporting evidence of any properties considered to be exempt.
Failure to register an exemption will amount to non-compliance with the Regulations and render the exemption ineffective.
A civil fine calculated by reference to the rateable value of the property, up to a maximum of £150,000, will be payable by landlords who fail to comply with the Regulations.
The Regulations are somewhat unspecific in discerning how costs should be managed between landlord and tenant and leave this issue to be addressed by reference to the relevant lease. The question of which party is liable for payment will therefore be dependent upon the measures taken, to what parts of a property they are made, and at what times.
As most improvements will be made at the time of a new letting, the cost burden will usually fall upon the landlord. However, there is the potential that service charge and indemnity clauses could be wide enough, depending on respective commercial bargaining positions, to allow for certain costs to be shifted onto the tenant.
Tenants will also need to be conscious of the Regulations if they are considering granting any subleases.
Scope of the Regulations
From 1 April 2018, the Regulations will prevent landlords from being able to let a commercial property with an F or G rated Energy Performance Certificate (EPC), initially applying to new lettings and lease renewals.
The scope of the Regulations is set to widen from 1 April 2023 to apply to all privately rented commercial property, including those subject to existing leases.
With approximately 18% of the commercial building stock (200,000 properties in total) rated F or G, raising the bar to a minimum E standard ensures that these Regulations cannot be ignored.
Certain lettings will fall outside the scope of the Regulations. For example, they will not apply to:
- properties that do not require an EPC on letting;
- properties that are let for six months or less (provided that the same tenant has not been in occupation for over 12 months), or where the lease is for a term of 99 years or more.
Exemptions will also extend to lettings where:
- it is not cost effective for the landlord to undertake the necessary work (cost effective generally means a payback period of seven years or less);
- reasonable efforts on the part of the landlord to obtain consents to install energy efficiency measures (i.e. from the tenant, superior landlords or lenders) are unsuccessful; or
- a suitably qualified independent surveyor asserts that the required improvements are expected to devalue the property by more than 5%.
Exemptions will expire after five years. The requirement for reevaluation at expiry indicates that the exemptions are essentially just deferrals until such time as the landlord is able to carry out necessary measures.
What next for landlords?
Although the implementation of the Regulations may feel like a long way off, in terms of risk minimisation in the real estate sector, this time frame will not allow for complacency.
Landlords should be identifying the potential impact of these changes to their own portfolios now and where they have properties that will be caught in the Regulations’ net, looking to put in place an energy efficiency plan for bringing properties up to at least an E rating, where possible.
The UK has set targets to reduce the country’s greenhouse gas emissions by 80% by 2050. For this to be achievable, the current average EPC rating of D will undoubtedly have to improve.
However, it is not clear from the Regulations exactly what course energy efficiency measures will take in the future. Disappointingly, the government has not set a trajectory for MEES and instead it has set a review of the Regulations for 2020 and every five years thereafter. Some uncertainty still remains and this will cause a degree of difficulty for landlords in deciding how far to go with improvements to their properties.
In the run-up to May’s election, Labour stated its intention to impose a minimum EPC rating of C by 2027. It is therefore safe to say that, whoever inhabits number 10 in the future, the implementation of the MEES Regulations is likely to be just the beginning.
This article originally featured in our summer edition 2015 commercial property newsletter.