As April 2018 looms ever closer, everyone involved in the private rented sector needs to be aware of the important energy efficiency changes which could seriously hinder, if not prohibit altogether, the letting of property which falls short of minimum efficiency standards.
The Energy Act 2011
The Energy Act 2011 ("the Act") was brought in to assist the UK in meeting its various environmental legislative targets, such as the requirement that carbon levels are reduced by at least 80% in 2050 from 1990 levels and that greenhouse gas emissions from all buildings must be ‘close to zero’ by 2050. In circumstances where 60% of building stock will still be standing in 2050, UK buildings need to become more energy efficient in order to meet these targets.
One of the obstacles to improving the energy efficiency of rented property is the landlords' reluctance to foot the bill for energy efficiency improvements, where it will be their tenants who stand to benefit from the resultant lower energy bills.
The government implemented the Green Deal to address this issue, whereby the energy bill payer paid the costs of the efficiency improvements through the energy bill and also benefited from the lower bills. Under the Green Deal, the bill payer was protected by the Golden Rule which provided that repayments must not be more than the expected energy bill savings.
The Green Deal was not successful, and government funding halted in 2015.
The government hopes that the provisions introduced by the Energy Act 2011 ("the Act") will be more successful. The Act introduces “Minimum Energy Efficiency Standards” which will, for the first time, place a value on energy efficiency.
Residential buildings contribute 25% of Green House gases while commercial buildings contribute 12%. The Standards are designed to improve the energy efficiency of buildings in both the residential and commercial private rented sectors.
Two main measures were introduced by the Act.
1. Tenants' Alterations
This measure only relates to residential private rented property, referred to under the Act as 'domestic'. From April 2016, tenants of residential private rented property have a right to request consent for energy efficiency improvement measures and such consent must not unreasonably be refused by the landlord (where financial support is available).
2. Prohibition on Letting
From April 2018, landlords will be prohibited from letting or continuing to let property that doesn't meet minimum energy efficiency standards (namely below an EPC rating of E). The prohibition on letting relates to both residential and commercial private rented property.
If the energy rating falls below an "E", the landlord will be prohibited from letting (or continuing to let) that property unless it carries out energy efficiency improvement works to raise the rating to an “E" or above.
It is important to note that the prohibition will apply to the grant of all new tenancies and the grant of any tenancy the result of an extension or a renewal of an existing tenancy - both residential and commercial. This will, therefore, catch contractual options to renew, term extensions by way of reversionary leases and, in the commercial context, 1954 Act renewals.
Owner occupied property and property that has vacant possession are not caught by the Act.
It is important to note that, from 1 April 2023 (commercial) and April 2020 (residential), the regulations will extend to all properties where a lease is already in place – i.e. mid-term, long leasehold properties.
2.1 Commercial property
There are three types of commercial leases that are not captured by the provisions:
(i) Where an EPC is not required in any event, for example:
- Listed buildings (but only where compliance unacceptably alters character or appearance)
- Places of worship
- Temporary buildings
- Certain industrial / agricultural buildings
- Shoeboxes (<50m2)
(ii) Short term lettings of 6 months or less (provided the tenant will not have occupied the property for more than 12 months).
(iii) Leases of 99 years or more.
Exemptions for Commercial property
The regulations include a number of safeguards to ensure that only appropriate, cost effective improvements are required. Landlords may be exempted from reaching the minimum standard if they are able to show that one of the following exemptions applies:
- The measures are not cost-effective, either within a seven year payback, or under the Green Deal’s Golden Rule;
- Despite reasonable efforts, the landlord cannot obtain necessary consents to install the required improvements, either from tenants, lenders or superior landlords;
- A relevant suitably qualified expert advises that the measures will reduce a property’s value by 5% or more.
2.2 Residential Property
The following residential tenancies are excluded:
- Housing Association rentals
- Low cost home ownership accommodation
- Temporary buildings or those earmarked for demolition
Again, a number of exemptions may apply, as follows:
(i) The property remains below an E rating despite cost effective measures having been taken (ie applying the Green Deal’s Golden Rule);
(ii) the landlord cannot obtain necessary consents;
(iii) a relevant suitably qualified expert provides written advice that the measures will reduce a property’s value by 5% or more.
Considerations for Valuers
In preparing a valuation for secured lending purposes, a valuer must ensure that the lender is advised of the risks to the potential future value of the asset to the cash flow it may generate.
EPC certificates should therefore be obtained where available and considered carefully before the valuation figure is prepared. It is important that the valuer does not stray outside of their area of competence; or proffer advice or make assumptions that then prejudice their own professional indemnity insurance.
Indeed, the valuer may identify where risk exists, but must recognise their limitation and only incorporate likely capital expenditure charges where they have obtained them from a reliable source and discussed them with the client (the report must refer to the source of figures).
So what should the valuer be seeking? If the property asset is being traded, then the valuer must request the EPC or EPCs; failing that, they should consult the EPC Registers. It is possible that, if the property is not being traded – for instance, because it is being refinanced – or existing lettings pre-date the 2008 legislation, certificates may not be available, although these situations are becoming rarer.
The valuer must ensure that they have sight of the 'recommendation' section of the certificate, which will set out what can be done in the short, medium or longer term to improve the rating of the property.
Where a rating is edging towards the danger zone or is already in the F or G bands, the valuer should advise that the steps recommended to improve it be properly costed by a building or quantity surveyor, as it is probable that these expenses will fall to the landlord – (ie the borrower) – at lease expiry.
If a property is being acquired on the open market, it is likely that the purchaser has already factored this risk into the price, although this should not be taken for granted. It is a situation that needs particular consideration with a refinancing, as a borrower may not have reflected the cost in their assessment of market value. In such circumstances the valuer will need to ensure that any risk is taken into account and that the lender is advised accordingly.
If preparing a vacant possession assessment, the valuer should certainly be looking to factor these costs in to ensure the property is fully marketable.
It is also worth bearing in mind that some lenders require an EPC less than two years old. The 'age' of the EPC should, therefore, be flagged in the valuation, with an appropriate assumption that it will be accepted by the lender unless communicated otherwise.
Also worth remembering that the monitoring of EPC assessors remains unregulated so the valuer should flag any doubts they may have.
The valuer should query how voids are assessed and consider that there may be other irrecoverable costs e.g. empty rates or service charge shortfalls if the property may be unlettable after April 2018/2020 due to failure to comply with the regulations.
Furthermore, the property may become less valuable as a result of the required capital expenditure that may be irrecoverable.
All these issues should be considered and flagged to the lender.
The RICS Valuation Sustainability Task Force advises valuers to incorporate explanatory text about the upcoming changes within their valuation reports and has drafted example wording to assist in providing clarification to clients and to offer a degree of protection to the valuer. The phrases will not cover all circumstances but are worth becoming familiar with to safeguard against potential issues which may arise in the future.
Estate Agents, conscious of the duties of both commission and omission contained in the Consumer Protection from Unfair Trading Regulations 2008, will also need to be fully alive to the issues for marketing property for their clients. So too letting and property management agents, given that if letting prohibitions arise as a consequence of failures to commission certificates and/or implement any recommended measures to move out of any E or lesser banding, the finger of blame is likely to be pointed in their direction.
Finally spare a thought for the poor EPC inspectors, often but not exclusively trained surveyors themselves. At the risk of stating the obvious, they may find themselves coming under pressure from landlords and/or their agents when assessing the energy efficiency of any particular property but must stand firm. If conditions warrant a sub-D banding they should stick to their guns but retain careful notes about the decision making process just in case they are challenged at a later date.