It will be illegal to let or renew the lease of a property that does not meet energy efficiency minimum standards from 1 April 2018. It is estimated that 20% of UK commercial property will be impacted, writes Robert Fairbairn, Director at south coast commercial property agents Goadsby:
From 1 April 2023 the regulations will apply to all leases of properties that have an Energy Performance Certificate (EPC).
WHO WILL THIS AFFECT?
This will affect sales and purchases of investment property, the grant and renewal of existing tenancies, and existing landlords and tenants. The effects of this will be widespread.
Lenders will be particularly concerned that a property that cannot be let will not be income producing and may not be considered to be a suitable security for a loan.
KEY POINTS TO THINK ABOUT
1. Is my property affected?
a. Your property will be affected unless it is Listed, is a place of religious worship, is a temporary building with low energy usage, is scheduled for demolition or is detached and less than 50 square metres in size.
b. The Energy Act 2011 is the source of MEES obligations (s.49 (1) and (6)). If a property that does not have a rating between A or E it will not be legal to let it. The sanction is a fine of up to £150,000, based on rateable value.
c. Properties that require EPCs are affected. Properties that are let for less than 6 months or more than 99 years are not affected.
d. There are some temporary exemptions, but they have to be claimed and registered on a central public register. The exemption will last for 5 years. The categories of exemption are:
i. There are no cost-effective (i.e. cost payback from energy savings in 7 years) improvements that can be carried out.
ii. Attempts to improve the energy efficiency of the property have failed because of existing restrictions or tenant refusal.
iii. An accredited report indicates that carrying out the work would devalue the property by more than 5%.
iv. The landlord is legally bound to lease or renew a lease on specific terms.
e. Exemptions are personal and not transferable (e.g. to a buyer). The buyer has 6 months to improve the property or demonstrate that an exemption should be granted.
2. Can the property be improved to meet the standard?
Some works that can improve the rating can be very cost effective, such as upgrading to more efficient lighting. Other works that may improve the rating include upgrading the boiler and improving insulation; in some cases improvements to the fabric of the building may be necessary and these could be costly and affect the valuation of the building.
Each property needs to be looked at individually. Robert Fairbairn of Goadsby reports that he is already undertaking investigations on behalf of some landlords.
3. Does the landlord have the right to carry out improvement works?
The answer to this question will depend primarily on the terms of the lease. If the improvements can be carried out without the landlord needing to gain access to the tenant’s premises or infringing the rights granted to the tenant, or if the lease gives the landlord a right to enter the tenant’s premises to carry out improvements, there should be no difficulty in principle.
In other cases, it may well be necessary to obtain tenants’ consent, and tenants may well impose conditions and/or want something in return.
4. Can the tenant behave in such a way as to impact the landlord’s exposure to MEES risk?
a. Yes, unless the lease provides protection. This depends on the lease terms. For example, the landlord is commonly not able to withhold consent for the tenant to carry out improvements. Whether a particular piece of work is an improvement is judged from the tenant’s perspective. Some improvements could lower the EPC rating, for example, in a shop the tenant may want to install an inefficient air curtain heating system over the entrance; this could push the EPC rating below the minimum threshold.
b. A well-drawn new lease will provide the landlord with various protections so that the landlord is able to refuse consent to works that would adversely affect the environmental performance of the property. Landlords should be seeking to introduce this kind of provision whenever the opportunity arises to do so.
5. Will there be an effect on rent review?
a. Yes, unless the lease provides protection in the rent review provisions. For example, if the premises with a review to open market rent fall below the minimum energy efficiency threshold the tenant is likely to argue that there is no evidence of rental value in the open market as letting the property would be illegal.
b. A well-drawn new lease will address this and include appropriate rent review assumptions. Landlords need to plan ahead how they can introduce these vital protections.
6. What impact does MEES have on repairing obligations?
a. The lease needs to be looked at carefully. In a standard multi-let, full repairing and insuring lease, the responsibility for external and structural repair may fall primarily on the landlord, with an ability to recoup the cost from the tenants. Whether such an arrangement would allow the landlord to upgrade the property by improving its energy efficiency, preserving or enhancing its capital value, at the expense of the tenants, who may benefit from reduced operating costs through greater energy efficiency, is very much open to doubt and unlikely to be specifically covered in historic lease drafting.
b. An argument that is sometimes raised is that that most leases will impose an obligation on the tenant to comply with statutory requirements and this should cover the MEES obligations. This is unlikely to hold up, depending on the precise wording. Normally, the tenant has to comply with “requirements” relating to the condition of the property: the MEES obligation is not to let sub-standard property – there is no requirement to improve it as such.
7. Can the risk be mitigated on renewal?
a. An existing lease of business premises, which is not protected by the Landlord & Tenant Act 1954, can be renewed upon whatever terms the parties are able to negotiate. A protected tenancy is different in that the tenant is entitled to a court order for a new tenancy and the court will not generally order a new lease on significantly more onerous terms than the old one. This has not been dealt with in the new regulations and could put a landlord in a difficult position.
b. When a lease comes up for 1954 Act renewal, the following summarises the base position that the court will work from on lease terms, other than rent and term:
i. The court will use the terms of the existing lease as a starting point.
ii. Where a change is required, it is for the party proposing the change to demonstrate that would be reasonable for the court to order it.
iii. The court does not have to take account of market practice.
iv. The court will permit reasonable updating.
v. For the court to insist on a change against the wishes of the tenant, the court will want there to be a good reason for doing so on the basis of essential fairness in all the circumstances.
c. In view of the above, a landlord may need to demonstrate the likelihood of lower operating costs for the tenant by carrying out works to improve the EPC rating. It may be that this will be clarified in due course.
HOW WILL THIS AFFECT LENDING AND EXISTING RELATIONSHIPS WITH LENDERS?
Already most Landlords are getting their valuers to comment on EPC ratings. It is likely that it will be a requirement to upgrade the EPC rating as a condition of any advance. This will be a cost that will impact on the value of a property.
Lenders will be concerned that a poor EPC rating has the potential to disrupt the income stream if a property cannot be let because of a low rating or there is a void while upgrading takes place. Lenders will also be concerned about the long-term performance of properties with a poor EPC rating and the effect on property valuations and loan covenants.
Lender’s consent may well be required for physical alterations/upgrades.
WILL THESE CHANGES BE AFFECTED BY BREXIT?
No. Although much of the energy efficiency legislation stems from EU directives it is written into UK law and the government has renewed its commitment to carbon reduction.
