Energy efficiency rules for UK commercial property to tighten from April 2023
Published on 16th Nov 2022
Landlords have five months to comply before sub-standard EPC ratings become unlawful for existing lettings
The Minimum Energy Efficiency Standards (MEES), established in The Energy Efficiency (Private Rented property) (England and Wales) Regulations 2015, were first implemented in April 2018 and currently require that landlords granting a new lease of a commercial premises must hold an energy performance certificate (EPC) with a rating of E or above, unless they have registered a valid exemption. Commercial properties with an EPC rating of F or G are considered "sub-standard".
From 1 April 2023, the regulations are tightening and it will become unlawful for a landlord to "continue to let" a sub-standard property unless they have made all possible cost-effective energy efficiency improvements prescribed by MEES or one of the exemptions applies.
With under five months to go and compliance not necessarily a quick process, landlords of existing leases of commercial premises that fall below this standard will need to act soon. All commercial landlords should take note that the tightening of obligations under MEES will not end after 1 April 2023.
The UK government views the improvement of EPC ratings as playing an important role in achieving its goal of net zero by 2050. The prime minister, Rishi Sunak, highlighted in his speech last week to the COP 27 climate summit in Egypt that the UK was on course, in the meantime, to fulfil its "ambitious commitment to reduce emissions by at least 68 per cent by 2030".
The intention, which the government set out in detail in its December 2020 white paper on the transformation of the UK energy system and the delivery of net zero, is that all rented non-domestic buildings achieve an EPC of C by 2027 before attaining B by 2030. On current assessments, only 12% of all registered commercial properties meet this criteria: the country has a long way to go to meet this goal.
And with budgets tightening and prices rising as a Bank of England-predicted recession looms, it is imperative that landlords consider MEES compliance in their financial planning and ensure they do not let it fall down the priority list and risk significantly devaluing their assets.
Which tenancies does MEES apply to?
The MEES regulations apply to all non-domestic properties that are let pursuant to either an assured tenancy or a regulated tenancy (or a domestic agricultural tenancy) and are legally required to have an EPC. However, the MEES regulations do not apply to tenancies of over 99 years or of less than six months (with no option for renewal).
The requirement to get an EPC (if one is not already in place) is triggered when certain alterations are undertaken, on the construction of new properties and where a property is sold, assigned or rented. The EPC certificate is issued by an assessor and is valid for 10 years from registration on the EPC Register.
Premises that are not required to have an EPC include: certain listed buildings, holiday accommodations that are rented out for less than four months a year or let under a licence to occupy, and industrial sites and workshops that do not use a lot of energy.
Why does compliance matter?
Landlords that let a sub-standard property (without a registered valid exemption) will be liable to two significant penalties: a financial penalty and a publication penalty. The financial penalties that can be imposed are for letting a non-compliant property for a period of less than three months - a fine of 10% of the rateable value with a minimum fine of £5,000 and a maximum of £50,000. For letting a non-compliant property for a period of more than three months, a fine can be imposed of 20% of the rateable value with a minimum fine of £10,000 to a maximum of £150,000.
It is likely that the costs which would be incurred in making the required improvements to make the premises MEES compliant could be very quickly outstripped by the potential penalties involved in not making them.
In terms of the publication penalty, details of a breach may be entered onto the publicly accessible part of the Private Rented Sector (PRS) Exemptions Register. For some landlords, particularly those with large portfolios or higher-profile reputations, the risk of adverse publicity (which may affect the attractiveness of properties to new tenants, buyers or investors) could be a greater deterrent than the financial penalty.
However, if an exemption applies, a landlord can enter details of a commercial premises to the PRS Exemptions Register and continue to let a sub-standard property without any enforcement action being taken. Some of the available exemptions are:
- The seven-year payback test. This applies if the improvement works necessitated by MEES are not paid for within seven years by the energy savings from the works.
- Third-party consent. Depending on the circumstances, certain energy efficiency improvements may legally require the consent of a third-party before they can be installed at the premises. For example, the improvements could include external wall insulation or solar panels, which require local authority planning consent or, perhaps, the consent of a mortgagee of the premises. Where the landlord has used reasonable efforts but has been unable to obtain required consents, this exemption applies.
- Devaluation. This applies when the landlord has obtained a report from a surveyor that advises that the installation of energy-efficiency measures would result in reducing the market value of the premises (or the building that the premises forms part of) by 5%.
The exemptions generally last for five years, after which the landlord must try again to improve the EPC of the premises in accordance with MEES. If this is still not possible, then a further exemption may be registered. The exemption must be registered in advance for a landlord to be able to rely on it without risk of attracting penalties, and exemptions are not transferable to a buyer if the property is sold.
Landlords should also note that if they purchase a premises that is subject to existing tenancies and holds a sub-standard EPC rating, they will be able to register a six-month exemption in order to give them time to bring the premises up to the required energy efficiency standard. This gives purchasers some well needed breathing space to assist with their portfolio management strategy. A purchaser should be aware of the requirement to carry out the works in the course of negotiations with the seller, as it should be a consideration when negotiating the purchase price.
Portfolio management and tenant relations
Under the MEES regulations, it is landlords that are expected to fund and carry out the improvement works. Whether a landlord can recover any of these costs back from the tenant will depend on lease provisions including reinstatement obligations, service charge, statutory compliance and consents.
Landlords should be aware that they do not have an automatic right to enter the premises using the justification of carrying out EPC improvement works. Whether a landlord has these rights if access will depend upon the lease drafting and if there is no such right then, tenant consent will be required. If consent cannot be obtained, the landlord may then be able to obtain a third-party consent exemption.
Impact for investors and lenders
Where developers or investors own the reversionary interest in freehold assets where the headlease is over 99 years, they will not be liable under the MEES regulations; but they should still consider how the value of the assets can be affected by the obligations falling on tenants and sub-tenant. Where the headlease is less than 99 years, investors should also be wary of which landlord in the chain is liable for MEES improvements under the headlease.
Lenders will also need to be wary of how the upcoming deadline can impact their security. Should premises subject to charges not comply with the MEES regulations by 1 April 2023, the value of the lender's security may decrease and the landlord may not be able to make required payments due as a result of penalties incurred due to non-compliance. Lenders may need to consider MEES as part of their lending criteria and monitoring of existing charges.
Landlords need to act promptly to prevent any financial and reputational exposure under the MEES regulations, as the deadline fast approaches, and should:
- Check the EPC of their premises and consider both the rating and whether a new assessment is required.
- Register any available exemptions (taking note of any expiration dates).
- Weigh the advantages and disadvantages of making cost-effective improvements to meet the requirements from 1 April 2023 or consider making more substantial improvements to meet the requirements that are forecast to follow in 2027 and 2030. In making more substantial improvements now, a landlord may be able to increase the value of the premises, which might make the works more commercially viable as they deliver greater long-term benefit.
- Ensure that the grant of any new leases includes sufficient access rights provisions that enable them to readily comply with MEES requirements.
- Consider if they are able to recover costs of improvements through the service charge provisions of the lease (which generally just cover repair and maintenance costs).
Osborne Clarke comment
Landlords need to prepare for the upcoming MEES deadline and work collaboratively with their tenants, who should benefit from lower utility costs; however, investors, lenders and purchasers must also be alive to the widescale implications of these tightened regulations.