Author: Roy Perrott
Energy Performance Certificates (EPCs) have been around for a few years. Since 2008, it has (subject to limited exceptions) been compulsory to supply an EPC for any property, commercial or residential, being let or sold. Most clients will now be familiar with the grading that EPCs confer on a property, with properties with an "A" rating being the most energy efficient and those with a "G" rating the least efficient. It would be fair to say that EPCs have, until now, had little effect on the property market. Energy bills continue to rise but we are not aware of tenants or buyers having pulled out of a transaction because of a low rating or sought to chip the price. Most buyers know what they are buying and so the EPC does not often come as a surprise.
This may be about to change. From April 2018, under current proposals a landlord will not be allowed to let a commercial or residential building that does not have at least an "E" energy rating. This rather alarming legislation was actually passed in 2011. It was understood that the industry would need time to carry out the necessary energy improvements so the implementation date was put back to 2018. However, little has happened over the last three years. This is surprising when one considers that, according to a recent editorial in the Estates Gazette, it will cost £29 billion to turn all the buildings in the country that are currently rated "F" or "G" into an "E". We do not yet know for sure whether "E" will be the minimum threshold as the enabling regulations are yet to be introduced. There is some speculation that the threshold may be lowered to "F", or that the legislation will be delayed. There is even talk that the proposals will be scrapped altogether, which would not be that difficult politically as they were originally introduced by the previous Labour government and go beyond what is required under European law.
Assuming for the moment that the proposals do go ahead, what are the implications? The most obvious concern is the cost of upgrading property that does not currently comply. It may be possible to spread the cost by signing up to the government’s "Green Deal" "cash backs" for certain expensive improvements to domestic property. This enables a domestic property owner to obtain funding from a Green Deal provider to carry out certain of the necessary improvement works. The cost of the works is then repaid over a number of years by means of a levy on the property’s utility bills. However, take-up so far has been low. An important consideration is the so-called "Golden Rule", which provides that the energy savings over 25 years must at least equal the cost of implementing the improvements. A further issue is the high interest cost of about 7%. The Green Deal still has not been rolled out to commercial property owners however.
Others in the property management sector argue that many improvements in energy efficiency are self-funding within a relatively short timeframe and may be of direct benefit to both landlords and tenants. Energy use audits can help to evaluate the costs versus the benefits.
It is thought that about 15% of commercial property in the UK is currently rated "F" or "G". The logistics of upgrading 200,000 properties in four years are staggering. The uncertainty surrounding the proposals has probably contributed to a general lack of awareness among buyers and tenants but there is evidence that some lenders are now reluctant to lend on properties with an "F" or "G" rating. Buyers may also start to ask for price reductions. The Estates Gazette article reported that an institutional investor recently reduced its offer for a large central London office block by 5% on late receipt of an "F" rating. There is also the risk of complacency. A building with an "E" rating now may slip to an "F" or "G" when the EPC is renewed (EPCs only last for ten years). Even buildings that currently comply, therefore, may need energy improvements before the EPC expires.
What of the effect on existing leases? With much detail still missing, and the uncertainty of whether the proposals will be introduced in their current form, or at all, it does not make sense at the moment to try to amend existing leases.
The legislation will, at least, not be retrospective so there is no question of existing tenants being evicted in 2018 if the building does not comply. However, if the proposals do go ahead in their present form, there are troubling implications for landlords with existing tenancies who want to upgrade the property to an "E" grade. Most service charge clauses will probably not allow the landlord to upgrade the property so that it complies and the lease may not even give the landlord sufficient access to carry out the works. Why should a tenant pay for works from which it may not benefit just so that the landlord can relet the property? Will the rent review clause in new leases need to disregard the existence of the Energy Act and how likely is that to be accepted by the tenant? What about the repairing covenant? Even premises with an "F" or "G" rating may be in good repair. Should the lease prohibit the tenant from doing anything that might push the building below an "E"? Will the yielding up clause require the tenant to yield up the premises with at least an "E" rating? What are the rent review implications of all these onerous tenant’s covenants?
For now, all we can do is sit and wait. With the clock counting down to the next general election, there is a chance that we will not see any further movement on this until after then.
Roy Perrott, Professional Support Lawyer, Fladgate LLP (firstname.lastname@example.org)