Author: Roy Perrott
Since 2008, it has (subject to limited exceptions) been compulsory to supply an energy performance certificate (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, an “A” rating being the most energy efficient and a “G” rating the least efficient. It would be fair to say that EPCs have, until recently, had little effect on the property market. However, we are now starting to see some tenants and buyers either threatening to pull out of transactions because the property has a low EPC rating, requiring the landlord or seller to carry out works to improve the energy rating, or seeking to chip the price. As you will see when you read on, we expect this practice to become more widespread over the coming years.
Minimum “E” rating
The Energy Efficiency Regulations 2015 provide that, with effect from April 2018, a landlord will not be allowed to grant a new lease of a commercial or residential building if it has an energy rating lower than an “E”. From April 2023 (or 2020 for residential property), existing leases will also be caught. From that date, a landlord will have a window of just six months in which to carry out any improvement works needed to bring the property up to an “E” rating. A landlord who fails to do so commits an offence.
It is important to note that a lease that does not comply with the Regulations will still be legally binding. However, the landlord will be at risk of fines of up to 20% of the property’s rateable value (to a maximum of £150,000). Offending landlords may also be “named and shamed” on a public register.
There are various exemptions and, as ever, the devil is in the detail. Long leases (99 years plus) are not caught and neither are very short leases (six months or less). An exemption that we expect to see being used a lot is where the landlord has unsuccessfully tried to get the tenant’s consent to carry out energy improvement works. However, this exemption lasts only for five years and evidence of the steps that the landlord has taken to obtain consent must be filed.
This rather alarming legislation has been waiting in the wings for quite a while. The relevant provisions, but not the detail, were included in the Energy Act 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 in that time. Until recently, there was uncertainty whether the proposals would be modified or scrapped after the General Election. This probably contributed to a general lack of awareness among property owners. Without tangible benefits such as a return on their investment, very few owners have carried out energy upgrades to their portfolio. It has been estimated that it will cost £29 billion to turn all the buildings in the country that are currently rated “F” or “G” into an “E”.
What are the implications of the Regulations? The most obvious concern is the cost of upgrading property that does not currently comply. For a time, it was possible to spread the cost under the Government’s “Green Deal” scheme but this was only ever available for domestic property and the scheme has, in any event, since been closed. Some in the property management sector might argue that improvements in energy efficiency are self-funding within a relatively short time frame, however this is of little consequence to a landlord that is not in occupation and therefore not paying the bills.
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 three years are staggering. There is evidence that some lenders are now reluctant to lend on properties with an “F” or “G” rating. Some buyers are also starting to ask for price reductions. We have personal experience of a tenant refusing to take a new lease of a “G” rated building until works had been carried out to upgrade the building to an “E”. 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 with the Regulations, therefore, may need energy improvements before the EPC expires.
Landlords have a lot to think about between now and 2018. It would be easy to rush into redrafting standard forms of lease but the issues are not straightforward. The tenant of a multi-let building, for instance, may object to being required to contribute to the cost of an energy upgrade through the service charge, especially if it cannot see a benefit from the works. The landlord may need a right of access to carry out the works but tenants will be concerned about the possible disruption to their business. Moreover, a right of access may be self-defeating if it prevents the landlord from claiming the five year exemption referred to above.
Greater control may be needed over tenant’s alterations for fear that those works may lower the building’s energy rating. 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”? Should the yielding up clause require the tenant to yield up the premises with at least an “E” rating, and what effect would that have on rent review? Existing leases present similar challenges, with the added complication that, if the lease needs amending, the tenant needs to be persuaded to vary it.
Roy Perrott, Professional Support Lawyer, Fladgate LLP (firstname.lastname@example.org)