Assuming the government’s proposed changes to the Minimum Energy Efficiency Standard Regulations come into force, in 2030 it will not be possible to let or continue to let commercial premises that are rated below EPC A or B. There is also a possibility of an interim transition period which would prevent lettings of premises rated below EPC C from 2027, only four years away.
What does this mean in practice?
Whether you have premises that are let today for a term that expires after 2027/2030; are looking to grant a lease today for a term of four or more years; or have a lease which expiries before 2027/2030 and you will be reletting the space, the question to ask is whether the premises have a rating of EPC C or D (on the basis that the minimum standard is currently E)?
If the answer is “yes”, then do you know what improvement works to the physical fabric and/or mechanical and electrical systems can be carried out to achieve the required minimum rating?
This is not just about the recommendations on the back of the EPC to enable a claim for a MEES exemption if the property cannot be brought up to standard. This is about a detailed technical analysis of what works in practice are possible that will improve the rating sufficiently. Then, how much will these works cost, what third-party consents are required, how will the works be funded and how long will it take to procure that these are carried out?
EPCs are valid for 10 years. On expiry of existing EPCs you should not assume that you will necessarily get the same rating as the methodology for calculating EPCs has changed over time. This is not just about looking at your EPC today, it is about checking when it expires and understanding any risk that you do not obtain an A/B rating on renewal.
These are not just considerations for landlords. These questions must be asked by occupiers, investors and funders. All will be impacted by the potential adverse impact on lettability and values from not complying by 2030 and void costs of unlet space. Ultimately the risk is owning or funding “stranded assets”. All stakeholders need to buy in to a strategy to own/occupy/finance energy-efficient buildings.
Tenants should have their eyes open to potential issues down the line even if they are not necessarily directly liable for breach of the regulations. Tenants need certainty on total occupation costs and business continuity. From an ESG perspective, does the building they occupy meet their strategy?
Yes, certain exemptions might apply (for example the “consent” exemption where you cannot obtain a required third-party consent, such as planning permission or superior landlord/tenant approval) but this just kicks the can down the road. The exemptions last for five years then the owner must try again to improve the rating. The point being, you still own or occupy a building that does not meet the required standard.
Collaboration is key
There will be relevant space that does not meet the minimum standard that is not occupied. That allows the landlord free rein to carry out the required improvements and it means new lease drafting can provide up front for the solution for how and when works will be completed and potentially the commercial deal as to cost.
If tenants accept additional costs to facilitate environmental improvements this may depress rents. But ultimately we are seeing more tenants demanding “green space” and a premium is being paid for that. Tenants are being drawn to premises that support or enhance their carbon commitments. Potentially a deal can be done as issues such as reputational risk and legal reporting risk drive outcomes as well as commercial reality.
But we believe a vast amount of space that does not meet the minimum standard is already let. The challenge for let space is collaboration between the landlord and the tenant. Landlords need an action plan to transition away from fossil fuel heating and improve energy efficiency and tenants need to take ownership for things like energy usage and energy performance of fit-outs.
Standard form leases will not necessarily permit landlords to enter premises to carry out works of this nature, even in a multi-let service charged building. Early discussions on what needs to be done, the mutual benefit (including potentially lower energy costs for tenants) and delivery methodology are important.
Tenants may claim compensation if they consider that their business and/or occupation has been disrupted by improvement works. Landlords may need tenants to move around the building to facilitate the works and will need to check whether their leases enable them to require the tenants to relocate. Lease drafting must cater for all this.
Whether for new or existing leases, the market has to settle on a position on how costs of improvement works are split and the ability to capture refined data which goes to the heart of how we can make buildings more efficient. That split has to become part of the established balance of liabilities between landlords and tenants. Leases must include repair, data and energy efficiency improvement clauses that are designed to cover sustainable and circular economy principles so the building is future proofed.
The clock is ticking and the time to address the practicalities of complying with MEES in 2030 need to be addressed now. The commercial real estate market is embracing change, in theory, but we are not seeing the changes in practice at the pace needed.
Richard Vernon is partner and practice group head for EMEA/US real estate at Ashurst
