Continuing his series on the Minimum Energy Efficiency Standard Regulations, Ben Strange looks at the effect of MEES on tenants’ works, service charges and rent reviews.
The variability of EPC ratings – as explained in last week’s article – is increasingly well recognised and commonplace, resulting in a significant unknown and unforeseen issue for landlords. While a cause for concern and action in its own right, this is compounded by the prospect of a tenant seeking to undertake works to a given property, particularly where those works are to be subject to a licence to alter.
MEES and tenants’ works
A licence to alter is intended to set out a landlord’s consent for their tenant to undertake certain defined works to a demised property, and the terms on which that consent is granted; be that the manner in which the works are undertaken, building rules which the tenant’s works must adhere to and, indeed, any terms of reinstatement.
The terms of reinstatement agreed in a licence to alter can fundamentally change the form of the property that the tenant has to provide back to the landlord at lease end. There are many variations of the reinstatement requirement incumbent on a given tenant within such a licence; for instance:
- full reinstatement: requiring the tenant to remove all alterations made and put the property back to a position as if their works had never been done;
- no reinstatement: requiring the tenant to leave their alterations in place, usually in a condition otherwise compliant with the lease terms; and
- partial/prescribed reinstatement: for example, where a landlord may ask for a tenant to undertake works of reinstatement to a degree and standard reasonably so requested.
The first two of these options in particular could result in significant loss to the landlord, as presented in example 1. Based on examples 1 and 2, the drafting of a licence to alter is absolutely vital and MEES must be taken into account.
Even in the case where a landlord can ask for partial or specific reinstatement, that request needs to be carefully considered in itself to ensure that the landlord does not inadvertently request the return of their property in an unlettable condition.
Example 1
A central Manchester office has been let in 2015 on a 10-year lease. The EPC rating when the lease was executed was G, this reflecting the presence of inefficient building services and the building consisting of generally poor building fabric including large single-glazed windows. The lease was granted lawfully in 2015 (when the MEES Regulations were not yet in force).
The tenant undertook fit-out and improvement works on occupation under a licence to alter. These included upgrading the air-conditioning and light fittings, and installing secondary glazing. The EPC rating resulting from those works was D. The licence committed the tenant to removing all of their alterations on vacation and yielding up the property as demised, but in repair.
In 2022, the tenant approaches the landlord requesting a surrender of the lease. The landlord proposes terms including full liabilities to term (comprising rent, service charge and rates), plus a sum for dilapidations.
The tenant rejects this approach on the grounds that now – under the MEES Regulations – the property they are liable to yield up is incapable of being relet, so the property in fact poses a liability to the landlord if the landlord enforces a contractually compliant surrender.
Instead, the tenant proposes a substantially lower surrender premium, based on their agreement to vary the terms of the licence and leave their alterations in place, thus enabling the landlord to re-let the property. The value of the tenant’s works in this instance would drive the case for a surrender on their terms.
Example 2
A Grade II listed property in central London is let with a dated fit-out originating from a previous tenant. Despite being poorly insulated and having dated services, with it containing no air-conditioning system, the property’s EPC rating is D so the letting goes ahead lawfully.
The incoming tenant seeks the landlord’s consent to undertake significant alterations, updating the property fully and installing air-conditioning. The landlord, noting that such an improvement seems immediately beneficial to its asset, grants consent under a licence to alter, and requires the tenant to yield up the property – as altered – in good repair.
The works proceed and the tenant obtains an EPC on completion. Despite the works improving the marketability of the property, the introduction of air-conditioning results in a significant worsening of the rating down to G.
The MEES Regulations make it unlawful for a letting of a residential property to continue beyond 1 April 2020 and for a commercial property letting to continue beyond 1 April 2023 where that given property has an EPC rating of F or G.
In this case, therefore, the landlord’s continued letting of the property (as altered by the tenant) will become unlawful during the term of the lease, solely through the tenant’s works as licensed by the landlord.
The landlord – in breach – has no remedy against the tenant, and instead the tenant can seek to enforce the landlord covenant to comply with statute, thus forcing the landlord to improve the tenanted space (at their cost) and potentially pursue a concurrent rent holiday (and other costs) during the course of the works.
MEES and service charges
Many commercial property leases include an agreement at the outset that the tenant will contribute to the ongoing upkeep of given communal elements and facilities at a property, of which they have leased part. This is to cover a variety of things, ranging from window cleaning costs and the supply of toilet roll to the supply and management of security or concierge staff.
It also tends to provide that a landlord can re-charge the cost to their tenants (on an apportioned basis) for the repair and maintenance of building services and building fabric items for which the landlord retains responsibility. In the context of MEES, this may provide substantial grounds for disputes to occur (see example 3).
Example 3
A landlord undertakes a programme of works to their multilet property, including new lighting to the common parts and replacing various items related to the building-wide air-conditioning system. The sum of the works is £700,000, and this is claimed from the tenants through on-account and balancing service charge.
The tenants in question convene and agree to challenge the claim. They pursue documentation relating to the building and establish that the air-conditioning installation – while dated – was still functional and capable of reasonable ongoing repairs.
They further establish that the EPC rating for the property as a whole before the works was F and that – as a result of the works – that rating improved to D.
In challenging the claim, therefore, the collection of tenants in this instance argue that the works were carried out by the landlord not because they were seeking to comply with their respective lease covenants to repair, etc, but instead because they recognised their need to upgrade their property in order to bring it up to a lettable standard – something which the tenants did not covenant to pay for under the service charge.
MEES and rent reviews
Many factors can affect the level of rent that a given property will demand, whether at the outset of a lease or during any rent review.
While location, condition, specification and general market sentiment are established factors, occupiers are increasingly placing importance on the sustainable credentials of the property. This may be to minimise their occupational costs, to meet their own sustainability standards or (for those alive to the risk) to avoid the potential scenario of their landlord needing to carry out invasive improvement works to the property during their tenure in order to comply with MEES.
When factored in with the risk on multilet properties of landlords seeking to put large improvement costs through the service charge (see above), tenants are increasingly seeking out – and willing to pay a premium for – properties which do not present such risks.
At the point of rent review, a given property subject to an ongoing lease is assessed to establish – most typically – its open market rental value, subject to certain assumptions and stipulations set out in the lease. This will normally involve surveyors for each party presenting comparable evidence on which to base a revised rental sum, largely driven by factors such as location, specification and market conditions.
A given property used as a comparable should be just that: comparable. Based on the above suggestion that rents are now being impacted by sustainability measures – most notably EPC ratings – it could be argued that this should form a characteristic on which a rent review should be based (see example 4).
The rent review implications of MEES appear to be substantial, with example 4 becoming all the more detrimental to the landlord when the tenant’s works/improvements are either accounted for or excluded. This will be explained in the final instalment, to be published in next week’s issue.
Example 4
A 20,000 sq ft industrial property was let in 2016 on a 15-year lease, with five-yearly rent reviews. The landlord approaches the tenant in 2021 with a proposal representing a 35% uplift in rent, citing comparables of lettings of similar properties on the same and adjacent business parks in the past six months.
The tenant responds, stating that none of the comparables presented are applicable as all of them were lettings of properties with an EPC of E or better. Instead, with an EPC of G (at the point of grant in 2016), the subject property could only be compared with another similar property at the rent review date, and that same property in 2021 could not lawfully be let and hence could not yield a rent at all, let alone one supporting a 35% increase in the passing rent.
See also: Reasons to be wary of MEES
Ben Strange is a director at Mobius Building Consultancy
