James Kingdom and Nick Macdonald Smith provide guidance on unresolved MEES and EPC questions in relation to the alternatives sector.
With the Minimum Energy Efficiency Standard (MEES) in force, it is now unlawful to let properties with F or G-rated energy performance certificates (EPCs) in England and Wales.
This is not news for the property industry and the implications of the legislation are fairly well understood for standard commercial and residential asset types. However, there are many ambiguities on interpreting the minimum EPC requirements when dealing with alternative forms of real estate (alternatives).
What are alternatives?
Alternatives have become an established feature of the commercial property market. The sector includes everything from student housing and hotels to less mature sectors such as retirement living, co-living and self-storage.
Transaction volumes exceeded £15.7bn in 2017 and alternatives now account for around 26% of the commercial property market. However, in emerging markets where investor demand is high, forward funding, income strip and corporate transactions are commonplace.
Given the variety of investment into alternatives and the continued evolution of its sectors, how well suited is the minimum EPC legislation?
We selected a series of questions relevant to this sector and asked a panel of EPC assessors for their views. The responses below reflect market opinion. Legal advice should be obtained in the case of uncertainty.
Are property types such as student housing or care homes classified as residential or commercial for the purposes of MEES?
The non-domestic guidance states that “rooms for residential purposes are not dwellings”. These are common in hostels, hotels, halls of residence or care homes.
Therefore, these property types will come under the non-domestic EPC and MEES regulations. Generally, these properties have common heating systems, so a single valid EPC for the whole building will cover separate leases within, and improvements to, poorly rated EPCs and will impact the whole building.
For mixed-use buildings, space classed as a “dwelling” needs an EPC from a domestic EPC assessor, using the domestic calculation software, whereas a space classed as “non-dwelling” will need an EPC from a non-domestic EPC assessor using different non-domestic calculation software. This could mean that a single property may have both domestic and non-domestic EPCs.
Residential guidance refers to improvement works being required only where “no cost” funding is available for upgrade works. Who is responsible for determining funding when considering dwellings in different property types?
Funding is a landlord’s responsibility when making improvements. The EPC assessor will make recommendations only, although an assessor could be commissioned to provide further advice to assist.
The three funding streams considered for domestic properties are the Green Deal (vastly reduced since 2015), the energy company obligation (ECO) and “additional no-cost funding”. The Energy Saving Trust is the go-to source for this information.
A government consultation is looking to remove the “no cost” statement from the regulations and replace it with a requirement for the landlord to pay for improvements – with a cap of £2,500 per property.
Will data centres always result in an F- or G-rated EPC owing to the large amount of cooling required?
In data centres, cooling provided to the data floors is for the specific requirement to cool the servers and therefore is “process cooling”, which is not part of the EPC calculation.
Only cooling related to conditioning the occupied space of a building should be included in the EPC calculation for data centres (such as office areas, welfare areas, toilets, and other areas that do not contain data centre operations).
How are shell and core or stripped back units dealt with under MEES?
This is one of the most common issues regarding the MEES regulations and is causing much discussion among EPC assessors and government representatives, without resolution.
Shell and core builds are properties built with some basic services provided, but without a specific tenant in mind. They are designed to Building Regulation standards and consequently will achieve an EPC rating of E or better.
Some properties are stripped back to the basic shell once a tenant vacates, as is common in retail, industrial, storage unit and data centre assets. In these cases, there is no HVAC for an EPC assessor to inspect, and so it reverts to the worst-case fit-out, which results in an F- or G-rated EPC.
There are mixed responses on how to tackle this stripped-back scenario. Suggestions vary from discussing the issue with the local authority, to assessment using minimum current building regulation standards, as in the case of shell and core. The former assumes that the local authority is equipped to deal with MEES issues, which is not clear yet. The latter has been rejected by government, which argues that a building can’t have a rating that does not represent what it currently is.
The typical advice from EPC assessors is to have the property assessed prior to stripping back or leaving some equipment in place (eg LEDs) to act as a reference. Lighting impacts heavily on EPCs, so leaving LEDs in place would generally result in a better EPC than an E.
Are EPCs required where property is transacted as part of the sale of a business?
The regulations state that the sale of a wholeco or shares in a company that owns property does not require the production of an EPC for the property(ies).
However, in practice it is standard due diligence for law firms and lenders to ensure that any property that a target company owns has an EPC unless it is subject to an exemption. So although not required under the regulations, it is good practice to ensure that there is an EPC in place.
In conclusion
There is a significant amount of ambiguity surrounding the MEES regulations, especially relating to the alternatives sector where a more complex mix of use within these properties will require some flexibility and clarity from government.
In addition, the enforcement of the regulations will probably be reliant on some self-regulation since those interested in safeguarding their reputation will develop their own processes to prove compliance as it is understood.
James Kingdom is the head of alternatives research and Nick Macdonald Smith is an associate director in upstream energy services at JLL
