Ben Strange explains how changing energy performance certificate standards and other related factors may have a major effect on rent reviews.
The impact of the Minimum Energy Efficiency Standard Regulations is being increasingly felt across the commercial property market in England and Wales. The implications of the regulations extend far beyond the common understanding that it simply means you should not have a property with an energy performance certificate rating of F or G any more.
As knowledge of the impact of MEES extends exponentially among tenants and occupiers and they become aware of the protection and opportunity it affords them in areas such as lease negotiation, alienation and dilapidations, the matter of rent reviews is emerging as a new area in which a property’s EPC rating has a direct bearing.
There are several published insights and data on the relationship between EPC ratings and both capital and rental values, so it may be tempting to assume that the matter of considering the impact of an EPC in rent reviews should be straightforward; the better the EPC of the subject property, the higher the rent should be. However, there are many factors which bring this approach into doubt and instead the strongest position respective parties can present is likely to rest on a more thorough understanding of EPCs, of MEES, and indeed the intricacies of the lease terms at play.
Changes to EPC ratings
An EPC registered for a given property is highly likely to not be the accurate rating in today’s terms. EPCs are valid for 10 years (unless superseded by a newer EPC); in general terms, the older the assessment, the less likely it is that it will reflect the current rating of the property. This may be, for instance, a result of the previous EPC having not been carried out accurately (particularly those done before MEES was prevalent), the building in question having changed, or a change in assessment methodology.
In June 2022, there was a significant change in EPC assessments (and outcomes) associated primarily with the updating of the “carbon factor” of electricity. This is a measure of the carbon emissions associated with the electricity a building uses. The change reflected a 56.6% reduction in carbon emissions associated with grid-supplied electricity (according to Department for Environment Food and Rural Affairs figures). The result of this change has generally seen:
- Properties with primarily electrically-powered heating/cooling systems achieving EPC outcomes 1-3 grades better.
- Properties with gas/oil fuelled heating/cooling systems achieving EPC ratings 1-3 grades worse than before.
With this having an impact on EPC assessments carried out as recently as 2022, it underlines the point that a subject property’s EPC is now unlikely to be accurate in today’s terms; something that a well-advised tenant could use to their advantage.
Impact on rent review: scenario 1
A rent review is due in 2025 of a 1980s-built headquarters building with an EPC rating of C from 2020. The 25-year lease was agreed in 2005 and the landlord now seeks a 30% rental uplift.
Supporting their position, the landlord provides comparable evidence of seemingly similar properties achieving the asking rent on recent transactions.
The tenant has the EPC on the subject property reviewed and identifies that it is no longer accurate. As a property heated primarily by gas, the 2020 C-rating is no longer accurate and instead a draft rating of F is identified.
The tenant, facing the proposed increase, opens their negotiation with the landlord presenting two options:
- They agree a nil-increase with the landlord, in exchange for entering into a side agreement to not lodge the drafted EPC on the property; or
- They enter into no such agreement and instead await negotiation in 2025, while at the same time lodging the F rating, placing the property immediately in breach of MEES.
The impact of option 2 here is significant for the landlord: they first have the issue of being in breach of MEES unexpectedly; secondly they are then required to upgrade the property to achieve compliance; but thirdly, if the tenant times it well, they may place reliance on the subject building as of the rent review date being a “sub-standard” F rating and being incapable of being lawfully let on the open market (so therefore supporting no case for uplift).
Impact on rent review: scenario 2
An upcoming rent review sees a landlord proposing a rental uplift from £55 per sq ft to £80 per sq ft on an office premises. The building at the point of lease grant in 2019 had an E-rated EPC. The tenant subsequently undertook a substantial fit-out which resulted in the rating improving to B. The landlord provides comparables in support of their uplift with EPC ratings of B to align with the subject property.
The tenant rejects these properties as unsuitable comparables, on the basis that the terms of the lease set out that tenant’s improvements are to be disregarded, and on that basis the hypothetical property to be considered should be an E rating and corresponding deals of E-rated properties should be considered instead (which command much lower rents in the open market).
This same scenario can play into the tenant’s hands, particularly where there is a rent review specification set out in the lease.
Cost of improvements
There will doubtless be differences in opinion on how significantly the impact of EPC ratings will be felt in rent review matters. For instance, there will be a temptation to assume that works to improve a rating will be de minimis and hence of little impact; this view, however, is unlikely to be accurate.
The impact of the carbon factor change is particularly significant and landlords of properties with gas-fired heating (including four-pipe fan coil systems) should be particularly wary, where improvements typically will involve significant system replacement at costs of specific relevance to the review.
Ben Strange is a director at Mobius Building Consultancy
