Landlords Need To Respond To Ambitious Targets For Minimum Energy Efficiency Standards
Over the past few months, we have witnessed a renewed interest in climate change, with environmentalists across the world descending onto the streets demanding greater action to combat the problem, writes Paul Henson, a real estate partner at Irwin Mitchell.
As mass protests continue to dominate the headlines and social agenda, the UK government is responding with ambitious plans to implement tighter minimum energy requirements for all commercial buildings in order to reduce carbon emissions and energy use, and stimulate the market in energy efficient technologies.
In line with its recent commitment to ensure net zero carbon emissions by 2050, the government is currently consulting on an extension to the Minimum Energy Efficiency Standards (“MEES”) that came into effect in April 2018. By way of reminder, the current MEES regulations made it unlawful for landlords to grant, extend or renew tenancy agreements of a ‘sub-standard property’ (defined as a property with an Energy Performance Certificate (“EPC”) rating below E grade), unless one of the various exemptions applies. The prohibition will be extended to existing tenancies from 1 April 2023.
The government has stressed in the consultation that the existing exemptions relating to MEES will continue. These include: the inability to obtain third party consent to undertake the required works; the seven year pay back test; and, whether the measures could significantly devalue the property. In particular, the seven year pay back test ensures that landlords are only required to make cost effective changes that can be determined on a building-by-building basis. In short, this exemption provides that the saving in energy costs over a 7 year period must be equal to or greater than the total cost of required energy improvement works. The exemption only lasts five years.
A two part consultation
There are two potential trajectory options for implementation that are proposed in the consultation with significant cost variations between them. The first option is the government’s preferred choice; that a minimum energy efficiency standard of EPC band B is implemented by 1 April 2030. In the impact assessment document the government has estimated that the investment required by landlords to reach this trajectory is £5bn, with an average pay back return period of 4 to 5 years.
The problematic issue for landlords (as acknowledged in the consultation) is that the capital cost to undertake the energy efficiency improvements lies with landlords, whilst it is their tenants that will benefit from the reward of paying lower energy bills. The government’s answer to this is that it believes that landlords will see rent levels increase to reflect the energy efficiency of the property and reduced bills for their tenants. This option also benefits, as far as the government is concerned, from bringing an estimated 85% of current commercial building stock into its scope, and would drive greater demand for energy efficient technologies.
The alternative, and the government’s least preferred option, is for a minimum EPC band C by 1 April 2030. The government believes this trajectory is ‘not ambitious enough’ to deliver the desired energy and carbon reduction targets, as it would only bring 42% of commercial buildings into scope. Their impact assessment suggests that achieving an EPC band C rating for al buildings by 2030 would require private investment of £1.5 billion, with the average payback period being estimated at just 3 years. Overall, the government believes this alternative trajectory would not stimulate enough demand in the energy efficiency market and are wary of implementing this option.
Milestones vs deadlines
In the consultation, the government have proposed alternative ways in which the trajectory options could be implemented before 2030. Under a single implementation date option, landlords would not be able to lease commercial buildings unless they had reached an EPC grade B or C by 31 March 2030. It is thought that having a specific and fixed deadline offers landlords the flexibility to make any necessary upgrades within that period. However, the consultation also notes that without intermittent deadlines between now and 2030, there would be no incentives for the improvements to be adopted earlier than the 2030 date. The consultation paper provides detailed examples of what these incremental milestones may look like and encourages landlords to share their views on implementing a phased approach, or alternatively the single date option.
With a General Election now confirmed for 12 December 2019, scrutiny will no doubt fall on all the parties’ manifestos and their focus on tackling carbon emissions and energy use. What the consultation highlights is a need for consideration when it comes to the degree to which private investors can be compelled to invest in order to achieve the government’s aims. The likelihood of a lengthy lead in time will provide landlords with the scope to evaluate how energy efficient their commercial buildings are, and consider the cost effective solutions to bringing them up to standard. As no decision has yet to be taken as to which trajectory will prevail, it is important that as many landlords as possible put forward their opinions. The consultation closes on 7 January 2020 and all responses should be submitted online via this link.
This article was first published in CoStar.