The long-awaited regulations on minimum energy efficiency standards in England and Wales have been laid before Parliament, just in time to get them passed before the general election.
From 1 April 2018, the regulations will make it illegal for a landlord to let out an F or G EPC-rated commercial property, subject to a few exemptions. Initially the regulations will apply to new lettings and some lease renewals. On 1 April 2023, they will be extended to most existing leases of F or G EPC-rated commercial buildings. F and G rated properties make up approximately 18% of the building stock.
That is just the beginning. The UK’s commitment to an 80% reduction in carbon emissions by 2050 will require an improvement in the average EPC rating from the current D to an A. The intention is to drive the improvements by progressively increasing the minimum energy efficiency standard set by the regulations, so few landlords will be able to ignore them. The government has not published the trajectory at this stage, although it acknowledges that this will be important in order for landlords to plan ahead.
This article considers only the rules for commercial property. There are slightly different rules for residential property.
The regulations in outline
- From 1 April 2018, a landlord will have to bring a sub-standard building up to an E EPC rating or better before a new lease is granted (including some lease renewals).
- By 1 April 2023, properties that are let on existing leases and have an EPC must be brought up to the same standard. Broadly, that catches properties that were sold or let since 2013.
- Leases of a fixed length under six months are excluded, subject to restrictions aimed at limiting renewals, and leases of 99 years or longer are also excluded.
- There are a few exemptions, including where a landlord is unable to obtain consents needed for the works. Rights of tenants, superior landlords and mortgage lenders to approve or agree to works are unaffected.
- Only energy efficiency measures of the types specified by the regulations need be carried out and only if they pass a so-called seven year payback test.
Who foots the bill?
The cost of the improvements is likely to fall principally on landlords. The market may have been slow to reflect the benefits of energy efficiency in rental values and prices, but it will be easier to reflect the anticipated cost of measures to improve sub-standard properties.
Some service charge and indemnity clauses found in leases may be wide enough to pass costs through to tenants, but in practice it often won’t come to that, because many improvements will be done at the time of a new letting and some tenants will effectively have a right of veto over some improvements.
That does not mean that tenants are off the hook. Leases will be scrutinised and argued over to identify those cases where tenants can be billed, and tenants will need to address any shortcomings in energy efficiency before they can sub-let.
The original idea that the cost of improvements would effectively be paid from savings in the tenant's energy bills is long gone. The Green Deal could not be made to work in the commercial sector and is now off the agenda, at least for the time being. There is no policy discernible in the regulations as to how costs should be shared between landlord and tenant, rather unsatisfactorily leaving the issue to be determined by reference to the lease. As well as depending on subtle distinctions in lease drafting that may date from before the regulations were even contemplated, the practical answer to the question of who pays will sometimes be different for measures installed in different parts of the building or at different times.
The regulations are intended to force through energy efficiency measures that landlords and tenants are not making voluntarily, so it is not a surprise that the bar for claiming exemptions has been set high. There is no exemption on the ground that cost of doing the works is expensive compared with the value of the property. Exemption can be claimed on the ground that carrying out a measure will devalue the property, for example by the reducing the lettable area, but the reduction has to be more than 5% of the property’s market value.
The exemptions are best viewed as deferrals, allowing energy efficiency improvements to be made at a more convenient time or when they become cost effective. They last for five years, at the end of which the landlord has to establish if the exemption still applies. Each new landlord has to establish its own exemption and cannot rely on that of its predecessor. It has six months from the date of purchase to comply.
Exemptions must be registered and the register is intended for publication, encouraging public scrutiny of the landlord’s sustainability credentials, as well as providing a target list for enforcement officers and sales teams.
Seven year payback test
The main exemption is, somewhat disingenuously, described as a simple payback of seven years: improvements only need to be carried out if they are expected (based on a standard calculation method) to deliver within seven years energy bill savings of at least the cost of purchasing and installing measures, plus interest at Bank of England Base Rate at the time of installation.
This approach is refreshingly straightforward (although the calculation method isn’t and might be flawed). It exempts energy efficiency measures that make no economic sense, without getting bogged down in – or indeed bearing much relationship to - the actual costs and benefits to landlords who bear the cost themselves. Landlord benefits will, in most cases, depend on whether energy efficiency is reflected in rental growth rather than in energy bill savings. The lifespan of most measures will exceed the seven year period used in the calculation. On the cost side, potentially significant ancillary costs are omitted from the calculation, including void costs, consultants’ fees, fees for obtaining consents, and realistic costs of finance.
One of the least satisfactory parts of the regulations concerns lease renewals. If the tenant has Landlord and Tenant Act renewal rights or an express option to renew, the landlord has no choice but to grant a renewal lease. However, from 2018 a lease renewal of a sub-standard property triggers an obligation to improve its energy efficiency if, as a result of earlier unrelated transactions, the property happens to have an EPC.
A game of tactics
The regulations are a vast improvement on the proposals on which the government consulted last summer. Nevertheless, a failure to deal with the need for cooperation between landlord and tenant and to address head on the question who of pays for the work, along with an opportunistic approach to bringing properties within the regime which is based on seemingly convenient trigger points rather than logic, produces a large number of anomalies. Tactical games could be played to delay work or shift the cost. We must hope that these do not distract from the policy objective of reducing emissions.