In this briefing John Stephens identifies threats and opportunities for existing landlords. Further briefings are planned for existing tenants, for grant of new leases, and for investors. Many of these points are applicable to both commercial and residential property, but this note deals specifically only with commercial property.
It will be illegal to let property (or renew the lease of a property) that does not meet energy efficiency minimum standards from 1 April 2018. It is estimated that 20% of UK commercial property will be impacted.
From 1 April 2023, the letting or renewal criteria will fall away and the regulations will apply to all leases (including existing leases) of properties that have an Energy Performance Certificate (EPC). (Bear in mind that an EPC might have been obtained by the tenant, e.g. on assignment or underletting.)
WHO WILL THIS AFFECT?
This will affect sales and purchases of investment property, the grant and renewal of existing tenancies, and existing landlords and tenants. The effects of this will be widespread. At its most vivid, the value of a property that cannot then be let is likely to be devalued.
KEY POINTS TO THINK ABOUT
1. Is my property affected?
a. Your property will not be affected if it is a place of religious worship, is a temporary building with low energy usage, is scheduled for demolition, is less than 50 square metres, or is listed.
b. The Energy Act 2011 is the source of MEES obligations (s.49 (1) and (6)). The landlord of a property that does not meet or exceed a rating of E (the ratings run from A to G) will not be able to let it unless and until it has been improved to meet the standard. The sanction is a fine of up to £150,000, based on rateable value.
c. It is reasonably likely that the threshold may be raised in future, so the current threshold at E is not set for all time; it is simply a starting point.
d. Properties that require EPCs are affected. Properties that are let for less than 6 months or more than 99 years are not affected.
e. There are some temporary exemptions, but they have to be claimed and registered on a central public register. The exemption will last for 5 years. The categories of exemption are:
i. There are no cost-effective (i.e. cost payback from energy savings in 7 years) improvements that can be carried out.
ii. Attempts to improve the energy efficiency of the property have failed because of existing restrictions or tenant refusal.
iii. An accredited report indicates that carrying out the work would devalue the property by more than 5%.
iv. The landlord is legally bound to lease or renew a lease on specific terms.
f. Exemptions are personal and not transferable (e.g. to a buyer). The buyer has 6 months to improve the property or demonstrate that an exemption should be granted.
2. Can the property be improved to meet the standard?
Works that may improve the rating include upgrading the boiler and improving insulation; in some cases improvements to the fabric of the building may be necessary and these could be costly and affect the valuation of the building.
3. Does the landlord have the right to carry out improvement works?
a. There is no statutory right of access to carry out improvement works. The Access to Neighbouring Land Act 1992 does not normally apply to improvements, but to preservation. In any case, it requires a court order.
b. The answer to this question will depend primarily on the terms of the lease. If the improvements can be carried out without the landlord needing to gain access to the tenant’s premises or infringing the rights granted to the tenant, or if the lease gives the landlord a right to enter the tenant’s premises to carry out improvements, there should be no difficulty in principle. In other cases, it may well be necessary to obtain tenants’ consent, and tenants may well impose conditions and/or want something in return.
4. Can the tenant behave in such a way as to impact the landlord’s exposure to MEES risk?
a. Yes, unless the lease provides protection. This depends on an analysis of the lease terms. For example, in relation to alterations, the landlord is commonly not able to withhold consent for the tenant to carry out improvements. Whether a particular piece of work is an improvement is judged from the tenant’s perspective. So, for example, in a shop the tenant may want to improve the shopping experience of its customers by installing an inefficient air curtain heating system; this could impact on the EPC rating, and push the rating below the minimum threshold.
b. A well-drawn new lease will provide the landlord with various protections so that the landlord is able to refuse consent to works that would otherwise be permitted if they adversely affect the environmental performance of the property. Landlords should be seeking to introduce this kind of provision whenever the opportunity arises to do so.
5. Will there be an effect on rent review, e.g. through comparison with the open market rents?
a. Yes, unless the lease provides protection and again this depends on close reading of the lease terms, including but not limited to the rent review provisions themselves. For example, if the premises with a periodic review to open market rent fall below the minimum energy efficiency threshold, there will be a lack of comparable properties being let in the open market (because letting them would be illegal) and so establishing an open market rent will be difficult and even if possible, the figure is likely to be depressed.
b. A well-drawn new lease will address this and include appropriate rent review assumptions. Again landlords need to plan ahead how they can introduce these vital protections.
6. What impact does MEES have on repairing obligations?
a. The lease needs to be looked at carefully. In a standard multi-let, full repairing and insuring lease, for example, the responsibility for external and structural repair may fall primarily on the landlord, with an ability to recoup the cost from the tenants. Whether such an arrangement would allow the landlord to upgrade the property by improving its energy efficiency, preserving or enhancing its capital value, at the expense of the tenants, who may benefit from reduced operating costs through greater energy efficiency, is very much open to doubt and unlikely to be specifically covered in historic lease drafting.
b. An argument that is sometimes raised is that that most leases will impose an obligation on the tenant to comply with statutory requirements and this should cover the MEES obligations. This is unlikely to hold up, depending on the precise wording. Normally, the tenant has to comply with “requirements” relating to the condition of the property: the MEES obligation is not to let sub-standard property – there is no requirement to improve it as such.
7. Can the risk be mitigated on renewal?
a. An existing lease of business premises that is not protected by the Landlord & Tenant Act 1954 can be renewed upon whatever terms the parties are able to negotiate and so the outcome will be a trade-off of bargaining positions. A protected tenancy is different in that the tenant is entitled to a court order for a new tenancy and the court will not generally order a new lease on significantly more onerous terms than the old one. So there is a problem here as the law currently stands, particularly for properties that may fall below the threshold. A partial answer may be for the landlord to take all steps available to them to put the property well above the threshold before the time for renewal arrives.
b. When a lease comes up for 1954 Act renewal, the following summarises the base position that the court will work from on lease terms other than rent and term:
i. The court will base its deliberation on the terms of the existing lease.
ii. Where a change is required, it is for the party proposing the change to demonstrate that would be reasonable for the court to order it.
iii. The court does not have to take account of market practice.
iv. The court will permit reasonable updating.
v. For the court to insist on a change against the wishes of the tenant, the court will want there to be a good reason for doing so on the basis of essential fairness in all the circumstances.
c. In view of the above, a landlord may need to be prepared to find a way of sweetening the pill that the tenant is being asked to swallow. Being able to demonstrate the likelihood of lower operating costs for the tenant might play a part in that. It may be that this will be clarified in legislation or by case law in due course, but in the latter case litigation is almost always to be avoided, if possible.
8. Can the risk be mitigated before the lease is entered into in an agreement for lease?
Yes. Where a landlord is letting a property it is quite common for there to be an agreement for lease that deals with such things as fitting-out works. It should be possible to ensure that these works result in the property having a safe rating. Furthermore, a well-advised landlord will be able to stipulate, in its heads of terms and in the agreement for lease, requirements to lessen the potential for MEES to cause problems during the term of the lease. Doing the homework in advance is key.
HOW WILL THIS AFFECT LENDING AND EXISTING RELATIONSHIPS WITH LENDERS?
Landlords may have to consider the concerns of their lenders, and these are likely to include the potential disruption to income stream in the event that a property cannot be let because of MEES or if there is a void while upgrading takes place, coupled with concern regarding how the cost of upgrading is to be met. Lenders may also become concerned about the long-term performance of properties falling foul of MEES and the effect on property valuations and loan covenants.
Lender’s consent may well be required for physical alterations/upgrades.
WILL THESE CHANGES BE AFFECTED BY BREXIT?
Ironically, most of the UK’s legislation regarding energy performance has its origins in EU directives. However, Brexit does not seem to have diverted the Government on this topic and no relaxation is anticipated.
This article is for general information purposes only and does not constitute legal or professional advice. It should not be used as a substitute for legal advice relating to your particular circumstances. Please note that the law may have changed since the date of this article.