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The Minimum Energy Efficiency Standard for Commercial Property

Napthens - December 2nd 2016

The minimum energy efficiency standard was introduced in March 2015 by the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 (MEES Regulations) which came into force on 1 April 2016 and introduced a minimum energy efficiency standard. Commercial properties with an ‘F’ or ‘G’ Energy Performance Certificate (EPC) rating, being approximately 18% of commercial properties, will need to undergo works to improve their energy efficiency.

It is worth noting that the minimum standard could rise in the future.

After 1 April 2018, landlords of buildings within the scope of the MEES Regulations  must not renew existing tenancies or grant new tenancies if the building has less than the minimum EPC rating of E (unless the landlord registers an exemption)

After 1 April 2023, landlords must not continue to let any buildings which have an EPC rating of less than E (unless the landlord registers an exemption)

MEES Regulations do not apply to:

  • buildings which are not required to have an EPC: such as industrial sites, workshops, non-residential agricultural buildings with a low energy demand, certain listed buildings, temporary properties and holidays lets
  • buildings where the EPC is over 10 years old or where there is no EPC
  • tenancies of less than 6 months (with no right of renewal) (provided the same tenant has not been in occupation for over 12 months) and tenancies of over 99 years

Exemptions will apply to lettings where:

  • it is not cost effective for the Landlord to undertake the necessary work(cost effective generally means a payback of 7 years or less)
  • reasonable efforts on the part of the Landlord to obtain consents to install energy efficiency measures ( i.e. from the superior landlord, tenant or lenders) are unsuccessful
  • a suitably qualified independent surveyor asserts that the required improvements are expected to devalue the property by more than 5%

Exemptions cannot be transferred to a new Landlord and will expire after five years. They are really just deferrals until such time as the landlord is able to carry out the necessary measures, as there has to be a re-evaluation at the expiry.

The central government PRS Exemptions register on which Exemptions must be registered is intended to go live in October 2016 although this looks to be delayed to April 2017.

Leases of affected properties will need to be reviewed to see whether the landlord has rights of access to undertake the improvement works and the necessary rights to carry out such works.

Non- Compliance Penalties

The penalty for the Landlord for failure to comply with the MEES Regulations will be a civil fine calculated by reference to the property’s rateable value, subject to a minimum penalty of £5,000 and a maximum of £150,000.

Who pays?

The MEES Regulations are unspecific on how costs should be managed between the Landlord and the Tenant.  The wording of service charge provisions and repairing covenants will therefore be fundamental to considering who pays for the cost of the works

 Investors’ considerations

 Where the term of the headlease is over 99 years freehold investors who own reversionary freehold assets will not be landlords for the purposes of the MEES Regulations.

  • Be aware that there is a threat of reduction in value of any property assets which do not meet the minimum standard. Further, freehold investors may struggle to find new tenant landlords willing to sub-let a property if it means they will need to carry out improvements.
  • Positively freehold investors with tenant landlords already in place will benefit from having energy improvements made to their reversionary asset paid for by the landlord tenant.

 Landlord considerations

  • the financial cost of upgrading non-compliant buildings and the potential loss of income if a property cannot be rented out
  • The provisions in existing leases may affect the statutory obligations of landlords under the MEES Regulations and may affect the position of the Landlord in dealing with the MEES Regulations
  • for a landlord wanting to delay compliance by relying on an Exemption, standard leases may not contain sufficient restrictions on tenants subletting to prevent the landlord's MEES  obligations from being activated
  • lease provisions on service charges, yielding-up, statutory compliance and rent reviews may not allow a landlord to recover from the tenant the  expenditure required for improvements
  • for a landlord looking to make improvements, do the landlord's rights in the lease provide necessary rights to enter for installing energy efficiency improvements. bearing in mind also any restrictions in a headlease to be considered.

 Funder considerations

  • a building does not meet the minimum standard leading to a reduction in value of their security and ability to let the property thereby affecting the ability of a landlord borrower to make repayments due to loss of rental income and additional capital expenditure costs.
  • where they take possession of a property following default and become freehold investors or landlords and, thus, subject to the MEES Regulations themselves.

Lenders could take the opportunity to check (or update their procedures):

  •  to see if they have enough information on valuation of the asset to; understand the impacts of MEES Regulations on their security, correctly price the risk and cost of borrowing and enable them to monitor the risk adequately
  • to see if the undertakings and representations in their facility agreements provide suitable protections and rights against borrowers who fail to comply with their statutory obligations under the MEES Regulations

What next?

  • Landlords, investors and funders should be auditing their assetsg. checking whether the EPC ratings for their properties are correct, seeing if exemptions apply, and reviewing leases to prepare for MEES Regulations coming into force and considering strategies on lettings, renewals and funding on properties against the background of the MEES Regulations.
  • Landlords with properties that fall within the scope of MEES Regulations should be thinking about making improvements now as the obligation to comply primarily rests with them. Many existing leases or those being renewed or granted now, extend beyond 1 April 2018 and perhaps the even more critical date of 1 April 2023, which catches all existing leases.
  • We are likely see in market valuations consideration being given to the effect of the MEES Regulations.

If you would like any more information on this topic, or any other Commercial Property query, please get in touch with a member of the team.