Update on EPC asset ratings

Discover the key changes the government is considering for raising the minimum EPC asset rating and what this means for landlords.

The below summary highlights, on a concise basis rather than an in-depth analysis, the changes.

A. EPC rating

The government, under its mandate, is looking to increase the minimum EPC asset rating for properties to be raised from an ‘E’ to ‘B’ rating by 2030. The intention is that, in order to let or continue letting a commercial premises, landlords will need to ensure that a property meets the increased minimum threshold to avoid the property being a sub-standard property. The new minimum threshold does not yet have any legal effect and is still in consultation.

Currently, the minimum EPC asset rating of a commercial property is an ‘E’. A property with an EPC asset rating of below an ‘E’ is a sub-standard property.

B. The Regulations

There are difficulties with the legislation relating to energy efficiency of buildings. This is largely because there are two sets of regulations in place: the Energy Performance of Buildings (England and Wales) Regulations 2012 (“EPB Regulations”) and the Energy Efficiency (Private Rented Property)(England and Wales) Regulations 2015 (“MEES Regulations). There are a number of contradictions between these regulations.

In general, the EPB Regulations relate to the requirement on a seller or landlord to have an EPC in order to sell or let a building/premises. The MEES Regulations deal with the requirements regarding the level of energy efficiency of a building/premises and the requirements under the Energy Act 2011. These regulations are referred to collectively in this summary as the “Regulations”.

An issue with the MEES Regulations, so far as the right for a landlord to continue letting a premises with a sub-standard EPC asset rating is that this has not been tested in the courts.

From a legal perspective, we understand that the lease will continue and therefore the tenant will still be required to pay the rents and observe the other tenant covenants; however, there is an obligation on the landlord to take steps to improve the EPC asset rating of the premises to try to bring it in line with the minimum EPC asset rating in force at the time. If a landlord is unable to do so or does not satisfy one of the exemptions to the MEES Regulations, then the landlord runs the risk of a fine if reported to the local authority. The maximum fine currently is up to £150,000 for a breach and there is also reputational risk.

C. The Exemptions

The exemptions are:

Consent exemption – where the landlord needs consent from the tenant (or third party) in order to carry out the works and the tenant (or the third party) has refused consent to the energy efficiency improvements being made. The consent exemption would also apply in the case of a third party if consent has been granted subject to a condition which the landlord cannot reasonably comply with.
Devaluation exemption – the landlord must obtain a report from an independent surveyor which states that the energy efficiency improvements will result in a reduction of more than 5% in the market value of the property, or the building of which it forms part.
Temporary exemption – the circumstances are varied, and the surrounding issues need to be considered separately. An example of a temporary exemption is where someone becomes the landlord by purchasing a property which was already let on an existing tenancy and the prohibition on “continuing to let a sub-standard property” is postponed for six months from the date of purchase. The prohibition on granting a new lease under these circumstances is not postponed.
All the relevant energy efficiency works for the property have been made (or there are none that can be made) and the property remains sub-standard. Under the MEES Regulations this is not called an “exemption,” but it qualifies as an exemption.

In all cases, the property must be added to the PRS Exemption Register to avoid enforcement action. Note that the exemptions are time limited and, in general, none will last more than five years (although in the example above “(3) Temporary Exemption,” the period is only six months). Exemptions cannot be passed on to a successor in title.

An additional point to highlight is that there are some types of property to which the MEES Regulations do not apply.

D. The Tenant

Under the MEES Regulations, the tenant has no responsibility unless it sublets. If the tenant sublets, it steps into the shoes of the landlord for the purpose of the MEES Regulations.

E. Other issues

The impact of a sub-standard property, in addition to the failure to comply with the MEES Regulations, could also result in a reduction in the value of the property and tenants may only be willing to pay a lower rent to reflect the fact that the property has a lower energy efficiency than other similar properties in the area. This could also impact on rent reviews.

F. The Lease

Many leases in circulation at the moment refer only to the EPB Regulations rather than the MEES Regulations. It is common to see provisions setting out the circumstances under which a tenant may obtain an EPC; the implications if any EPC obtained by a tenant has an adverse effect on the asset rating; the right for a landlord to refuse consent to any alterations if such works will adversely impact on the asset rating; and in some cases, there are rights for the landlord (at its own cost) to carry out works to the premises (at the tenant’s discretion). However, consideration needs to be given to a number of issues when drafting, including:

Access rights

As mentioned above, landlords have the benefit of a consent exemption under the MEES Regulations; however, whether the tenant by refusing to give such consent is sufficient, in itself, to satisfy this condition has not been tested. There is an argument that by having wording in the lease to permit the landlord access rights may backfire and it is therefore preferable not to include any such right. Presumably, this is because the landlord could take steps to enforce the right to take access and carry out the works. In addition, the clause may not add much to the situation because the tenant could still refuse access despite there being such right in the lease.

There are also possible issues if the works are seen as ‘improvements’ rather than ‘repairs’.

Rent review

A sub-standard property is likely to have a negative effect on rent review since a hypothetical tenant is likely not to pay as much rent for a sub-standard property as it would for similar properties which comply with the Regulations.

However, including a rent review assumption that the property complies with the Regulations could impact negatively on its marketability to prospective tenants.

At present, it is uncommon to see an assumption of this kind in the rent review provisions of leases.

Cost of works

Passing the improvement cost of the works on to the tenant for the premises and/or the centre (via the service charge) could have a negative impact on the marketability of the property to a prospective purchaser or the value of the building. This is because a tenant might not be willing to lease a property where there it is likely to incur costs for improving the energy efficiency of the property or contribute to the costs of improving the centre – this is likely to particularly be the case in respect of shorter lettings. For the same reason, this could result in a tenant paying, or arguing to pay, a lower rent for the property.

However, in the absence of any provision otherwise in the lease, the cost of the improvement works will fall solely on the landlord (unless the tenant agrees to make a contribution).

Green clauses

Another option is to include green clauses under which the landlord puts in place a forum which places obligations on the landlord and the tenant to co-operate with each other and to work towards making the centre more energy effective, which should result, over time, in sustainability and environmental improvements at the centre.

However, these types of green clauses will not change the impact of the Regulations; nor the costs a landlord will incur if the minimum threshold is changed and, as a result, works are required to be undertaken at the premises to prevent it from becoming a sub-standard property.

Conclusion

The updates on EPC asset ratings highlight the importance of energy efficiency in commercial rental properties. Landlords must ensure their properties meet the required standards to avoid penalties and contribute to the government’s overall energy efficiency goals.

If you would like to discuss any of the matters raised in this article please contact Kelly Clarke.