FROM APRIL 2018, A NEW LEGAL STANDARD FOR MINIMUM ENERGY EFFICIENCY WILL APPLY TO RENTED COMMERCIAL BUILDINGS.
Darren Millis, Head of Commercial Property looks at this new legislation in more detail and how this will affect Landlords.
What is the minimum energy efficiency standard (MEES)?
The minimum energy efficiency standard (MEES) was introduced in March 2015 by the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015.
The MEES Regulations originate from the Energy Act 2011 which contained the previous coalition government’s package of energy efficiency policies including the Green Deal (government initiative that is designed to aggregate business and home owners to employ more green measures in their buildings).
At present, commercial buildings have an energy efficiency rating that goes from A – G, with F and G being the lowest rating. The new law aims to introduce a minimum standard of E. If this standard is not met, buildings cannot be rented out.
From 1 April 2018, landlords of buildings within the scope of the MEES Regulations will be penalised if they renew existing tenancies or grant new tenancies where the building has less than the minimum energy performance certificate (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.
So why is the government introducing MEES?
The built environment has been identified as a major contributor to Greenhouse Gas emissions, at the time of the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015, the government estimated that 18% of commercial properties held the lowest EPC ratings of F or G. If the UK does not take steps to reduce Greenhouse Gas emissions carbon reduction targets for 2020 and 2050 may not be met.
While Building Regulations ensure that new properties meet current energy efficiency standards, MEES will focus on the UK’s older buildings.
It is important to note that the minimum standard could rise in future.
Buildings and tenancies
MEES does not apply to:
- Buildings not required to have an EPC: such as industrial sites, work shops, 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)
- Tenancies of over 99 years.
Determining whether a building and tenancy are within scope
This requires owners to look at two sets of regulations:
- Energy Performance of Buildings (England and Wales) 2012
- MEES Regulations.
As this may be complicated for owners as the interchangeable naure of the regulations is complex, the government has provided guidance:
The Private Rented Property minimum standard – landlord guidance documents
The non-domestic private rented property minimum standard
The domestic private rented property minimum standard
Landlords will still be able to let buildings to which MEES apply, but which are below the E rating, if certain exemptions apply:
- The ‘Golden Rule’: An independent assessor judges that improvements made or not made would not pay for themselves through energy savings within 7 years.
- Devaluation: An independent surveyor judges that improvements would be likely to reduce the property’s market value by more than 5%.
- Third party consent: A tenant, superior landlord or planning authority has refused consent or given consent with conditions that cannot reasonably be complied with by the landlord.
It must be noted that exemptions should be registered on the government’s PRS Exemptions Register (https://prsregister.beis.gov.uk/NdsBeisUi/used-service-before); the exemptions are valid for five years only and cannot be transferred to a new landlord.
Penalties for non-compliance
The MEES Regulations will be enforced by Local Weights and Measures Authorities (LWMAs).
They will have powers to impose civil penalties which are set by reference to the property’s rateable value.
E.g. – If a property is rented out in breach of MEES for less than three months, there will be a penalty of 10% of the property’s rateable value (minimum £5,000, maximum £50,000). For more than three months, the penalty increases to 20% (minimum £10,000, maximum £150,000).
Where a property is let in breach of the MEES Regulations or where a penalty is imposed, the lease as between the landlord and the tenant remains regardless.
Who will be affected?
Landlords are the most affected parties because the key obligations and restrictions in the MEES Regulations fall on them.
The most obvious threats to landlords is the financial cost of upgrading buildings that fall outside of the scope of MEES, and the potential loss of income if a property cannot be rented out due to non-compliance.
Landlords can prepare now by:
- Auditing their portfolio to identify properties within the scope of MEES.
- Checking the accuracy of EPC ratings by carrying out energy assessments.
- Understanding how lease terms, break dates, renewals dates, etc., fit with the timetable of MEES’ implementation.
- Reviewing leases to understand rights and liabilities.
Freehold investors will not be affected by the MEES Regulations where the term of the headlease (lease held directly from the freeholder and subject to one or more underleases) is more than 99 years.
However, they should be aware that there is a chance that the value of any property assets which do not comply with the minimum standard could be negatively impacted. Also, 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.
On the other hand, Freehold investors who have tenant landlords in place will, however, benefit from the improvements being paid for by the landlord.
If a property has more than one landlord, the terms of the headlease will be likely to determine which landlord has the financial burden of making the necessary improvements to comply with the MEES.
Similar to landlords, investors and developers can prepare now by auditing their portfolios to identify which properties may be within scope of the MEES Regulations and understanding how the terms of the headleases and future development programmes fit with the MEES timetable above.
Lenders will also be affected by the MEES Regulations.
There is a threat to lenders where a building does not meet the minimum standard leading to a reduction in value of their security and ability to let the property. This may affect the ability of a landlord borrower to make repayments due to loss of rental income and additional costs for improving the building’s energy efficiency.
There is a further threat to lenders where they take possession of a property following default and become freehold investors or landlords and, thus, subject to the MEES Regulations themselves.
The MEES Regulations also provide opportunities to lenders where landlords need to borrow to bring their properties up to the minimum standard.
Lenders can prepare now by reviewing their lending criteria and conditions to check: Whether they are obtaining sufficient information on valuation of the asset to;
- Understand the impacts of MEES on their security
- Correctly price the risk and cost of borrowing and enable them to monitor the risk adequately
- Whether loan monitoring procedures need to be adapted to take account of the potential risks; (e.g. mandating that EPC certificates are provided by the borrower on all non-exempt lettings and/or requesting borrowers undertake and provide an MEES audit prior to the 2018 deadline)
- Whether 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.
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