22 October 2019

EPC B by Twenty Thirteee…?!

Most real estate professionals are presumably familiar with minimum energy efficiency standards (MEES) in non-domestic property, now that the relevant legislation has now been in place since 2015. MEES is a consideration on any investment in non-domestic property (together with any related financing) and on any letting of that property. Professionals must now ask the question on any such transaction: “is MEES a concern?”

Why? It is now unlawful to grant or renew an occupational lease a non-domestic property where the EPC rating is below the minimum standard (subject to exemptions). As of April 2023, such a letting will not lawfully continue. The minimum standard is currently EPC rating E.

The Department of Business, Energy and Industrial Strategy (BEIS) has now launched a consultation on MEES in non-domestic property, setting out its preferred trajectory for the minimum standard. Yet the consultation goes further, identifying BEIS’s wider thinking on improving energy efficiency in non-domestic building stock. There are two key takeaways, plus a few snippets of further interest in the consultation.

1. What is the trajectory?

BEIS’s preferred target is that the minimum standard is EPC rating B by 2030 and arguably, with the tone of the consultation, it will take some persuasion for BEIS to proceed differently. BEIS proposes an alternative strategy of EPC rating C by the same date, but according to its own internal modelling, this alternative (unlike its preference) will fail to deliver carbon reductions consistent with the Paris Agreement. Apparently its preferred strategy will bring 85% of existing building stock within the scope of MEES, as opposed to 42% on the alternative strategy. So if it is set to be a minimum standard of EPC rating B by 2030, what are the key takeaways for current building owners? Firstly, as for existing stock, 85% will require energy efficiency investment where an owner is looking to let that property. Secondly, 36% of that stock could require a MEES exemption, unless owners go above and beyond the requirements of the legislation (i.e. according to BEIS, 36% of stock cannot reach EPC rating B on a “cost effective”, seven-year payback basis). In short, the vast majority of landlords will need to take positive steps to address MEES, and furthermore, exemptions will become far more prevalent.

Whether it is EPC rating B or C by 2030, does BEIS propose a jump from E in 2030, or an incremental increase between now and then? BEIS is consulting on different approaches. The consultation hints at a preference to apply increments on the basis of entering, renewing or extending new tenancies so that, using the BEIS example, a landlord cannot lawfully grant a new lease or renew unless the property has achieved an EPC D by 2024, EPC C by 2026 and EPC B by 2028. It then cannot lawfully continue to let a property in April 2030 unless it achieves a B rating, without an exemption. However, as the consultation asks, would it be more cost effective and practical to implement measures to increase to a B/ C rating in one go?  

2. “Operational” EPCs too?

Last year, BEIS launched a consultation on EPCs, but whilst it acknowledged the potential for operational, “real time” EPC ratings, it did not go any further (see our blog here). Apparently BEIS continues to review responses to that consultation. Pleasingly BEIS has now confirmed that in 2020 it will consult on the introduction of mandatory in use energy performance ratings for commercial buildings. As both consultations acknowledge, an EPC rating can only go so far. A property with a high EPC rating may be able to achieve high levels of energy efficiency, but if used inefficiently by an occupant, the “static” nature of an EPC is rather misleading. As Anne Johnstone, Partner at Hollis stated in her excellent EG article last month: “To design truly sustainable buildings, the way tenants use them must be taken into account”, further citing the alarming statistic from UKGBC that there can be as much as a 250% performance gap between an EPC rating and actual energy performance. Julie Hirigoyen, Chief Executive of UKGBC, has since welcomed the move, stating: “There is strong evidence from the Australian NABERS scheme, amongst others, that mandatory operational ratings can radically drive down energy use and reduce emissions. The best-performing business buildings in Melbourne use between five and six times less energy than their London equivalents”.

If there really is a genuine move from the Government to change behaviour, surely “real time” ratings are the next step? If so landlords and tenants will no doubt need to collaborate to monitor usage. “Green lease” provisions may have to become the norm, rather than the exception, as is arguably the current case.

Anything else?

The consultation again acknowledges the “shell and core” dilemma, which is particularly prevalent in retail leasing. Typically, a landlord will hand over a unit in a “shell and core” state, and it is only the tenant’s fit out that will increase the EPC rating. However, if a “shell and core” unit does not meet the MEES minimum standard, the landlord cannot lawfully let, and almost inevitably, transactions require the additional complexity of conditional agreements for lease. The consultation requests “market-led” solutions, and so for those frustrated by this common dilemma, now is the chance to have your say. 

Has anybody had firsthand experience of enforcement, whether in relation to the provision of EPCs or the MEES regulations? This firm has not. The consultation acknowledges that if the MEES regulations are to have the necessary “bite”, enforcement is key, and the consultation asks how the Government could improve enforcement. Interestingly, the consultation identifies that the Government is currently running a pilot project with seven local authorities to establish how the MEES regulations can be most effectively enforced, with four local authorities looking at commercial stock. Are we set to see a more stringent level of oversight?

What about domestic stock? In April next year, it will be unlawful to continue to let domestic property with an EPC rating of F or G, again subject to exemptions. Therefore, in terms of energy efficiency requirements, the residential sector is ahead of the commercial sector. However, is there a similar proposal on trajectory? The consultation confirms that it will further consult on the trajectory to higher EPC bands for domestic stock this winter. As a reminder, the Government’s Clean Growth Strategy identified an aim to get as many homes as possible to EPC rating C by 2035. Is this set to be the proposed benchmark, or can we expect something more?

Edward is a senior associate in our Commercial Real Estate team.

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