Under the 2018 EPC Minimum Standards Regulations, landlords will only be able to let properties if they have achieved a minimum EPC rating band of E. With figures suggesting that 18% of commercial property in the UK currently has an EPC rating of F or G and just two years to meet the standard, David Fairley, partner and accredited non-domestic energy assessor at property consultant Sanderson Weatherall, considers the potential impact for commercial landlords.

Under Section 49 of the Energy Act 2011, landlords will be prohibited from letting (but not selling) any property which does not meet the Minimum Energy Performance Standard (MEPS) by 1st April 2018. The bill was introduced to try and speed up energy efficiency upgrades in the non-domestic sector. It means landlords with properties which have an EPC rating of F or G, will only be able to let the property after they have carried out improvements to bring it up to the minimum EPC rating band of E.

Market Effect

It is estimated that buildings account for around 40% of the EU’s total energy consumption and 43% of the UK’s total carbon dioxide emissions. In addition to this, data from the national EPC register suggests that 18% of commercial property has an EPC rating of F or G and a further 20% with a rating of E.

Whilst as yet untested, the regulations will apply from 1st April 2018 and it is considered that there are three possible scenarios, depending on whether the minimum EPC rating will apply only to new leases from 1st April, to all leases from 1st April, or a combination of the two approaches. In the latter scenario, which is believed to be the Government’s preferred option at present, it is likely the regulations would apply to all new leases from the 1st April 2018 with a long stop date of 2023 for all existing leases to ensure compliance.

Whichever approach is taken, it is clear that the 2018 EPC minimum standards regulations will have significant implications for landlords and occupiers who wish to assign or sub-let space.

Most notably, it will be impossible to market properties with F and G ratings unless they are upgraded to meet the minimum standards. Whilst further clarification is required on the transactional trigger for minimum energy standards, it is likely that they will apply to all lettings, re-lettings including sub lettings and assignments.

However, there are further implications too. The impact on valuations of such properties is likely to be affected with a significant diminution in their value, whilst rent reviews for properties of an F or G rating are also likely to be affected. The effect of diminution in value and Section 18 implications with regard to unlettable properties is also a matter that will need to be further considered at the end of a lease, during the dilapidations assessment. Any property with inadequate energy efficiency measures will be affected.

Exempt Properties

Despite the fact that the regulations are to be brought into force from 1st April 2018, the Government is proposing several instances where a landlord may be exempt from compliance and therefore able to legally let a property with an EPC rating below the minimum requirements.

A landlord will be able to claim an exemption if third party consent is denied from tenant, lender, planning authority or a higher landlord/ freeholder. In such instances, the landlord must notify the exemption on a centralised online register and lodge evidence to prove the exemption before the letting goes ahead.

A landlord will have six months to comply with the regulations or register an exemption following lease renewals. The exemption is also only available if the proposed energy efficiency improvements would have a negative impact on the value of the property. There is also dispensation if all the improvements that are possible to be undertaken at no upfront cost to the landlord, such as those that can be completed through a Government finance arrangement, still do not lift the EPC rating above the minimum requirements.

It is important to note that an investment landlord who purchases a property with a rating below the minimum requirement, will not inherit exemptions from the previous landlord and will be given six months to comply with the regulations. For example, if a previous landlord has an exemption on the basis that the tenant refused consent to energy efficiency measures being carried out, the new landlord will have to again try to obtain the tenants consent.

It is likely that exemptions will last for five years, after which the landlord will either need to achieve the minimum EPC rating of E, or seek to obtain a further exemption.

Compliance and enforcement

It was originally thought that the landlord will be required to make improvements to a building if they involved no upfront cost and are works that could, for example, be recovered through a Government finance or incentive scheme. This position is now believed to have changed and it appears that the landlord will have to carry out energy saving measures that effectively pay for themselves through savings in energy bills within a timescale of approximately seven years. Only measures that fall outside of that bracket will be covered by an exemption.

In accordance with the procedures currently in place for EPCs, the enforcement of the MEPS regulations will be via local Trading Standards Officers. The level of penalty has not yet been disclosed but is likely to reflect the rateable value of the property, with fines in the region of £5,000 to £150,000 depending on the length of the non-compliance and the rateable value of the property. There will also be a penalty of £5,000 for providing false or misleading information to the exemptions register.

Next steps

By working with a property consultant to complete a review of their property portfolio, landlords can identify those properties with a rating below the minimum Energy Performance Standard and, crucially, establish the cause of the rating.

Leading property consultants can also support landlords to identify what improvements could be made to raise the energy standard of the property, assess the lease to identify where the responsibility lies and provide an assessment of the impact on maintenance life cycle costing.

Even if a property does not meet the minimum standard, this regulation will not necessarily mean that expensive energy efficiency upgrades are needed. In some cases the rating may be a direct consequence of inefficient tenant alterations which will be removed at the end of their term, whilst others may discover that refurbishing the external fabric of the building as part of normal cyclical maintenance could upgrade the rating. There have even been occasions when an error was made during the preparation of the original EPC and no additional measures were required.

Clearly there is still some detail to be confirmed but with less than two years until the regulation comes into force, landlords must act sooner rather than later to ensure compliance and reduce energy bills for tenants – before it’s too late.