Hit and MEES: How the UK commercial property market is preparing for tighter energy efficiency regulations

Upcoming changes to MEES and EPC requirements could pose an expensive headache for owners of buildings with poor energy efficiency performance, but some circumstances may buy landlords more time to make improvements

What are the MEES regulations?
 
The rules on Minimum Energy Efficiency Standards (MEES) for buildings are dealt with in The Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 (MEES Regulations).
 
The MEES Regulations only apply to properties that are required to have an EPC.
 
What is changing?
 
Prior to the 1 April 2023, the MEES Regulations make it clear that if you want to let a building to which the regulations apply, you have to have an EPC rating of 'E' or above at the time of grant to let that property.
 
From 1 April 2023, as well as ensuring the building has an 'E' rating at the start of the lease, the lessor has an obligation to ensure premises held under existing leases have a minimum of an 'E' level of efficiency.
 
If it is below an 'E', then subject to certain exclusions (which need to be registered and last for five years), that letting will be unlawful and subject to financial penalties.
 
The penalty for failing to comply with the new MEES rules is based on the rateable value of the property and will be between £10,000 – £150,000 per breach. Details of the breach may also be published.
 
It has been indicated that these requirements may tighten again in the near future. Draft proposals published in 2022 suggest that the minimum EPC requirement for residential rental properties could be increased to C for new tenancies in 2025 and existing tenancies in 2028, with commercial properties being required to have an EPC rating of B by 2030.
 
What does this mean for financing commercial property?
 
A consequence of energy efficiency legislation ramping up should be a more positive ESG profile for the UK commercial property sector.
 
In terms of lenders' requirements, there will always be an obligation for borrowers to comply with the law, but in reality the importance of the ESG agenda is likely to depend on the individual lender.
 
The largest and most reputable lenders will want to be seen to be lending to borrowers with high energy efficiency and a good overall ESG performance, as this will feed into their own ESG policies.
 
Owners and operators of buildings with poor energy efficiency/ESG performance may find their pool of financing options is smaller than it would be if they had a higher rating.
 
How is the property market responding?
 
It depends on the individual landlord/developer/investor how up to speed they are with MEES.
 
Anecdotal evidence suggests there is significant variation in preparedness in the commercial property market.
 
Larger landlords are starting to focus on MEES through the lens of the stricter requirements which will be imposed upon them as the legislation ratchets up throughout the rest of the decade.
 
However, at the moment, there are still a number of 'get out of jail' cards for landlords.
 
These include where a landlord has completed all relevant energy efficiency improvements that can be made and yet the building remains substandard, where the costs of carrying out the improvement will not pay for themselves within a seven-year period (or cost more than £3,500 for residential properties).
 
Another circumstance that might give rise to an exemption from meeting the MEES requirements is where the landlord needs third party consent to do the work necessary to improve the building's energy efficiency, which is either withheld or issued subject to conditions with which the landlord cannot reasonably comply. 
 
For example, if a building owner lets a property to a third party hotels business, if the tenant decides to fit out the property with low-efficiency heating systems – for example, installing electric heaters in all the rooms – this will keep the building's EPC rating low.
 
In this situation, the best way to significantly increase the building's EPC rating is likely to be to remove all the electric heaters and replace them with a new efficient centralised heating system.
 
But unless the landlord agrees with the tenant to redo the heating system (and comes to a reasonable agreement on who will bear the cost) then the landlord will not have the necessary third party consent it needs to do the works.
 
These exemptions need to be registered and have a life of five years, so this is not an indefinite 'free pass', but does buy the landlord some time to plan its strategy going forward. 
 
In the latter example, the exemption may be sufficient to get the landlord to a point where the hotel needs refurbishment and replacement of its old heating system as a matter of course.
 
Should landlords retrofit or dispose of low-EPC rated properties?
 
There is no "one size fits all" on this. There will be some properties that are so inefficient that a complete rebuild might be the only solution. And there will be other properties where you can make improvements that make a real difference to the energy efficiency.
 
What seems certain is that property owners will have to start spending quite significant sums of money if the UK commercial property sector is going to get to where the government says it wants to be by 2030 in terms of energy efficiency.
 
This article was authored by Rhodri Pazzi-Axworthy, real estate partner at Fieldfisher.