As a result of the MEES, landlords of commercial properties will be required to ensure that their let premises have a minimum Energy Performance Certificate (EPC) rating of “E”.
From 1 April 2018, landlords must not: grant a new tenancy; or extend/renew an existing tenancy if the building does not comply with this minimum standard.
From 1 April 2023, landlords must not continue to let a property, under an existing tenancy, if the building does not comply with this minimum standard.
Therefore, landlords who are leasing or sub-leasing property with a sub-standard rating of “F” or “G” need to carefully consider steps required to improve the energy efficiency rating in advance of the introductory dates. Landlords who fail to give this adequate consideration could find the investment values of their properties fall considerably and may even find that their premises can no longer be let.
Enforcement of the MEES
A landlord who is, or has, been letting a non-compliant, non-domestic property in the preceding 18 months, in breach of the MEES, faces financial penalties from between £5,000 to 20% of the rateable value of the property (up to £150,000). Therefore, the consequences of failing to comply with the MEES can be significant.
Exceptions and exemptions
The MEES will not apply to:
- Properties that do not need an EPC under the EPC regulations or buildings regulations;
- Short leases of 6 months or less (subject to a 12 month maximum period of occupation); and
- Long leases of 99 years or more.
There are also a number of key exemptions, where a property with a sub-standard energy rating can still be let, or continue to be let, including where:
- All possible relevant energy efficiency improvements have been undertaken, or where no such works can be undertaken;
- The landlord is unable to obtain the necessary consents to carry out the improvement works from third parties, such as tenants, lenders or the planning authority, despite reasonable efforts, or third party consent has been granted subject to a condition to which the landlord cannot reasonably comply; and
- A suitably qualified independent surveyor determines that compliance with the regulations would de-value the property by 5% or more, or would damage the property.
However, these exemptions are only ever going to be a temporary fix, as they do not pass from one landlord to another and only last for a period of five years.
The impact on rent review
There has been a lot of discussion on the potential impact of MEES on rent review.
On the one hand, it has been argued that a tenant taking a new lease would now consider paying more for a non-compliant building because at a rent review in five years (which would be after 1 April 2018), there is unlikely to be an uplift in rent. At that review, the hypothetical lease would unlikely be capable of being sublet, as under the regulations, it could expose the willing tenant to a fine as landlord of a sublease.
On the other hand, it has been argued that where a building is non-compliant, a landlord may be able to recover the cost of energy efficiency works via the service charges provisions. If so, a higher service charge, compared to the comparables, is likely to have a negative impact at rent review.
To avoid uncertainty, landlords should ensure that the rent review provisions within any new leases specifically state that the rent review is on the assumption that the landlord would carry out any works to the premises required under the regulations at its own cost. This should be effected before the landlord grants the notional lease.
Drafting considerations for new leases
There are a number of drafting points, which ought to be considered, including:
1. Compliance with statute
Landlords of existing leases may argue that the tenants’ obligation within a lease to comply with statute extends to the tenant complying with the MEES. However, tenants may argue that the landlord cannot lawfully let the premises unless it has an “E” rating and these works do not relate to the use and occupation of the premises. It is yet to be seen how provisions in existing leases will be interpreted but they are unlikely to be interpreted as placing the onus on the tenant to comply with MEES. Nevertheless, for the avoidance of doubt in new leases, a tenant may want to make it clear that they will not be liable, in any event, for the costs associated with improvement works required as a result of the regulations.
2. Repairs and yielding up
It would be difficult for a landlord to argue that the obligation on a tenant to keep the premises in good repair and condition obliges the tenant to improve the EPC rating of a property. Therefore, in new leases, landlords should consider making it clear that it is the tenant’s obligation to carry out any energy efficiency works that are required. Landlords should consider having an express provision within the lease which requires the tenant to yield up the premises with at least the same EPC rating as when the property was let. Such clauses should be resisted by tenants, as the minimum standard could rise over time and therefore this could be a very costly and burdensome obligation.
Landlords should bear the regulations in mind before they provide their consent to any alterations which could affect the energy efficiency of the property. In new leases, it may be worth expressly prohibiting alterations which may have otherwise been permitted if these alterations would have an adverse impact on the environmental performance of the property. Again, tenants should be weary of such clauses, as the minimum standard could increase over time.
Landlords of new leases should consider a clause which would either: prevent a tenant from obtaining a further EPC of the premises, which might be at a lower rate than the existing one; or which would give the landlord some control over the process.
5. Service charge
Landlords may consider that the sweeper clauses within their existing leases, allowing them to charge for any other services for the benefit of the tenant, entitles charging tenants for any improvement works to the EPC rating. However, the courts are likely to interpret these clauses narrowly. In new leases, landlords may wish for service charge clauses to be drafted so that they aim to recover the cost of replacing items, whether in need of repair or not, to improve the energy efficiency. Tenants, on the other hand, may want to include a clause to the contrary that they will not be responsible for the costs of any work required as a result of the regulations.
It is vital that landlords review their existing portfolio, as 1 April 2018 is imminent and tenants are becoming more aware of the valuation arguments at rent review for non-compliant buildings. Where a property is clearly non-compliant, landlords need to consider whether they should undertake and pay for the works required to comply with the standards, or risk arguments for a rent reduction and/or fine.
The MEES will be reviewed every five years and we do not know how stringent these regulations could become. However, it is likely that the minimum standards will rise over time and therefore landlords should consider aiming for a “D” rating rather than the minimum standard rating of “E”.
Time will tell how active a role the enforcement authorities will take but most organisations will not want to take the financial and reputational risk of letting non-compliant buildings from 1 April 2018 and continuing to let non-compliant buildings from 1 April 2023.