Getting to grips with minimum efficiency standards affecting commercial property from April 2018

Posted: 01/07/2015

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The Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 (SI 2015/962) (MEES Regulations) were made on 26 March 2015. John Alker, acting CEO of the UK Green Building Council, said: “This is the single most important piece of green legislation to affect our homes and buildings that has been introduced in the whole of this Parliament.” The new regulations could adversely affect a property’s income stream and require capital expenditure so planning ahead will be crucial if investment values are to be maintained. Whilst the implementation date is almost three years away, that is not long in asset management and business planning terms. Accordingly, practitioners are advised to get up to speed now. 

This article looks at the letting prohibition contained in the MEES Regulations as it relates to commercial property and considers when it applies, the exemptions that may be available and the penalties for non-compliance. 

Key points 

Scope	Property must be: Non-domestic private rented property In England and Wales With a “valid” EPC (reg 20, 22 of MEES Regs and section 42(1)(b) of the Energy Act 2011)
Minimum standard	‘E' Rating on EPC No future trajectory
Implementation date	1 April 2018 - granting new tenancies 1 April 2023 - all existing tenancies caught
Exemptions	Not cost effective on seven year payback or under Green Deal Golden Rule Consent for works not available Expert states that measures will reduce property value by 5% or more Expert states that wall insulation will damage the property Temporary exemption for “forced” lettings  Subject to exemptions being recorded on PRS Exemptions register Exemptions subject to time limits
Penalties	Renting out a non-compliant property for less than three months - 10% of rateable value with a minimum penalty of £5,000 and a maximum penalty of £50,000 plus publication of non-compliance  Renting out a non-compliant property for more than three months - 20% of rateable value with a minimum penalty of £10,000 and a maximum penalty of £150,000 plus publication of non-compliance

Timescale for implementation

From 1 April 2018: additional hurdles will have to be overcome in order to let commercial property. From that date, where the letting prohibition contained in regulation 27 applies and the property has an EPC rating of F or G, a landlord should not grant certain types of tenancies of that property unless it can demonstrate that either: 

(a) an exemption applies and that exemption has been registered in the PRS Exemptions Register; or

(b) there are no “relevant energy efficiency improvements” that can be made or it has undertaken “relevant energy efficiency improvements” to the property. 

From 1 April 2023: a landlord should not continue to let out such properties unless either (a) or (b) above applies. 

Beyond 2023: the MEES Regulations do not provide for a future trajectory for the minimum level of energy efficiency but it is likely that the 'E' rating will be reduced in order to meet the UK’s legally binding carbon targets. What we do know is that the Secretary of State must review the operation and effect of the MEES Regulations after five years, ie in 2020 (reg 4). 

Scope of MEES letting prohibition

The letting prohibition (reg 27) relates only to “non-domestic PR Property” (defined in reg 20) which is “sub-standard” (defined in reg 22). As a result, in order to fall within the letting prohibition, the criteria set out below must apply. 

The property must be situated in England and Wales. The letting prohibition does not apply to property situated elsewhere. 

The property must be one that is required to have an EPC: if current or previous EPC regulations (Energy Performance of Buildings (England and Wales) Regulations 2012 or Energy Performance of Buildings (England and Wales) Regulations 2007) or the Building Regulations 2010 do not require a property to have an EPC, that property will not be caught by the letting prohibition. This takes the following property types outside the letting prohibition:

• properties which do not use energy to condition the indoor climate;
• certain listed buildings;
• buildings used as places of worship;
• temporary buildings with a time of use of two years or less;
• industrial sites, workshops and non-residential agricultural buildings with low energy demand;
• stand-alone buildings with a total useful floor area of less than 50 square metres;
• property which is to be demolished. 

Unfortunately, it is not always easy to identify whether a property falls within one of the classes of buildings exempted from the EPC regime (and thus outside the letting prohibition). The Government’s EPC guidance on the EPC exemptions creates uncertainties and these uncertainties flow through to the MEES regime. 

There must be a valid EPC: in order to fall within the letting prohibition, the property must be classed as “sub-standard” under regulation 22. That means there must be a “valid” EPC showing an F or G rating for the property. Accordingly, the letting prohibition does not apply where:

• the property does not actually have an EPC;
• there is an EPC but it is more than 10 years old.

Short lets and long leases are not caught. Regulation 20(3) takes the following outside the definition of “non-domestic property” and thus outside the letting prohibition:

• a tenancy granted for 99 years or more;
• a tenancy granted for a term not exceeding six months but only where:
• there is not a provision for renewing or extending the term beyond six months;
• the tenant has not already been in occupation for a continuous period of over 12 months. 

Only tenancies are caught. The letting prohibition does not apply to:

• sales of commercial property nor to owner occupied commercial property;
• licence arrangements;
• tenancy at will (despite its name, it is not a tenancy as it does not have a term certain). 

Tenancies falling within the prohibition include:

• those granted for more than six months but less than 99 years;
• those granted for less than six months where there is a provision to renew or extend the term;
• those granted for less than six months where, at the time the tenancy is granted, the tenant has been in occupation for more than 12 months;
• lease renewals and extensions;
• underleases;
• reversionary leases;
• overriding leases under LTCA 1995;
• those granted to a guarantor on a tenant’s insolvency;
• those granted pursuant to options to renew or extend;
• those granted by operation of law (eg deemed surrenders and re-grants).

Exemptions

Relevant energy efficiency improvements exemption (reg 28) 

A landlord can let F and G rated property falling within the scope of the MEES regulations (without the possibility of a civil penalty) in any of the following circumstances:

• where he can demonstrate that there are no “relevant energy efficiency improvements” that can be made (reg 29(1)(b)); or
• where he can show that all available “relevant energy efficiency improvements” have been undertaken but the property still falls below an 'E' rating (reg 29(1)(a)). 

“Relevant energy efficiency improvements” are defined in regulation 28. The provisions are complicated and reference also has to be made to section 49(4) of the Energy Act 2011. Essentially, the combined effect of these sections is that landlords only need to carry out improvements which satisfy all of the following criteria: 

• the improvements must be of a type listed in either the Schedule to the Green Deal (Qualifying Energy Improvements) Order 2012 or Table 6 of the Building Regulations Approved Document L2B (reg 28(1)(a));
• the improvements must be recommended in a green deal report, an EPC recommendation report, or a report by an RICS surveyor (reg 28(1)(b)); and
• the improvements:
• can be wholly paid for by a green deal plan (section 49(4)(b)(i) Energy Act 2011); or
• (for improvements listed in Table 6 of the Building Regulations Approved Document L2B) will pay for themselves through energy bill savings over a seven year period (regs 28(3) to 28(8)). 

In order to rely upon the above exemptions, the information specified in the Schedule to the MEES Regulations must be registered on the PRS Exemption Register. Furthermore, the exemption only lasts for five years (reg 29(2)). 

Also note that landlords do not need to install wall insulation where an independent professional gives a written opinion advising that it is not an appropriate improvement because of the potential damage it would cause to the fabric or structure of the property (or the building it forms part of). Again the exemption is only available where the opinion has been registered on the PRS Exemption Register) (reg 28(3). 

Lack of consent exemption (reg 31) 

The MEES regulations do not require landlords to carry out improvements where necessary third party consents cannot be obtained or are subject to unreasonable conditions. 

“Third party consent” is defined in regulation 2(1) and includes consents, approvals and permissions required from:

• planning authorities (eg planning, listed building and conservation area consents);
• a superior landlord or a freeholder;
• an existing tenant;
• neighbouring property owners/occupiers; and
• lenders. 

In most cases, the landlord needs to use reasonable efforts to get the necessary consent. 

In addition, the exemption will only be available where a registration has been made on the PRS Exemptions Register in accordance with the Schedule to the MEES Regulations. 

The exemption is time limited and only lasts for a five year period. 

Devaluation exemption (reg 32)

Landlords will not have to carry out improvement works where an independent surveyor says they would result in a reduction of more than 5% in the “market value” of the property. 

Again the exemption will only be valid for a five year period and, in order to take advantage of it, a copy of the independent surveyor’s report will need to be registered on the PRS Exemptions Register. 

Temporary exemption where a landlord is ‘forced’ into a letting (reg 33) 

Where an entity becomes a landlord in any of the circumstances specified in regulation 33(2), the letting prohibition is postponed for six months. 

This includes where:

• the landlord is under a contractual obligation to grant the lease. This is very wide and appears to cover leases granted under agreement for lease and other contractual arrangements such as options to renew. It is hoped that further guidance will clarify what is intended;
• a lease is granted by operation of law (eg because of a deemed surrender and re-grant);
• an overriding lease is granted pursuant to the Landlord and Tenant (Covenants) Act 1995;
• a lease renewal is granted pursuant to Part 2 of the Landlord and Tenant Act 1954;
• a lease is ordered by the court. 

A six month postponement of the letting prohibition will also apply where an entity becomes a landlord because it purchases an interest in a property and there is a tenancy already in place. This exemption is relevant only to the ‘continue to let’ prohibition in regulation 27(2)(b). 

As with the other exemptions, details must be registered on the PRS Exemptions Register before these temporary exemptions can be relied upon. 

Re-registering exemptions

When any of the exemptions expire, the landlord will need to carry out the improvements necessary to get an ‘E’ rating or again demonstrate and register an applicable exemption in order to let or continue to let the property. 

At present it is unclear whether successor landlords can rely upon exemptions claimed and registered by previous landlords. It is hoped that Government guidance will clarify this point. 

Penalties 

Regulation 41 sets out the level of civil penalties that can be levied where the letting prohibition is breached. The level of penalty depends upon the duration of the breach and the rateable value of the property, subject to specified minimum and maximum amounts:

• breach of less than three months: the penalty will be 10% of the rateable value of the property, subject to a minimum penalty of £5,000 and a maximum penalty of £50,000
• breach of more than three months: the penalty will be 20% of the rateable value of the property, subject to a minimum penalty of £10,000 and a maximum penalty of £150,000. 

In addition to the above, the enforcement authority can publish on the PRS Exemptions Register (for a minimum of 12 months) details of any breach and penalties imposed (known as “the publication penalty”). 

Helpfully, regulation 30 makes it clear that any tenancy granted in breach of the letting prohibition remains valid and enforceable. 

Advice for landlords

Plan ahead: landlord clients should be advised to:

• start/continue to carry out portfolio reviews to identify which assets fall in the F and G EPC bands;
• provide for future capital expenditure on energy efficiency works that may be required under the MEES regime. Consideration also should be given to how the upfront costs will be financed;
• review the terms of existing leases. Knowing what the landlord can/cannot do can then be factored into any retrofit program. Access rights and service charge provisions are particularly relevant;
• program any energy efficiency works to coincide with void periods, regular maintenance, lease expiries etc;
• take sustainability factors into account when making acquisition/disposal decisions. Question the reliability of existing EPCs and get a second opinion if necessary. Investment appraisals should take account of the cost of energy efficiency works. Post completion procedures will need to be altered to ensure that relevant exemptions are registered quickly.

Lease provisions? Introducing provisions into leases to make it easier to carry out relevant improvements (and get a tenant’s consent) will need to be weighed against the fact that such provisions may prevent the landlord from relying upon the lack of consent exemption in regulation 31. 

Landlords may, however, want to control when a tenant can commission an EPC (and control the identity of the energy assessor that can be appointed). 

Should EPCs be prepared voluntarily? The benefit of knowing which properties may fall within the letting prohibition will need to be weighed against the fact that the letting prohibition only applies where an EPC actually exists.

This article was published in Landlord and Tenant Review in June 2015.

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