Minimum Energy Efficiency Standards: Key information and update

9th November 2017

Last year we published a briefing on the Minimum Energy Efficiency Standards (MEES) introduced under the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 (Regulations). Since then, the long-anticipated government guidelines have been published and there are now less than 6 months to go until the changes come in to force. It is therefore a good time to remind landlords on how best to prepare for the MEES and to shed further light on what can be expected in April 2018.

Background

According to the government’s Non Domestic-Private Rented Property Minimum Standard Guidelines (Guidelines), the energy used for heating and powering non-domestic buildings is responsible for around 12% of the UK’s emissions. In an attempt to combat damage to the environment and improve the economy, the Regulations will impose a condition that after 1 April 2018, a property cannot be let if it is rated F or G on its Energy Performance Certificate (EPC).

Key Information

Where MEES apply, the energy efficiency provisions will be rolled out in two parts:

1. From 1 April 2018, commercial landlords will not be able to grant tenancies if their property is rated below band E on its EPC. This applies to new or existing tenants in new leases, renewals or extensions.
2. From 1 April 2023, the minimum standard will also apply to all leasehold properties. This means that a landlord cannot continue to let a property with an F or G rating, even if it is subject to an on-going lease.

Generally the Regulations will apply to all non-domestic properties that are required to have an EPC and are privately rented on tenancies with terms of not less than 6 months and not more than 99 years. However, determining whether the MEES will apply is not always straightforward. The list of properties not required to have an EPC can include places of worship, holiday lets and some listed buildings. As this is a non-exhaustive list, it is a good idea to take legal advice if you are unsure whether the Regulations apply.

Where an EPC is obtained, it will be valid for 10 years, even if there is a change of tenant or the property is sold. When an EPC expires, a new one will only be required on the next ‘trigger point’ which can be sale, let or modification of the property. If a new EPC is applied for before the expiry of the 10 year term, this will always supersede any previous EPCs.

Exceptions

If a property is subject to the Regulations, there are limited exemptions available that may exclude a landlord’s responsibility, or at least buy some time. A new landlord may be exempt for a maximum of 6 months from when they take on a new property. Following this, exemptions can only be registered on one of the following basis:

• High Cost – to avoid landlords being faced with disproportionate costs, they are not required to install measures where the improvement costs will not be recovered within 7 years. A detailed formula for calculating this payback is set out in regulation 28(3).
• Consent– where consent to carry out works is required and cannot be obtained e.g. where a tenant sub-lets and requires consent from a superior landlord in order to make alterations.
• Impact on Value – where an independent surveyor determines that improvements will reduce the market value of the property by more than 5%.
• Unsuitable Measures – For wall insulation, where a written report provides that the improvement is not beneficial due to its negative impact on the property structure.
• Where all works have been done – if a landlord has made all the relevant energy efficiency improvements to the property that can be made and the property remains substandard.

It is important to note that these exemptions only last for 5 years from registration and do not transfer with the property. If a substandard property with a registered exemption is transferred, or if the exemption is more than 5 years old, the landlord must improve the rating or register a new exemption.

Enforcement

The MEES will be enforced by the Local Weights and Measures Authority (LWMA). If the LWMA believe that the landlord has been in breach of the Regulations at any time in the past 12 months, it may serve a compliance notice requesting information from a landlord which will help to decide if there has been a breach.

If it is found that a property is rented in breach of the Regulations, the following penalties will be imposed:

• Where a property is rented for a period of fewer than 3 months, the fine will be equivalent to 10% of the property’s ratable value, to a minimum £5,000 and maximum £50,000.
• When the breach exceeds three months, the penalty is 20% with a minimum of £10,000 and a maximum of £150,000.

Further penalties of up to £5,000 may be imposed where the landlord has registered false or misleading information on the exemptions register, or where it has failed to comply with a compliance notice.

If a landlord believes that a penalty notice was based on an error of fact or law, that the notice does not comply with the Regulations or that it was inappropriate to serve a penalty notice on them in the circumstances, it may appeal to the First-tier Tribunal (General Regulatory Chamber). Details of how to appeal are contained in the Guidelines.

Landlord and Tenant Act 1954 (the Act)

The Guidelines make clear that the nothing in the Regulations should impact on the rights of a tenant under any other regulations, including those set out in the Act. This means that where a tenancy has protection of the Act and the tenant has a right to renew, the landlord cannot refuse the renewal on the basis that the property is substandard. Equally, tenants cannot use a landlord’s non-compliance as a reason to get out of a tenancy agreement early.

Generally, if a new lease is to be granted on a sub-standard property, the landlord has no choice but to improve the rating or register an exemption. However, where a new lease is granted in accordance with the Act, the new Landlord could be eligible for the aforementioned sixth month exemption.

Lenders

Lenders should be aware that if they have security in a property and that property falls below the minimum standard, its value could decrease on the basis that it will no longer be rentable. Further, lenders may find that borrowers with a substandard EPC rating are impaired financially and may be unable to make payments as a result. A lender should be mindful that if this leads to it taking possession of the property, it will become the landlord and will be liable under the Regulations itself.

Landlords of Long Leases

As has already been mentioned, the MEES will not to apply to leases with a term of more than 99 years, meaning that many freehold owners/long lease landlords will not be subject to the Regulations. These landlords should still be aware of the changes though, as they may notice knock-on effects.

As with lenders, the landlord of a long lease should be mindful that their property may face a reduction in value caused by a substandard EPC rating. It may make their interest more difficult to sell on, and new tenants may be unwilling to take on a lease where they will be responsible for improvement works.

Cost Implications

The Regulations initially referenced the Green Deal and Green Deal finance, a finance mechanism introduced under the 2010-2015 Government. It has since been confirmed that such finance has not been extended to non-domestic property and is therefore unavailable to commercial landlords. The implication is that landlords will be required to fund improvement works themselves, or attempt to recoup costs from their tenants.

Clearly, the Regulations are going to be a financial burden for landlords, as improvement works could be costly, but not carrying them out could result in a complete loss of rental income. The high cost exemption detailed above should ensure that any amount that is paid out in improvements is returned in energy savings over 7 years. Unfortunately, a 7 year recoup will not assist in the initial cost of works and as many tenants are responsible for utility payments, it may transpire that it is only them that reap the benefit.

In order to share the costs, a landlord could try and include an express obligation in a lease that the tenant foot the bill for improvement works. Otherwise, it should ensure that lease provisions on service charge, rent reviews and yielding up are drafted to ensure that expenditure for improvements can be recovered elsewhere.

Relevant Lease Terms

In addition to specific provisions relating to costs, a landlord may consider the following amendments to its current lease terms:

• Right of Entry – It may be beneficial to reserve a right to enter the premises to carry out improvement works;
• Obligation to do works – The landlord may wish to oblige the tenant to carry out the required improvement works;
• Alterations – The landlord may want to prevent the tenant from making alterations that could negatively impact the EPC rating of the property;
• Obtaining the EPC – The landlord may wish to prohibit the tenant from obtaining an EPC, so as to avoid the tenant obtaining a substandard EPC that would supersede the landlord’s current certificate;
• Yield Up – The yield up provisions could be amended so that the tenant cannot yield up with less than an E rating on the EPC
• Break Option – A break option could be included so that the landlord is able to terminate the lease if continuing to let the property would put it in breach of the Regulations;
• Green Leases – Generally, a landlord and tenant may wish to enter in a ‘green lease’ in which their responsibility for efficient energy is shared.

WM Comment

It is crucial for landlords and lenders to assess their portfolios to work out which of their properties will be subject to the Regulations and which of those may fall in to substandard EPC categories. Purchasers of properties intending to let those properties and landlords with upcoming renewals should ensure that their lease terms protect their position in line with the costs and practicalities of making their property energy efficient.