Energy Performance Certificates (EPC’s) have already been a part of property landlords’ lives for many years.  However, there are changes coming into force in the next few years that could have game changing implications for many investors in commercial property. It may not be the most exciting of topics but it has potentially far reaching implications!

Since 1 May 2018, in England and Wales, it has been illegal to do a new letting of a property with an EPC rating of less than E unless there is a valid exemption.  These exemptions include, amongst others, listed buildings, temporary structures, some industrial sites or workshops, and detached buildings with a floor space of less than 50 sq. m.  Some vacant properties and buildings which are due for demolition are also exempt. 

The EPC requirement for E and above will be widened from 1 April 2023 to capture all let properties in England and Wales, even if there has been no change in tenant.

In June 2021 a consultation closed which is looking to enhance EPC ratings for commercial buildings even further, in England and Wales (there is a separate consultation and proposed regime for residential buildings).  The Government is proposing that by 2030 all non-residential buildings should achieve an EPC rating of either A or B, should this be able to be reached ‘cost effectively’.  It seems likely that this will become law given the support received during the consultation.  Various matters still require clarification, including whether the range of current exemptions should continue and whether the standards required in each EPC band should remain the same.  There will be various milestones along the way – including a proposed C rating by 2027.

The most recent consultation is also seeking to address various important points of detail, including greater clarity around the requirements for older and listed building; putting some detail around a ‘payback calculator’ (if the works are deemed ‘uneconomic’ there is a potential exemption) and what happens to properties that are let in a ‘shell and core’ condition.  This is very common with commercial properties and effectively means that the landlord will let the building structure ready to receive a tenant’s fit out.  Obviously in this case the tenant should have some obligations to comply with the regulations.   

Enforcement will be keen – with a proposed new central register to record EPC ratings – and there are also proposed substantial financial penalties.

It’s pretty clear that this something that us landlords need to take notice of, as it has significant  implications for both our investment and letting activity on commercial buildings. 

According to the lawyers, Pinsent Mason, it is estimated that the UK’s largest industrial and commercial buildings account for a third of total emissions from all buildings, and they pose a significant threat to the UK Government’s ambitions with regard to net zero carbon emissions. 

And it seems that the real estate industry is slowly waking up to the implications of this.  A recent report by Colliers commented that one in ten London offices could become unusable in two years unless landlords invest heavily in them, and that buildings rated D to G currently make up roughly two thirds of the London office market.  Large landlords such as British Land and Land Securities are each spending an estimated £250m to bring their portfolios up to the expected 2030 standards, according to the Financial Times, which is equivalent to roughly 4% of the companies’ net asset values.  The cost of these works is expected to hit their earnings significantly. 

So, what are the implications of the changes and how can we turn this potential issue into an opportunity that we can take advantage of?

Well, firstly, there does appear to be an emerging value implication.  Estates Gazette published a detailed study in 2020 which showed the rental yield impact of EPC ratings in the London area.  The margins in rental yield between the different EPC ratings were as high as 14.3%.  Of course, other factors would have come into play with this, including how recently a building was refurbished and its location, amongst other factors, but it now seems clear that the value implications will increase as the regulations become more stringent. 

In addition, tenants – most particularly large corporations and brands – are also trying to improve their green credentials and are becoming insistent on occupying only sustainable buildings.  This is something to watch for the future as achieving a letting to a blue-chip covenant can have a significant impact on the value of your investment.  If the property’s energy credentials are not up to scratch you may be restricting yourself to being able to let only to smaller, less financially stable, occupiers.

The onus is currently very much on the landlord to satisfy the EPC requirements and, even though tenants’ ongoing use of the property may be reflected in new, future, legislation, it will be important to ensure that you can get hassle-free access to your properties in order to carry out energy improvements.  If this isn’t written into existing leases you will have to negotiate with tenants to gain access and this may involve having to incentivise them by offering rent free periods or similar.  It will be important to make sure that access for these purposes is written into new leases and, of course, is one of many great reasons to maintain a good landlord-tenant relationship.  Similarly, ensure that you include a lease covenant for the tenant to comply with obligations that may be brought about by any change in the Government’s energy performance requirements.

Of course, there will be a lot of smaller landlords who will find the cost of making the energy performance improvements prohibitive.   This could well facilitate some interesting discussions with landlords who may be keen to offload their properties or portfolios – potentially setting up below market value (BMV) discussions.  However, having spoken to many landlords recently, it is apparent that many are blissfully unaware of the changes over the horizon and the implications of this.  If you are doing some direct to vendor marketing, it may well be worth pointing this out to them.

It goes without saying that you need to factor in the cost of EPC works into your purchase discussions.  It will be worth speaking to specialist consultants to make sure that you have fully factored in the 203O changes into your pricing so that you don’t catch a cold in the medium term.

Equally, if you are already a commercial property landlord now is the time to start to make decisions about your portfolio and to take steps to make sure you are prepared for the forthcoming changes.  This includes reviewing all existing properties to understand which properties are unlikely to meet an increased EPC threshold and what the cost of the works may be to bring these properties up to the required threshold.  It is worth getting the works costed so that you can make decisions about whether to sell, develop, or to hold and swallow the cost of the works.  There are several funds available that could potentially help landlords fund the cost of EPC works – for example, the Minimum Energy Efficiency Fund (MEEF) in London where smaller businesses can apply to the fund for financial help with adopting carbon reducing initiatives.

Older buildings, including listed buildings, will be more challenging to improve in order to reflect the changing legislation.  It could be prohibitively expensive to bring these properties up to standard and the Government is doing a separate review to make recommendations more tailored to older properties by end of 2021.  Watch this space on that one but if you hold older commercial buildings, such as old industrial buildings etc, now may be a good time to consider their future.  It could be that there are different ‘ratings’ for different types of buildings but all will be revealed when the legislation gets announced.

The changing energy performance requirements present some significant threats but also some potentially game changing opportunities.   It is clear that those who address any potential issues early will be in the driving seat.  Equally, if we can find solutions to solve looming problems for existing landlords who have potentially significant future liabilities then this could present some once in a generation acquisition opportunities.  Landlords who stick their heads in the sand on this one will be those that lose out!