Real estate investors and lenders have had several years to come to terms with the Minimum Energy Efficiency Standards (MEES) legislation*, which broadly speaking will make it unlawful to let any building in the UK with a ‘sub-standard’ energy rating (currently defined as an F or G rated Energy Performance Certificate (EPC)). This will apply to new lettings and lease renewals from April 2018 and existing leases from 2023. As the 2018 deadline approaches the real estate industry has been waiting to see how some of the finer points of detail will be fleshed out. Importantly, last week the Department for Business, Energy and Industrial Strategy published their long-awaited guidance on the application of the MEES Regulations to non-domestic property. It provides interpretation and guidance for landlords, enforcement authorities and others with an interest in MEES.
Whilst the guidance is not legally binding, it is useful in providing landlords and their letting agents, property managers and consultants with further detail on the practical mechanics of MEES implementation. In this article, I highlight some key learnings for real estate investors and lenders.
The new guidance provides more detail on the following areas:
General application of MEES to non-domestic (commercial) property, such as the meaning of ‘landlord’ and ‘tenant’, application to sub-letting and application to multi-let buildings and mixed use (residential and commercial) assets. Notably the guidance:
confirms that allowing occupation of a sub-standard property by licence or under an agreement for a lease is unlikely to trigger MEES compliance;
indicates that an EPC that has been obtained ”voluntarily’’ (i.e. without legal obligation under the EPC legislation) will not normally trigger MEES compliance.
Relevant technical measures that qualify as ‘energy efficiency improvements’ under MEES, cost considerations and how the 7-year payback calculation will be applied. It includes detail on how to calculate the ‘relevant energy price’ and ‘interest rate factor’ for the purposes of payback calculations.
How MEES compliance will be monitored and enforced, including compliance notices, financial penalties (fines potentially up to £150,000), publication penalties (public names and shaming on the Exemptions Register) and rights of appeal.
Application of exclusions and exemptions under MEES. There is detail on the Exemptions Register, which will be available from April 2017 (whereas it was originally scheduled to open in October 2016). Registration does not attract a fee or charge. Exemptions are made on a self-certification basis with enforcement authorities undertaking monitoring and auditing. Whilst landlords can start earlier, there is no requirement to register exemptions until the minimum standard requirements come into force on 1 April 2018.
Exemption Register and Data
Organisations should bear in mind that if they register an exemption then most of their data will be publicly accessible! Of course, in compliance with the Data Protection Act, no personal data (e.g. names of individuals) will be public. However, most of the data about the building and exemption will be, such as address of property, name of landlord organisation (but not if the landlord is an individual person) and the exemption relied on.
The guidance makes it clear that exemptions claimed by a landlord will not pass over to a new landlord who acquires the property on sale. So a purchaser of property would need to re-assess whether the exemption applies, obtain the appropriate evidence and register it again. This will be an important due diligence point on property transactions. It is a further reason why landlords may determine it is commercially advantageous to undertake improvement works rather than try to take advantage of exemptions as they may blight the property.
One of the exemptions that may be claimed under MEES is where a relevant consent (such as from the tenant or a lender) could not be obtained. The guidance provides more detail on how much effort a landlord needs to put in to gain those consents before this exemption can be claimed.
Impact for commercial real estate lending and investing
This guidance is important reading for anyone advising real estate investors or lenders on compliance or sustainability strategy. Many sophisticated investors already have comprehensive MEES programs in place and the banks and real estate lenders have been catching up (for examples see this BBP industry insight paper). The recent guidance does not change anything fundamentally, but will help real estate players to finalise some of their procedures and strategies. It impacts on acquisition due diligence, underwriting, transaction documentation and post-closing actions, as well as asset and property management and lettings.
My key takeaway from reading this guidance is that the exemptions and exclusions will not provide much practical help in avoiding the need to upgrade sub-standard buildings. They may work in unusual circumstances, but generally are quite hard to achieve and maintain and time/money spent doing so will often be much better spent trying to undertake a smart upgrade on the building rather than jumping through hoops to benefit from what will be just a short-term exemption.
One new impact for banks and debt funds undertaking commercial real estate lending that may not have been considered is that they will need to establish a policy and procedures on how to deal with requests from borrowers to undertake upgrade works required under MEES. This may be covered under existing loan documentation and procedures for capex requests, but is there a reason to treat these differently?
We should also remember that April 2018 is really just the beginning of a journey and something of a ‘test phase’ as MEES will apply only to new lettings and lease renewals. Soon eyes will be focusing on 2023 when the minimum energy standards under MEES will apply to all buildings let on existing leases. Due to the public accessibility of some of the data on Energy Performance Certificates, rapid technological advances in data ‘scraping’ and big data analytics, and the much wider applicability from 2023, the issue of poor energy ratings in commercial buildings will become much more transparent. However, it’s a very manageable risk if real estate investors and lenders start planning now.
*The main relevant legislation is contained in the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015
David Short is a partner with Lux Nova Partners and former sustainability director and environmental legal counsel with GE Capital Real Estate. He chairs the Commercial Real Estate Lender Sustainability Working Group for the Better Buildings Partnership. Please get in touch if you have questions or require advice.