When a minimum energy performance certificate (EPC) rating of “E” for commercial property was set in 2018, the deadline for compliance by 1 April 2023 for existing leases seemed a long way off. In a matter of days, there will be a prohibition on landlords continuing to let commercial properties with an EPC rating of either “F” or “G” irrespective of when the lease was entered into.
But does this mean that all commercial property has to comply with the Minimum Energy Efficiency Standard (MEES) or will some be exempt? In this alert we will look at what types leases are impacted by this (often confusing) legislation and which exemptions may apply.
Which commercial property leases are affected?
- New leases and the renewal or extension of existing leases. These have had to comply with MEES since 1 April 2018, with the result that a “sub-standard” property (with a rating of F or G) cannot be let out unless either improvements are made to bring the rating up to E or above, or the landlord can claim an exemption.
- Existing leases i.e. leases that are currently in place. MEES will now apply whether the lease was granted before or after 1 April 2018, with the same provisos as above. This means that, where there is a lease in place at 1 April 2023 (even if that lease has been in place for a number of years) and the property is found to be “sub-standard”, the landlord will need to enter the property to carry out any necessary works to bring the property up to standard, even though the tenant remains in occupation. A further point to note is that the landlord and tenant relationship is unaffected even if the property is classed as sub-standard but the landlord will be subject to penalties (assuming no exemption can be claimed). Non-compliance with MEES does not invalidate the lease and so cannot be used by tenants as grounds for breaching the terms of a lease or even trying to get out of one.
- Holding over - leases which are “held over” by a tenant after its lease has expired are treated in the same way as an existing lease and therefore will have to be compliant by 1 April 2023.
- Other leases not specifically excluded. There are a number of other lease arrangements which are assumed to be subject to MEES on the basis that they have not been excluded from the MEES Regulations including: reversionary leases; overriding leases; leases granted for a premium; leases granted for a nominal rent; periodic leases and leases which the landlord was obliged to grant, for example pursuant to a contractual obligation.
Are any leases exempt?
- Short leases. These are not subject to MEES provided that all of the following applies: the lease term does not exceed six months; there has been no previous continuous period of occupation by the tenant exceeding 12 months; and the lease has no right to renew.
- Long leases. These are exempt provided the lease is for a term of 99 years or more.
- Licences to occupy. The Non-domestic MEES Guidance indicates that licences to occupy are not subject to MEES, which would include occupation under an agreement for lease, so it is highly unlikely they would need to comply.
- Tenancies at will. This is a grey area as unlike licences there is no similar indication in the MEES Guidance for a tenancy at will. Generally the view is that they will not be caught as they grant a right to occupy and not a lease for a term of years, but this view has yet to be tested.
What are the exemptions?
It is worth noting that no landlords are exempt as the MEES Regulations apply to all landlords whether they are in the private or public sector. Where an exemption is claimed, it lasts for five years and is personal to the particular landlord, which means that if the property is sold, the new landlord will have to apply for its own exemption. Exemptions have to be registered on the PRS Exemption Register, with the exception of very long or short leases referred to above or where the MEES Regulations do not apply.
There a number of exemptions which may apply, the main ones are:
- Consent exemption. This is likely to be the most common exemption for a landlord to claim where improvement works can only be carried out with consent from a third party. Typically this would be where the tenant has refused consent or planning permission is required for the proposed works but cannot be obtained or is refused. An exemption may also be claimed if consent is only forthcoming subject to an unreasonable condition e.g. payment of a considerable sum for costs.
- Devaluation exemption. This is regarded as the least common exemption as the landlord has to prove that within the last five years it has been unable to increase the EPC rating as the relevant improvements would devalue the property by more than 5%. Evidence for this has to be provided by an independent surveyor.
- Impossible to improve rating. This applies where either the landlord can show that all relevant energy improvement works have been carried out but the EPC rating is still below an E or where there are no relevant improvement works which can be carried out to the property.
- Seven year payback test. This would apply where the cost of making the energy efficiency improvement would not show a saving in energy bills over a seven year period. The MEES Guidance includes details of how this is calculated preferably by an EPC assessor.
- Temporary exemption for six months. This gives a short extension of time to enable landlords in certain circumstances to comply with various letting restrictions. For example it can be used where a landlord buys a non-compliant tenanted property and it then has six months to either carry out the works to bring the property up to standard or apply for a longer term exemption. It is likely to be used where a landlord is contractually bound to grant a lease of a sub-standard property e.g. to a guarantor or where a new lease has been granted under the Landlord and Tenant Act 1954.
Impact of MEES
The Government has already announced its proposals to increase the requirement for a minimum EPC rating of “C” in 2027 increasing to a rating of “B” in 2030, although it is not known whether this deadline will be extended when legislation is passed. With energy efficiency improvements and sustainable building credentials high on the agenda of many organisations as part of their commitment to ESG, the current minimum rating of “E” is only a starting point.
Penalties for non-compliance with MEES are substantial and range from £5,000 to £150,000 so any landlord ignoring these changes would be foolish indeed. Lease drafting should take into account the impact of MEES both now and in the future and is something we can help with, so please get in touch with a member of the team.