Effect on commercial leases
To reduce the amount of carbon emissions by 2050 the government has introduced scheduled stages that properties must meet minimum energy efficiency standards. As part of this scheme, it became unlawful for landlords to enter new lettings agreements for commercial premises that fall below an E standard on an EPC on the 1st of April 2018. Commercial properties that are currently classified as F or G have to be improved before leases can be renewed or created. Failing to comply will result in a fine of up to £150,000.
As 20% of commercial properties are classified as F or G rated properties this regulation is going to create a significant impact on private commercial renting. The exact repercussions of this change in regulations are hard to predict, as market forces and case law will affect the shape it takes. Here are some of the possible impacts MEES will have on both tenants and landlords of commercial properties.
Landlords will be unable to make new leases or renew leases with existing tenants without undertaking work to make the EPC classification an E rank. This means that they’ll experience not only a loss of income where the building has no tenants but will have expenditure to meet as well in terms of building work. Some landlords might find selling a more practical choice but be aware the EPC will most likely affect the valuation the building receives too.
The Impact of MEES on existing commercial leases for Landlords
Although commercial properties in existing leases will not need to be refurbished to meet the E rating standard until 1st of April 2023 there could still be the impact on the value of a lease before this date. Sub-letting could have been considered a huge aspect of a leases value. With the introduction of MEES, any tenants who sub-let a property become landlords who are responsible for MEES. The new MEES regulations will impact the value and viability of the sub-letting option in G and F rated buildings. The lower value of the lease will be seen through rent reviews.
The Impact of MEES on Rent Reviews for Commercial properties
Subletting is not going to be the only thing that affects the rent review process that could result in lower rent periods. The tenant could argue their own improvements to the property has enabled it to be classified as an E rated building or above and claim their improvements have increased the rental value of the property. They could ask for the cost of the improvement to be paid back over the period of the lease. When renewing a lease, the tenant’s business might be disrupted or need to relocate while improvement works are undertaken. This cost will be reflected in the rent with lower rates to cover the business cost or a free rental period. A research paper conducted by Dr. Paul Mcnamara et al used a hypothetical as estimated that rent could drop by 10% in price.
The Impact of MEES on EPC accuracy
The regulations stress that the EPC rating has to be accurate. Inaccurate classifications could have very serious and expensive repercussions for the landlord. With the focus on accuracy, it is best to have everything you need to have an accurate EPC rating ready to hand. It is also advisable to use a reliable and trusted energy assessor.
The Impact of MEES on a Landlord’s dilapidations claims
The amount a landlord will be to claim will be reduced for properties that do not meet the E grade standard of energy efficiency. This reduction in claims will include the loss of rent and diminution of value.
The impact of MEES on tenant’s alterations to commercial buildings
Where existing tenants have made significant improvements that have helped the EPC they may be able to recover the cost throughout the period of the lease. The flip side is that businesses that need to make alterations to a building that lower the EPC standard might not be able to get the landlord’s consent. Landlords will have ‘reasonable’ grounds for preventing these alterations. Or tenancy agreements will include a clause where they have to restore the initial condition of the building before the lease expires. This means industries that impact EPC rating might have greater difficulty finding a property to rent as they will negatively affect the property’s value.
The impact of MEES on tenants who Sub-let
Tenants who are subletting their property become a landlord themselves, which means they are responsible for making sure the minimum energy standards are met for that building. This may make sub-letting untenable for the leaseholders and will create a complex issue between the property owners and leaseholders. Tenants may find themselves unable to continue to sub-let the build without investment but may not be able to claim that investment back.
The impact of MESS on Lease Negotiations
Lease negations will become more complex. It will need to establish how the parties share the responsibilities and costs of MEES are cost-shared. More leasing transactions may be aborted in the late stages due to dwindling EPC standards.
The impact of MEES on commercial property Investors
Investment transactions may be postponed, lessened or aborted due to an EPC risk uncovered through the investigation process. Banks and other financial institutions have produced detailed guidance on how MEES risk should be accounted for during the valuation process. This may result in lower or no investment.
The Future Implications of MEES
By the 1st of April 2023, the minimum E rating will extend to existing leases on commercial properties. Tenants could put pressure on the property owners to put an EPC policy in place and to draft a plan for future-proof their premises.
It should be noted that the MEES change is a result of the government’s commitment to have zero CO2 emissions by 2050. This might mean that buildings may be pushed to a higher grade again before this date. Although this policy and target was part of an EU mandate and may change after Britain cedes from the European Union.