With the UK’s commitment to reach net zero by 2050, owners and occupiers of commercial property have major changes ahead to meet legal minimum requirements. Key questions include who will be paying for energy efficiency upgrades, how will liabilities be shared between landlords and tenants and what terms will green commercial leases include.
What are minimum EPC requirements?
The UK Green Buildings Council (UKGBC) says that 25% of UK emissions are directly attributable to the built environment, with 19% of carbon emissions resulting from the need to heat, cool and provide power to buildings.
The Minimum Energy Efficient Standards (MEES) require that privately rented non-domestic property must currently have an Energy Performance Certificate (EPC) rating of E or above unless an exemption applies. From April 2027, a minimum rating of C will be required and from 2030, a minimum rating of B.
The rating is arrived at by looking at a building’s size, design, construction, age, heating, cooling, lighting, ventilation, insulation, energy usage and estimated carbon dioxide emissions.
What will net zero involve for owners and occupiers of commercial property?
Energy benchmarking of commercial premises is extremely likely for offices at first and then for other buildings. This will help owners understand energy usage and identify where improvements can be made. Targets can be set, and comparisons made with other buildings to find viable efficiencies that will improve the EPC rating.
However, it may not be easy to agree on the financing of the necessary building upgrades. In the UK, the concept of a clear lease implies that investment costs in a building should be recouped from occupiers via a service charge. While a commercial lease will normally allow landlords to recover the costs of maintenance works from tenants by way of service charges, the work required to reach net zero is likely to be substantial and require improvements going beyond normal maintenance and may need to be shared between the parties to retain the concept of a clear lease for investor landlords.
UKGBC says that 80% of the buildings that will be occupied in 2050 are already in existence, meaning that green upgrades are going to be essential for many.
Will a new commercial property market develop?
Retrofitting some commercial properties will be very difficult. There is a potential that a two-tier commercial property market could be established, with one tier of properties that are already relatively energy efficient and that will be easy to improve further and a second tier of property that will be complex and expensive to remediate with valuations and yields being factored accordingly.
How will the net zero targets affect corporate occupiers of commercial property?
Corporate tenant occupiers will need to approach the situation with caution. Well advised tenants should consider a cap service charges and have an expert commercial property solicitor check the agreement for seemingly innocuous provisions such as agreeing to cooperate with the landlord on improving a building’s environmental performance and an obligation to contribute to the cost of any upgrades via the service charge. Pre-completion surveys by such occupiers will become more relevant not just by reference to the existing condition of a building but also by reference to requisite net zero or energy efficiency upgrades that may become relevant over the Lease. Quite apart from the cost of such works, depending on the condition of the relevant building, there may be an element of disruption as a landlord exercises its rights to carry out upgrade works during the term. Tenants are advised to consider such matters including the risk exposure both in terms of service charge contribution and potential for disruption over the Lease term.
Landlords may be prepared to agree on a reduction in rent if a tenant meets energy efficiency targets.
How will the net zero target affect corporate investors in commercial property?
For investors considering a commercial property purchase, it will be essential to understand what work will need to be done to the property to meet future EPC requirements and how much this will cost. A clear strategy for carrying out disruptive work and financing it will be needed alongside ensuring that legal rights of entry for the purpose of building works are reserved in leases to enable that such works may be carried out without unnecessary delay over the short and medium term.
New leases should include clauses that set out how energy efficiency improvements will be dealt with and how the costs will be shared. With the tenant likely to benefit from lower utility bills, the landlord could consider claiming a reciprocal amount towards the cost of alterations. However, it is unlikely that tenants will agree to pay the full cost of improvements that could increase the value of the landlord’s investment.
Landlords will also need to address how access will be arranged to allow work to take place. This could be a problem for existing tenancies where occupiers are not bound to allow access.
It will also be necessary to ensure that tenants are not able to make alterations or use a property in a way that could reduce energy efficiency.
So-called ‘green leases’ address a range of energy efficiency measures. Offering a property with a green lease could be advantageous in the future as tenants become more aware of the need to meet minimum EPC requirements and comply with their own environmental and social governance requirements. Corporate tenants will need to consider the requirement to demonstrate sound environmental credentials. It could be the case that buildings with better green credentials command a higher rent as they become more sought after in the market.
Green leases can include clauses that require tenants to work with the landlord to explore the possibilities for environmental improvements and the right for landlords to carry out work that will improve energy efficiency.
Tenants should be required to use sustainably sourced materials when meeting their repairing and other maintenance obligations or when making alterations.
For landlords with existing leases, a non-binding statement can be proposed to occupier tenants where possible. This can include details of what work it is intended to carry out, a co-operation procedure, when it will happen, how access will be arranged and how costs will be dealt with.
How 3CS can help
Our expert property solicitors can assist you with commercial leasehold matters.
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