The recent statement from the British Property Federation calling on the government to immediately publish its response to the consultation on the Energy Efficiency (Private Rented Property) (England and Wales) Regulations (the MEES Regulations) shows the degree of concern and uncertainty over the future direction of the MEES regulations.
The government has indicated that it is committed to improving the energy efficiency of commercial real estate. Under the MEES Regulations, on 1 April 2023 it became unlawful, subject to various exceptions, to continue to let substandard non-domestic properties, meaning those with an energy performance certificate (EPC) rating of F or G.
The government has said that its target is to make it unlawful to let commercial property below an EPC B rating by 2030, though this is yet to be confirmed.
A recent report by Savills suggests that 87% of offices has an EPC rating of C or below. In another survey, nearly one fifth of UK landlords still have commercial properties with an EPC rating of F or G and, of more concern, 52% of landlords do not think the 2030 requirements will be achievable.
There is justification for this concern – the current and future targets may well put pressure on many landlords to undertake works to meet the minimum standard, which in turn will bring into play issues around access for works and recoverability of costs incurred in meeting the minimum standards, as well as control over works by tenants. Good communication and clear, balanced lease drafting is of course the best starting point to reduce the scope for disputes between landlords and tenants. However, increased friction is unfortunately inevitable.
In this article we take a closer look at those potential pinch points, so that the risk of disputes can be reduced.
Service charge
Some landlords may be willing to fund energy improvement works themselves because they ought to improve the value of the property. However, all landlords are likely to want to either recover some or all of their expenditure from their tenants or have their tenants fund the works in the first place.
Where the works relate to the common parts, the service charge provisions in the lease are likely to be the best starting point for understanding the parties’ rights and obligations. Most leases have provisions for landlords to be able to carry out works to the common areas.
However, the landlord’s ability to recover energy-improvement costs from the tenant is likely to depend not only on the wording of the service charge clause but also, on whether the works are ‘improvements’ or works of ‘repair’. The costs of pure improvement works are unlikely to be recoverable from tenants unless the only appropriate method of repair is replacement with a modern, more energy efficient equivalent.
In new leases, landlords may look to include express rights to recover costs for energy efficiency works. Most tenants will push back on such provisions although some business occupiers may be more open to this where they understand the long-term benefit to them, such as a reduction in energy bills and/or meeting their own ESG targets.
Access
Where landlords want to carry out internal energy improvement works to areas occupied by their tenants additional considerations are likely to arise and recovering the costs of the works may prove even more difficult.
Neither the repairing obligation nor the usual lease obligation on tenants to comply with statute are likely to be helpful for landlords seeking to recover such costs. For instance, an item is not in disrepair simply because it is not energy efficient, and the MEES regulations do not in fact impose an obligation to carry out energy improvement works but simply imposes fines on the landlord for letting properties in a non-compliant condition.
Even if the landlord is resigned to undertaking the works at its own cost, it will need to understand whether it will be able to obtain access during the term of the lease to do those works. The tenant may be able to resist access if the only purpose of the landlord’s access is to undertake energy improvement works, especially if the works are going to be disruptive to the tenant’s business.
That said, it may be of some comfort to landlords that where, despite all reasonable efforts, they are unable to obtain the tenant’s consent to access the premises to undertake the works by 1 April 2023, they can apply for an entry on the PRS Exemptions Register permitting them to continue to re-let their substandard property for as long as that tenant who did not consent to the works remains the tenant.
Alterations
If a tenant wishes to carry out alterations to a property, its landlord will now need to consider the MEES regulations. A landlord should be alive to the potential impact the works may have to the EPC rating of the premises and may wish to put safeguards in place, including seeking to vary the lease to prevent a tenant carrying out works which will bring the premises to a substandard rating or the right to refuse consent where the works might downgrade the EPC rating for the premises.
Dilapidations
Dilapidations disputes at the end of the lease may well be the key battleground in terms of seeking to recover improvement works.
Some of the legal issues which will be relevant to end-of-lease dilapidations claims have already been referred to above. The key issue is likely to be showing that the item is in disrepair in the first place or that the appropriate method of repair is replacement with a modern, energy efficient equivalent.
Where a landlord carries out energy improvement works which go beyond the tenant’s liability under the terms of the expired lease then the tenant may have a defence based on supersession. In other words, the tenant’s repairing obligation is superseded by the improvement works the landlord will need to carry out to re-let the premises, which may therefore cause no loss to the landlord. If successful, that defence would significantly reduce the value of the landlord’s claim resulting from the dilapidated state of the premises.
It is fair to say that the cards may be stacked against landlords when it comes to trying to recover the costs of undertaking energy-improvement works. However, landlords may well be encouraged by reports suggesting that tenants want to occupy energy efficient buildings giving them the opportunity to add value to buildings that are substandard by undertaking works that will hopefully result in higher rental values.
Lease renewals
On renewal of a business lease, landlords may well try to improve their position by seeking terms which address some of the above problems.
For instance, landlords may look to introduce greener clauses or additional restrictions on tenants carrying out alterations which might downgrade the property’s EPC rating. Where the lease has the protection of the Landlord and Tenant Act 1954 (LTA 1954) if a landlord seeks a departure from the terms of the existing tenancy then, unless the tenant agrees, that departure must be reasonable.
Unfortunately for landlords, while each case turns on its own facts, recent case law suggests that where a proposed new lease term imposes an additional burden on the tenant, it is unlikely to be considered reasonable. We are likely to see more of these kinds of cases coming to court in the next few years. But again, to avoid such litigation, landlords and tenants may prefer to work collaboratively to reach a compromise on the terms to include in a lease during the lease renewal process.
It is also conceivable that energy efficiency issues will have an impact on opposed renewals. There is increasing noise around the environmental benefits of retro-fitting existing buildings rather than demolishing and rebuilding them. So far as the LTA 1954 is concerned, it is generally far easier to oppose the grant of a new tenancy where the intention is to demolish rather than to substantially reconstruct part. If, in the future, there is legislative pressure not to demolish, this could have a meaningful impact on a landlord’s ability to recover possession and redevelop.
If, at the end of the term, the landlord needs to undertake improvement works to ensure that a fine is avoided and needs possession to do that, it may struggle to use that reason as a ground to oppose the grant of a new tenancy if the tenancy is protected by the LTA 1954. Undertaking pure improvement works may not be substantial enough to come within ground (f) (the redevelopment ground) and the landlord may be unable to satisfy ground (g) (the own occupation ground) solely based on the need to undertake works.
Some landlords will be looking at poor energy performing buildings as an investment opportunity. To avoid some of these issues, landlords may want to ensure that the leases are excluded from the protection of the LTA 1954 and incorporate early landlord break rights. However, taking those steps may impact on rental values at least in the short term.
Tim Rayner is a partner and joint head of real estate disputes and Sana Ikhlaq is a solicitor at Irwin Mitchell LLP
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What might MEES regulations mean for landlords?
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Tim Rayner and Sana Ikhlaq
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The recent statement from the British Property Federation calling on the government to immediately publish its response to the consultation on the Energy Efficiency (Private Rented Property) (England and Wales) Regulations (the MEES Regulations) shows the degree of concern and uncertainty over the future direction of the MEES regulations.
The government has indicated that it is committed to improving the energy efficiency of commercial real estate. Under the MEES Regulations, on 1 April 2023 it became unlawful, subject to various exceptions, to continue to let substandard non-domestic properties, meaning those with an energy performance certificate (EPC) rating of F or G.
The government has said that its target is to make it unlawful to let commercial property below an EPC B rating by 2030, though this is yet to be confirmed.
A recent report by Savills suggests that 87% of offices has an EPC rating of C or below. In another survey, nearly one fifth of UK landlords still have commercial properties with an EPC rating of F or G and, of more concern, 52% of landlords do not think the 2030 requirements will be achievable.
There is justification for this concern – the current and future targets may well put pressure on many landlords to undertake works to meet the minimum standard, which in turn will bring into play issues around access for works and recoverability of costs incurred in meeting the minimum standards, as well as control over works by tenants. Good communication and clear, balanced lease drafting is of course the best starting point to reduce the scope for disputes between landlords and tenants. However, increased friction is unfortunately inevitable.
In this article we take a closer look at those potential pinch points, so that the risk of disputes can be reduced.
Service charge
Some landlords may be willing to fund energy improvement works themselves because they ought to improve the value of the property. However, all landlords are likely to want to either recover some or all of their expenditure from their tenants or have their tenants fund the works in the first place.
Where the works relate to the common parts, the service charge provisions in the lease are likely to be the best starting point for understanding the parties’ rights and obligations. Most leases have provisions for landlords to be able to carry out works to the common areas.
However, the landlord’s ability to recover energy-improvement costs from the tenant is likely to depend not only on the wording of the service charge clause but also, on whether the works are ‘improvements’ or works of ‘repair’. The costs of pure improvement works are unlikely to be recoverable from tenants unless the only appropriate method of repair is replacement with a modern, more energy efficient equivalent.
In new leases, landlords may look to include express rights to recover costs for energy efficiency works. Most tenants will push back on such provisions although some business occupiers may be more open to this where they understand the long-term benefit to them, such as a reduction in energy bills and/or meeting their own ESG targets.
Access
Where landlords want to carry out internal energy improvement works to areas occupied by their tenants additional considerations are likely to arise and recovering the costs of the works may prove even more difficult.
Neither the repairing obligation nor the usual lease obligation on tenants to comply with statute are likely to be helpful for landlords seeking to recover such costs. For instance, an item is not in disrepair simply because it is not energy efficient, and the MEES regulations do not in fact impose an obligation to carry out energy improvement works but simply imposes fines on the landlord for letting properties in a non-compliant condition.
Even if the landlord is resigned to undertaking the works at its own cost, it will need to understand whether it will be able to obtain access during the term of the lease to do those works. The tenant may be able to resist access if the only purpose of the landlord’s access is to undertake energy improvement works, especially if the works are going to be disruptive to the tenant’s business.
That said, it may be of some comfort to landlords that where, despite all reasonable efforts, they are unable to obtain the tenant’s consent to access the premises to undertake the works by 1 April 2023, they can apply for an entry on the PRS Exemptions Register permitting them to continue to re-let their substandard property for as long as that tenant who did not consent to the works remains the tenant.
Alterations
If a tenant wishes to carry out alterations to a property, its landlord will now need to consider the MEES regulations. A landlord should be alive to the potential impact the works may have to the EPC rating of the premises and may wish to put safeguards in place, including seeking to vary the lease to prevent a tenant carrying out works which will bring the premises to a substandard rating or the right to refuse consent where the works might downgrade the EPC rating for the premises.
Dilapidations
Dilapidations disputes at the end of the lease may well be the key battleground in terms of seeking to recover improvement works.
Some of the legal issues which will be relevant to end-of-lease dilapidations claims have already been referred to above. The key issue is likely to be showing that the item is in disrepair in the first place or that the appropriate method of repair is replacement with a modern, energy efficient equivalent.
Where a landlord carries out energy improvement works which go beyond the tenant’s liability under the terms of the expired lease then the tenant may have a defence based on supersession. In other words, the tenant’s repairing obligation is superseded by the improvement works the landlord will need to carry out to re-let the premises, which may therefore cause no loss to the landlord. If successful, that defence would significantly reduce the value of the landlord’s claim resulting from the dilapidated state of the premises.
It is fair to say that the cards may be stacked against landlords when it comes to trying to recover the costs of undertaking energy-improvement works. However, landlords may well be encouraged by reports suggesting that tenants want to occupy energy efficient buildings giving them the opportunity to add value to buildings that are substandard by undertaking works that will hopefully result in higher rental values.
Lease renewals
On renewal of a business lease, landlords may well try to improve their position by seeking terms which address some of the above problems.
For instance, landlords may look to introduce greener clauses or additional restrictions on tenants carrying out alterations which might downgrade the property’s EPC rating. Where the lease has the protection of the Landlord and Tenant Act 1954 (LTA 1954) if a landlord seeks a departure from the terms of the existing tenancy then, unless the tenant agrees, that departure must be reasonable.
Unfortunately for landlords, while each case turns on its own facts, recent case law suggests that where a proposed new lease term imposes an additional burden on the tenant, it is unlikely to be considered reasonable. We are likely to see more of these kinds of cases coming to court in the next few years. But again, to avoid such litigation, landlords and tenants may prefer to work collaboratively to reach a compromise on the terms to include in a lease during the lease renewal process.
It is also conceivable that energy efficiency issues will have an impact on opposed renewals. There is increasing noise around the environmental benefits of retro-fitting existing buildings rather than demolishing and rebuilding them. So far as the LTA 1954 is concerned, it is generally far easier to oppose the grant of a new tenancy where the intention is to demolish rather than to substantially reconstruct part. If, in the future, there is legislative pressure not to demolish, this could have a meaningful impact on a landlord’s ability to recover possession and redevelop.
If, at the end of the term, the landlord needs to undertake improvement works to ensure that a fine is avoided and needs possession to do that, it may struggle to use that reason as a ground to oppose the grant of a new tenancy if the tenancy is protected by the LTA 1954. Undertaking pure improvement works may not be substantial enough to come within ground (f) (the redevelopment ground) and the landlord may be unable to satisfy ground (g) (the own occupation ground) solely based on the need to undertake works.
Some landlords will be looking at poor energy performing buildings as an investment opportunity. To avoid some of these issues, landlords may want to ensure that the leases are excluded from the protection of the LTA 1954 and incorporate early landlord break rights. However, taking those steps may impact on rental values at least in the short term.
Tim Rayner is a partner and joint head of real estate disputes and Sana Ikhlaq is a solicitor at Irwin Mitchell LLP
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