In 2015, the Government introduced the Minimum Energy Efficiency Standards (MEES) to look to drive improvements in the energy efficiency of some of the worst performing building stock, across both the domestic and non-domestic private rented sectors.
An EPC (energy performance certificate) rating reflects the energy efficiency of a building, and these ratings range from A (very efficient) to G (inefficient). Included within the MEES are minimum EPC ratings that private rented property needs to meet. EPC ratings are given by qualified assessors who inspect properties for a number of factors, including potential for heat or energy loss, insulation, and double-glazing. Each factor is scored based on its energy efficiency, and this feeds into an overall score that informs the EPC rating.
The rules differ slightly between “domestic” and “non-domestic”, private rented property:
Not all residential property will be affected by MEES; the property must be privately rented under a ‘qualifying lease’ and certain property types (i.e. low-cost rental accommodation) are expressly excluded from the regulations. Since 1 April 2018, landlords of domestic properties covered by MEES have not been able to grant a new tenancy (including by extension or renewal, although there is some uncertainty around this) of such properties if the EPC rating is below an E rating. Additionally, since 1 April 2020, landlords generally can no longer let or continue to let such properties if they have an EPC rating below E, unless they have a valid exemption in place. The MEES regulations are enforced by local authorities, who have a range of powers to verify compliance and may issue financial penalties of up to £5,000 per property.
The exemptions include circumstances where the landlord requires tenant consent in order to carry out improvement works and is unable to obtain that consent despite making reasonable efforts; and where a surveyor confirms that making energy efficiency improvements would adversely affect the value of the property by more than 5%. In both cases the exemption must be registered on the PRS exemptions register.
Although not strictly termed an exemption, the MEES regulations also provide that a landlord will not fall foul of the prohibition against letting sub-standard property if there are no relevant energy efficiency improvements that can be made to the property; or if they have made all of the relevant energy efficiency improvements they can, and the property remains below an E rating. A relevant energy efficiency improvement is defined in the regulations, therefore a landlord cannot assume that all efficiency improvement works will qualify. For example, where the landlord pays all or part of the cost of buying and installing an improvement and the cost exceeds £3,500, the improvement will not qualify. If a landlord cannot improve a property to the standard of EPC E or above for £3,500 or less, they may make all of the relevant improvements that can be made up to that amount before registering for an “all improvements made” exemption. This exemption lasts for 5 years, after which it will expire and landlords must try again to improve the EPC rating to an E standard. If they cannot do so, they must register another exemption (if possible to do so).
The domestic MEES guidance (rather than the MEES regulations) introduces the related concept of a “high cost” exemption. The landlord would be able to state that no relevant energy efficiency improvements can be made if the cost of installation of even the cheapest measure would exceed the £3,500 threshold.
Savills have estimated that the average cost of bringing property rated D to G to an EPC C is £10,730. This is almost 3 times the improvement cost threshold landlords are expected to meet, suggesting that exemptions may be frequently sought. The Government has however consulted on raising the maximum spend landlords will need to invest to bring the tenancies up to standards to £10,000, applying to new tenancies by 1 April 2025 and all tenancies by 1 April 2028.
The Government has also signalled in its “Clean Growth Strategy” a commitment to the tightening of energy performance standards in the domestic private rented sector, with the aim of having as many homes as possible upgraded to EPC C or above by 2035, where “practical, cost-effective and affordable”. This is also reflected in the Government Energy White Paper. Additionally, the Government has consulted on requiring that by 2028, all domestic rented properties require an EPC rating of C or above and that any new tenancies must meet these new criteria from 2025. It is also proposed that the penalty for not having a valid EPC will be raised from £5,000 to £30,000 from 2025.
Since 1 April 2018, landlords of private rented non-domestic properties have been unable to grant a new tenancy in respect of a property with an EPC rating below E. From 1 April 2023, they will not be able to continue to let the property without a “legitimate reason” as permitted by the MEES regulations. Such a reason could be that all relevant improvements have been made but the property remains sub-standard, or that another exemption applies. In these circumstances, landlords must submit the relevant details on the PRS Exemptions Register in order to avoid enforcement action. As with domestic properties, these exemptions are time-limited.
Following consultation, in 2021 the Government confirmed in its Energy White Paper its intention to raise the MEES for privately rented non-domestic buildings to EPC B or above by 2030. The proposals would implement this standard by way of two “compliance windows”: the first requiring all privately rented non-domestic rented buildings to achieve an EPC C or better (or register a valid exemption) by 2027; and the second requiring a privately rented non-domestic building to have improved to an EPC of B or better (or a valid exemption having been registered) by 2030. At each enforcement date in 2027 and 2030, landlords would need to demonstrate that the building has reached the highest EPC band that a cost-effective package of measures can deliver.
What policy changes are likely going forward?
The Government’s consultation on implementing EPC B standards in the commercial sector ended in June 2021 but the outcome is not yet published. While the Government has clearly signalled its intention to tighten the MEES in respect of both domestic and non-domestic properties, its policy proposals have yet to be formally implemented by a statutory process. It is estimated that the outcome of the Government’s consultation will crystallise into regulation in 2025.
In its 2022 update report to Parliament, the Climate Change Committee (CCC) noted that while already around two fifths of homes are estimated to be EPC C or above, if the Government wants to meet its ambition for all homes to achieve EPC C by 2035, the number of domestic properties receiving energy efficiency upgrades needs to scale up substantially. The report flagged that energy efficiency in “non-fuel poor homes” is the most significant policy gap in the building sector, with only the private rented sector covered in the UK through the consultation on raising the minimum standard for domestic rental properties to EPC C by 2028. The CCC also noted that there is no funding to support home retrofits and there are no regulations to drive improvements in standards. The CCC noted that the Government is still considering a voluntary energy performance target for mortgage lenders, which is currently the only policy proposal that impacts the owner-occupied housing market in the UK. The CCC commented:
“The Government needs to address the policy gap for energy efficiency in owner-occupied homes and commercial buildings. It should bring forward credible policies which create incentives or enforceable requirements for home and building owners to act. For homes, this could include a policy requiring EPC C from 2028 at the point of sale and/or a clear mandatory minimum requirement for mortgage lenders.”
What is the likely market impact?
In respect of the non-domestic sector, CBRE recently commented that the Government estimates there are 1.8 million non-domestic premises across England & Wales of which approximately 60% are rented and fall within the scope of MEES. CBRE further estimates that the issuance of EPCs rated B or higher would need to grow by at least 41% every year if the target of achieving EPC B or better in the non-domestic sector is going to be met. Mike Prew of Jefferies has stated that Jefferies will begin to incorporate EPC information into its research reports, which, if other financial services firms follow suit, could encourage compliance across commercial landlords. As stated in our blog post of 2019, the issue of retrofitting and upgrading current building stock remains pertinent and still looms in 2022. Jefferies singled out large property investors and developers as the institutions best positioned to ‘upcycle’ properties with poor EPC ratings and has suggested it may even be lucrative to do so. However, not all properties can or will be capable of being improved in this fashion, leaving a significant risk of stranded assets and, according to EG, around £2.5bn of rental income under threat.
Due diligence that encompasses ESG data (including EPC ratings) will become increasingly pertinent as the risk of real assets becoming stranded increases. As RICS highlights, investors will be much less attracted to unsustainable real assets that are at risk of becoming stranded, not only because they can achieve higher rental income from properties with better sustainability credentials but also to avoid penalties for non-compliance with regulation.
In the domestic arena, Savills estimates that 58% of domestic properties in the rental market currently have an EPC rating between D and G, signalling that a significant proportion of rented homes will fall short of the standards. The percentage of non-compliant properties soars when considering the Government’s long-term target of implementing the EPC B level by 2030 for all non-domestic rented buildings. It is estimated that 85% of properties in this sector will be affected. Therefore, whilst in the living sector most “build to rent” developments will already be achieving high EPC ratings, the Government’s aspiration to achieve an EPC C and B standard may hit harder where investment strategies involve assembling a portfolio from existing stock, which may need to be improved.
It should be underlined that EPC only measures potential/hypothetical efficiency, and it does not reflect actual energy consumption or carbon emissions. Even if the Government reaches targets of EPC B across the board, this is not guaranteed to be a reflection of real data on energy efficiency. Transparent measurement and monitoring of the data on how EPC targets are working will be necessary to ensure that Government regulations translate into real energy efficiency impact. Every property needs tailored solutions to match its efficiency shortcomings based on factors including age, location, design and building materials, and yet recommendations to improve an EPC rating are not always relevant or possible.
What is the alternative? A “fabric first” approach to property design and development may be a more robust solution for future property developments. Considering the materials of a development with energy efficiency in mind at the outset can not only reduce costs but will reduce reliance on energy saving products and is more sustainable overall. Where the EPC targets are intended to fix an existing problem, a “fabric first” approach seeks to reduce energy inefficiency from manifesting at all.
In June 2021, the Government concluded a consultation into the “Performance-Based Policy Framework in Large Commercial and Industrial Buildings in England and Wales.” This scheme is intended to provide owners of and investors in commercial and industrial buildings above 1,000m² in England and Wales with a metric by which to assess energy use and carbon emissions and to reduce consumption and related energy costs.
It is important not to underestimate the value of the EPC database as it holds energy efficiency data on 20 million homes and non-domestic buildings which has allowed for the setting of energy efficiency targets and has fed into the conversation about tackling energy efficiency on a national scale to achieve the 2050 net carbon zero deadline. An Energy Performance Certificates Action Plan was also launched by Government in September 2020 with the intention of increasing the quality of EPCs (and therefore trust in their use) through improvements to the system of producing EPCs.
The requirements for EPC ratings, once a speck on the horizon, are now hurtling towards players in the market. These hardening regulations mean that landlords will come under increasing pressure to bring properties up to required EPC standards, the cost of which is a staggering £15bn, as estimated by EG.