Lease advisory

Over the last 12 months, there has been a noticeable increase in awareness around EPCs and MEES (Minimum Energy Efficiency Standards) for both landlords and occupiers, especially as part of the lease renewal negotiations, with many corporate occupiers and businesses starting to take government messaging seriously. We have also seen increasing awareness around ESG (Environmental Social and Governance), with targets being implemented at board level and accelerated by the impact of Covid. Landlords are responding by making provisions to ensure the future proofing of their real estate assets and investment strategy.

There will be changes in the minimum EPC band requirements as a result of the MEES regulations which will impact on lease renewals.

Current situation

There continues to be uncertainty about the MEES regulations and the impact on commercial leases, including lease renewals. Current regulations have proven to be open to interpretation, leading to confusion about the government’s overall MEES and EPC legislation. As a result, the overall limited impact of EPCs and MEES has not had ensured stringent compliance, with tenants, in particular, not rising to the challenge.

Government messaging

Following the government’s White Paper released in December 2020, it is clear that the trajectory is targeting EPC B by 2030. Government was reassured in its consultation paper that this was achievable and its proposed framework being: –

In the near future, it would be prudent to focus on the April 2023 MEES regulations milestone, when landlords must not continue to let a non-domestic property which is already let, if that property has an EPC rating of band F or G.

The consequential impact on lease events

Avison Young have been scenario planning with a number of organisations on the consequential impact of implementing a coherent EPC strategy for lease events for both landlords and occupiers. Whilst one size doesn’t fit all, a decision tree can assist in responding to EPC issues. The following issues should be considered as part of any scenario planning exercise:

  1. The consideration of the lease term on lease renewals, ahead of any future and present lease renewal, and the interrelationship with the EPC expirations.
  2. Understanding the impacts on lease renewals for leases both protected and unprotected.
  3. The modelling, the cost and the extent of implementing improvements to comply with the various categories of EPCs, in particular, to achieve a B rating by 2030.
  4. What actions are required to ensure that all leases have an EPC by 2025 at a C rating.
  5. Who should be doing the EPC improvement works, whether this is a landlord responsibility as set out by the legislation, or tenant obligation as set out in the lease or “agreement for lease” on any future lease renewal and possibly a mixture of both.
  6. The disruption to the tenant’s business of any improvement works undertaken.
  7. The impact of the tenant’s fit out on the EPC rating.
  8. The impact on future breaks and rent reviews.
  9. Tightening of the lease obligations regarding compliance with the relevant EPC legislation and in particular, to tenant’s fit out.
  10. The parties’ overall aspirations to comply with improvements to sustainability and compliance with an ESG policy.

As well as organisations working internally to develop their own EPC policies on lease renewals, there will also need to be a wider engagement. This includes:-

  • landlords and tenants having detailed discussions regarding any improvement plans and ensuring the lease drafting is compliant.
  • sharing of experience and knowledge from within the industry.
  • consideration of the potential legal scenarios, which could evolve as a result of parties avoiding compliance.

Perceptually, EPCs have to date been seen as a landlord problem, whereas the issue is one for both landlords and tenants to consider collectively. Occupiers can no longer continue to avoid the impact, especially in their approach to fitting out and alterations to premises.

Tenant fit out

A clear concern is the impact of tenants’ fit out on EPC ratings. Government, even in its subsequent consultation paper released in June 2021, was challenged by the issue and subsequently recognised by their statement “Under a tightened EPC B trajectory, tenants would need to increase investments to meet this higher standard which they are obliged to do”. There has been limited discussion concerning the potential workaround solutions, to improve the EPC consideration for tenants’ fit out works. However, this is an overall issue that needs to be tackled either at lease commencement or to coincide with the tenant proposing to undertake works. There are a number of associated considerations relating to tenant fit out. The simplest step would be to amend the alteration clause obligations, to ensure tenants remain compliant with current EPC ratings. The more difficult position rests with the tenant in the need to ensure fit out proposals are compliant and potentially achieve a B rating.

The way forward

Organisations may still wish to see government’s final implementation plan, although to delay consideration especially ahead of a lease renewal, for either the landlord or tenant may be a costly mistake. Both landlords and occupiers need to start thinking about the consequences of implementing an overall plan of action to future proof assets and meet government’s trajectory.

Stuart Powesland Director, Lease consultancy

stuart.powesland@avisonyoung.com 0117 988 5208

Munish Vaswani

Associate Sustainability Consultant

munish.vaswani@avisonyoung.com

020 7911 2061

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