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New EPC rating requirements and the impact on retailers

Published on 01 September 2021

What is happening?

Since April 2018 the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 (the Regulations) have imposed minimum energy efficiency standards (MEES) for private rented properties (subject to a handful of exemptions). The energy efficiency standards are evidenced by an energy performance certificate (EPC). From 1 April 2023, the second phase of the Regulations will commence, and the requirement will be extended to include existing leases, even where such leases have been in place for years and the tenant will not be changing.
 
The more significant changes, however, were proposed in the Government’s Energy White Paper published in December 2020. The planned measures are:
  1. to prevent landlords from letting commercial property with an EPC grade of less than C from 1 April 2027 unless an exemption applies (and existing exemptions must be reviewed), and
  2. to prevent landlords from letting commercial property with an EPC grade of less than B from 1 April 2030 unless an exemption applies (and existing exemptions must be reviewed).

Why does it matter?

According to the Government, 85% of commercial stock is currently estimated to be below a B rating and so this would force an enormous retro-fitting exercise on landlords, ie to upgrade the property’s rating. Obvious considerations include:

  • how are stores/other premises currently rated? Would they require an upgrade?
  • How do leases currently deal with energy ratings/ECG certificates? Terms are likely to need close consideration if the term spans to 2027 and beyond
  • how will landlords seek access to stores/other premises in order to conduct remediation works?
  • will landlords try to make performing works conditional upon being granted access, and pass on liability for non-compliance onto the retail tenant if it doesn’t grant effective access?
  • will landlords expect tenants to conduct works themselves and/or bear some/all of the costs?
  • how will landlords compensate retail tenants in relation to closed stores/properties?
The changes the Government have proposed are ambitious and we expect a bumpy ride for unprepared landlords and retail tenants over the coming years.
 
Whilst we focus on retail tenants here, we appreciate that some retailers will also be landlords and should consider taking their own specialist advice on the considerations for landlords which we have flagged. In a similar vein, we have concentrated to a large extent on retail stores in this piece, given the direct impact this could have for store visitors and staff, but the impact on the wider property portfolio should also be considered.
 
In terms of warehousing/distribution centre spaces, we do not expect the exemption covering any ‘Industrial sites, workshop or non-residential agricultural buildings that do not use much energy’ to change. However, most modern warehouses/distribution centres with a heating and cooling system will continue to require an EPC and so would be caught by the upgrading requirements.

 

What actions should we consider? 

1. Disruption – Landlords will be keen to reserve access rights to carry out necessary works. As the most common energy-efficiency works are to windows, insulation and heating and cooling systems, there is potential for huge disruption to a retailer’s business. Retail tenants will want to limit landlords to required works only and to be able to enjoy a rent free period or other compensation. Retail tenants should consider the term of existing leases and how they can seek to best position themselves in preparation for the changes – when is the next renewal? Will there be an opportunity to negotiate favourable terms?

2. Fit-Out – Commonly a retailer will take a property in “shell and core” state, to allow its own installation of lighting, heating, ventilation and air conditioning to a standard pattern. The Government is proposing to offer landlords short term exemptions where letting on this basis to avoid wasted works on the part of the landlord which the tenant will then remove. However, since this leaves the landlord dependent on the tenant to meet the EPC target, the Government is considering imposing compliance duties on tenants for the first time, including a duty of cooperation with the landlord. This is of particular interest to retail tenants leasing on a “shell and core” basis. We already see landlords refusing consent to alterations where they are not sufficiently energy-efficient, but this will only be exacerbated when landlords are shooting for an EPC rating of B or above.

3. Costs – The costs of energy-efficiency works could be huge where a property needs to be raised from an E to B EPC rating and who pays is a key question. Clearly the Government views the improvements as the responsibility of landlords. However, whether costs can be passed on depends on the wording of the lease. The usual “compliance with laws” obligation is not thought to be sufficient to require a tenant to pay for energy-efficiency improvements. However, if a service charge includes improvements or replacement of equipment with a more energy-efficient alternative then the works may be charged to tenants. Retail tenants should ensure that any replacements are for end-of-lifecycle equipment only or, better still, that works required by the Regulations are specifically carved out of the list of provided services.

This article was written by Elizabeth Alibhaias and Julianna Khudoliei as part of RPC's Retail Compass Autumn edition 2021.