Upcoming Energy Efficiency Requirements in the Rented Sector
The UK government has set a target to reduce greenhouse gas emissions by at least 80% by 2050, compared to the 1990 baseline. Since energy use in buildings is a major source of UK carbon emissions, improving their energy efficiency is central to achieving this target. Data suggests that domestic buildings were responsible for 25% and non-domestic buildings for 12% of the UK’s total carbon emissions in 2009. However, to date, incentives for making energy-efficiency investments in the rental sector have been lacking. A general absence of a standard mechanism to split costs and benefits between parties has left property owners reluctant to make investments where their tenants are the ones taking full benefit. The problem has only been exacerbated by high tenant turnover. With this background it is not surprising that voluntary initiatives have had disappointing results and the carrot has now been replaced with the stick...
The Energy Act 2011 (“the Act”) placed a duty on the Secretary of State to draw up regulations to improve energy efficiency of buildings in the domestic and non-domestic private rented sector in England and Wales. The Department of Energy and Climate Change (“DECC”) duly drew up regulations prescribing a minimum level of energy efficiency for such properties known as the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 (“the Regulations”), which were passed into law on 26 March, together with the Energy Efficiency (Domestic Private Rented Property) Order 2015 (“the Order”). Both remain to be published, although material changes to the drafts are not expected.
How the Regulations and Order work
The Regulations provide that, subject to certain limited exemptions, landlords of both domestic and/or non-domestic private rented properties may not:
(a) grant a new tenancy or renew an existing tenancy of a private rented property after 1 April 2018;
(b) continue with any existing letting of domestic private rented property after 1 April 2020; or
(c) continue with any existing letting of non-domestic private rented property after 1 April 2023
where its energy efficiency falls below the specified minimum standard.
Specified minimum standard
The Regulations require all affected buildings subject to, or proposed to be the subject of, affected lettings to achieve an Energy Performance Certificate (EPC) rating of “E” or better.
The Regulations apply to all buildings requiring EPCs (broadly all buildings with heating or air conditioning systems except those due to be demolished). Lettings affected Domestic private rented property was defined in the Act as property let on an assured or regulated tenancy, but excluding certain low-cost social housing. The effect of the Order is simply to extend this to also include certain agricultural tenancies.
Non-domestic private rented property is any property which is let on a tenancy but not a dwelling.
The landlord will generally be responsible for the cost of any works required to bring its properties up to the specified minimum standards required by the Regulations. However, a tenant of domestic private rented property will be entitled, from 1 April 2016, to request its landlord’s consent to it making energy efficiency improvements to a property and the landlord will not be permitted to unreasonably withhold consent to such works. In this case only, the tenant will be responsible for the cost of the works, unless third party funding is available (for example through a “green deal” loan).
There is a six-month grace period for a landlord to make improvements in circumstances where the landlord is not at fault for delayed compliance, for example where a lease is granted pursuant to a court order or by operation of law. However this will not apply where there is opportunity for advance preparation, for example on acquiring a non-compliant let property for the first time.
There are a few limited exemptions from the Basic Restriction referred to above, which include:
(a) where third party consent is required before any necessary works can be carried out and such consent is withheld;
(b) where an independent surveyor’s report states that the necessary works will reduce the market value of the property by more than 5%; and
(c) for non-domestic properties, leases that are either under six months (unless already renewed twice) or originally granted for over 99 years.
In addition, there is the “golden rule” that the costs of the works required to bring a property up to standard (including interest) must be the same or less than the expected energy savings. In the case of non-domestic property, the efficiency measures must be cost-effective over a maximum seven year pay-back period. Click here to view timeline in browser.
Penalties for non-compliance
If a landlord intends to rely on one of the prescribed exemptions to let a property, details will need to be provided for an online exemptions register, which will be maintained by the DECC. The register will be open to public inspection and local authorities will use it to monitor compliance.
Where a breach occurs, this will not affect the validity of the tenancy. However, there will be financial and publication penalties for both domestic and non-domestic properties. For example, renting out a sub-standard domestic property for three months or more will attract a fine of up to £4,000. Moreover, renting out a sub-standard non-domestic property for three months or more will attract a fine of the greater of £10,000 and 20% of the rateable value of the property, up to a maximum of £150,000. In each case, breaches will also be published on the register, with the attendant reputational damage.
Key observations and outlook
While the Regulations have been well received, clearly their effect will be far-reaching. Currently around 13.5% of all private rented properties have an EPC rating of “F” or “G”, rising to approximately 20% in the context of commercial property.
Prospective landlords, or tenants looking to assign or sublet, will need to assess the property’s energy efficiency and then the costs and viability of a retrofit or refurbishment. Any changes required should be implemented in good time to take advantage of void periods and ongoing maintenance and plant renewal.
There is also an expectation that the minimum “E” level of energy efficiency will be raised in the future as part of an ongoing drive to push up energy efficiency levels as the Regulations place a duty on the Secretary of State to carry out a review at regular intervals (no more than once every five years). Accordingly, consideration should be given to improving efficiency beyond the minimum standard, where appropriate. The penalty regime may similarly become stricter over time.
Property owners should be aware that similar energy efficiency measures are to be introduced in Scotland which, where relevant, will need to be considered in conjunction with the Regulations.
In light of the above, we predict the Regulations will impact on investment decisions and pricing. Energy efficiency is also likely to feature much more prominently in rent reviews and lending decisions.
The details of the Regulations and their specific exemptions are complicated. If you have any concerns or would like further guidance or assistance, please feel free to contact us. We would be happy to advise, if appropriate as part of a broader portfolio appraisal.
This update was authored by Elizabeth Alibhai, counsel at Dechert LLP.