As much as £16.54bn could be wiped off the value of the UK’s commercial property portfolio in response to the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015, better known as the Minimum Energy Efficiency Standards (MEES) Regulations.
These Regulations will prohibit a landlord from letting a sub-standard property from April 1st 2018 and from continuing to let a sub-standard property from 1st April 2023. A sub-standard property is one that fails to meet the minimum energy efficiency standard set at an Energy Performance Certificate (EPC) rating of an E. Therefore, a property with an F or a G rated EPC, unless exempt or excluded, is likely to be at risk from the Minimum Energy Efficiency Standards Regulations.
There is some expectation that the incoming regulations will potentially suppress rental levels at rent review or lease renewal. If rental growth is suppressed then, all things being equal, growth in capital values will likewise be suppressed. This could manifest itself through both the complexities and nuances of rent review and lease renewal negotiations, or through transactional evidence becoming available showing buildings that are compliant with MEES achieve higher rents or sale prices than those that are not.
“These Regulations will prohibit a landlord from letting a sub-standard property from April 1st 2018 and from continuing to let a sub-standard property from 1st
These hypotheses are not new, but were tested by engaging arbitrators and solicitors to identify and quantify this risk using a realistic case study building and lease in our research paper: MEES: The Implications for Rent Reviews, Lease Renewals and Valuation. The paper was peer reviewed by former Director & Head of Research at PRUPIM, Dr Paul McNamara OBE, RICS fellow, Ian Feltham, and Chartered Surveyor Sue Elwood.
The research used a hypothetical G rated EPC building with a 7% yield, a base capital value of £13m and four tenants at the point of either a rent review or lease renewal. It analysed the range of possible rents assuming the tenants made energy efficiency improvements, with and without landlord consent. It simulated a range of landlord and tenant valuations and the resulting capital values fell by a sum slightly in excess of the cost of relevant energy efficiency improvements, to one considerably in excess of those costs, leading to a reduction of over 10% in the building’s capital value. However, there are ways to ensure that your Commercial Property is MEES compliant.
- Valuers will be able to develop highly polarized arguments in rent negotiations, depending on whether they are appointed by the landlord or the tenant.
- Reductions in capital value were found to be between 0.7% and 11.6%.
- It is unlikely that leases ‘inside’ the 1954 Act will escape any impact from MEES. However, the main impacts on value will tend to follow statutory lease renewals.
- Leases inside or indeed, outside the 1954 Act might only be affected at rent reviews if transactional evidence proves the existence of a rental discount.
- Central to this debate on value impacts are the typical lease covenants relating to the hypothetical letting and the provisions of section 34 of the 1954 Act.
- The regulations place a great deal of importance on the accuracy of the EPC, therefore inaccurate EPCs could have serious and expensive consequences for a landlord.
- Impact on UK Property Values
Impact on UK Property Values
The July 2016 IPM report on size and structure of the UK property market estimated the total worth to be £871bn. 2014 research figures from Landmark Information Group showed that 19% of Energy Performance Certificates in England and Wales are currently F or G rated. The figures were cited in The Green Construction Board, Mapping the Impacts of Minimum Energy Efficiency Standards for Commercial Real Estate, August 2014. Therefore £16.5bn of total commercial UK property is estimated to be not complying with Minimum Energy Efficiency Standards legislation and therefore at risk. In the worst-case scenario, if properties are affected by reductions of 10% in capital values, this would result in a fall of approximately £16.5bn in the UK’s commercial property portfolio.