What risks will MEES create for the Commercial Real Estate Industry?

As the 1st April draws closer, property managers, asset managers and all professionals within the commercial real estate industry will be preparing (or at least getting ready) for the introduction to the Minimum Energy Efficiency Standards (MEES) 2018.

As we outlined in our energy agenda for 2018, there will be many changes to look out for this year, including the use of Artificial Intelligence and the consultation on changing the carbon and energy reporting framework for companies, but the introduction to MEES is by far the most impactful.

All properties rated F or G will no longer be lettable as of 1st April and as our recent research showed, 1 in 5 of our 3,620 properties now have lower EPC ratings after being re-simulated through the latest version of SBEM. The research also found that 14.8% of our properties are now F or G rated and 28.2% are rated E, F or G. These are quite worrying results considering the proximity of the introduction to MEES. It also suggests that many landlords and building owners have still not started the improvement measures to become MEES compliant. A reality which could be quite concerning.

With this in mind, we take a look at the main risks that will arise from the introduction of MEES:

Industry Risks:

  • Many properties (those where leases are being renewed or are obtaining new leases) may be unable to generate an income from properties that don’t meet MEES:

– Where properties cannot be let, they provide no source of income for the landlord. In fact, the landlord will have to invest money into the property in order to carry out improvement measures and comply with the legislation.

  • There is the potential that MEES could lead to a reduction of over 10% in the building’s capital value:

– It is expected that MEES will suppress rental levels at both rent reviews and lease renewals. As a result, if rental growth is suppressed then it is very likely that growth in capital value will also be suppressed. Furthermore, if evidence emerges that MEES affect rental values and the property in question is thought to be at risk in a future rent review or lease renewal, then the yield could be adjusted for an investment sale. This could also potentially suppress capital values further.

Overall, the sum of MEES could be great, and not only due to the increase in pricing for energy efficiency improvements, but because it could result in a reduction of more than 10% of the building’s capital value.

  • Properties sitting just above the threshold of MEES may become unattractive to potential tenants, and give rise to rental discounts:

– There are a number of issues which can arise from this. If properties do not comply with MEES from the start of the lease, tenants may have to make other living arrangements, incurring more costs which could then be compensated by the landlord as way of a rent reduction.

Tenants’ advisors could argue that any potential EPC improvements made by the tenant should be disregarded. As a result of this, this would mean that the letting could not go ahead at the review date because the EPC rating without the tenant’s improvements was below E. Furthermore, tenants could argue that the landlord must pay for the improvements at their own cost. If so, improvements to the property would result in some disruption for the tenant, therefore, they could require a rent-free period. Once again, the landlord would be losing out on money.

Operational Risks:

  • There are large volumes of EPC data to decipher, therefore it is a challenge to centralise:

– If you are carrying out EPC assessments on a range of buildings, it can be challenging to manage the organisation of this data and to centralise it in a clear way for others to interpret it.

  • It is time consuming and expensive to understand retrofit strategies portfolio wide to manage MEES risk:

– Unlike our arbn consult software, the process of carrying out an EPC and then evaluating the improvement measures is one which can take a considerable amount of time. This also requires manual labour and a great deal of hours can be required while working on these projects, particularly as the legislation only relates to non-domestic buildings. Therefore, the floor area will be much greater than that of domestic buildings.

Unknown Risks:

We’ve mentioned how MEES will affect the real estate industry and how it will affect individual businesses, but there’s also some unknown risk that MEES could bring:

  • When existing leases come in to play in 2023, although it seems a way off, what risks will this bring? Will a new strategy be required by building owners?
  • Will the legislation be extended to EPCs rated ‘E’ or higher in the coming years?
  • Could Scotland see increasing demands to the current Section 63 legislation?

Overall, the risks are severe and the only method of avoiding the impact of MEES is by being prepared.

Our arbn consult software is the only quick MEES solution to avoid risk of non-compliance.

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