What impact will MEES have on landlords and lenders?

MEES comes into force on 1 April 2018. In the first of four articles on the subject, Sue Highmore and Peter Williams review the legislation and find that uncertainties remain Readers will know that the main provisions of the Minimum Energy Efficiency Standard regulations (known as MEES) take effect on 1 April 2018. From that date, landlords of commercial and residential properties may have to carry out energy efficiency improvement works before they are permitted to grant a lease. The potential impact of MEES on the income stream from investment property is of concern to both landlords and lenders. The intention behind MEES is laudable. Buildings make a very significant contribution to greenhouse gas emissions, so the government is keen to improve their energy efficiency. MEES is one way in which the UK will comply with its obligations under the EU Energy Efficiency Directive. MEES will apply only to properties with a “sub-standard” level of energy efficiency. Currently this level is an EPC rating below E, but the government signalled recently in its Clean Growth Strategy (published in October) that tighter standards are desired for commercial property and the aim is a C rating for as many homes as possible by 2035. In simple terms, MEES prohibit a landlord from letting a sub-standard property until sufficient energy efficiency improvement works are made to bring the property up to an E rating. However, for commercial properties (which the legislation calls “non-domestic”), works only need to be made that pay for themselves (in resulting energy savings) within seven years. Those works are required, regardless of whether the landlord has the means of funding them. For residential (or “domestic”) properties, landlords need only carry out works for which full funding is available from external sources. MEES is being phased in. It applies to new lettings of residential and commercial properties from 1 April 2018. In April 2020, MEES is being extended to existing lettings of residential property and in April 2023 to existing lettings of commercial property. MEES does not apply to owner-occupied property or to sales of property. One of the greatest disappointments of MEES is that there are many areas of uncertainty, most notably in relation to listed buildings, voluntary EPCs and lease renewals. These are explained below. Government guidance on MEES does not clarify these uncertainties. Indeed, in some cases, it has increased them. The Clean Growth Strategy suggests the government will be consulting in 2018 about how to improve MEES, but in the meantime landlords have to face 1 April 2018 with these key issues unresolved. Listed buildings The greatest uncertainty around MEES relates to listed buildings. While the Historic England website (as recently as 1 November) states authoritatively that “… since January 2013 listed buildings have been exempted from the need to have an EPC”, this is not what the EPC regulations say. Regulation 5 of the EPC regulations states that an EPC is not required for “buildings officially protected as part of a designated environment or because of their special architectural or historical merit, in so far as compliance with certain minimum energy performance requirements would unacceptably alter their character or appearance”. This text repeats verbatim the English version of the EU Energy Performance of Buildings Directive. Unfortunately, it has two serious shortcomings. First, it is not clear which buildings qualify. The phrase “buildings officially protected as part of a designated environment or because of their special architectural or historical merit” is likely to equate to the UK concepts of conservation areas and listed buildings – but no one can be sure until an English court has decided the point. Secondly, the wording from “in so far as” is inappropriate out of its context in the EU directive. When using this text to decide whether an EPC is needed for the sale of a listed building, it makes no sense at all: there are no “certain minimum energy performance requirements” because MEES does not apply on a sale. Even in the context of a letting, the requirement is circular: until you have obtained an EPC, you do not know whether you need to comply with MEES at all – but you are expected to know whether compliance with MEES would unacceptably alter your building’s character or appearance in order to decide whether you need an EPC in the first place. The writers drew this drafting error to the attention of the Department for Energy and Climate Change several years ago but nothing has been done to resolve it. The MEES guidance merely repeats the formula with no acknowledgment that it is nonsense. So what are owners of listed buildings and properties within conservation areas expected to do? MEES applies only to buildings for which an EPC is required. If EPCs are not required for listed buildings, MEES will not apply to listed buildings. The answer to whether an EPC is needed on a letting of a listed building must surely be either yes or no. If the government’s intention was that MEES should apply to listed buildings except where energy efficiency improvement works “would unacceptably alter their character or appearance” then it should have said so. That is not what the EPC regulations or the MEES regulations say. The MEES guidance advises “If an owner or occupier of a listed building is unsure about whether their particular property is or is not required to have an EPC, appropriate advice should be sought at the earliest opportunity.” Unfortunately, no adviser can be definitive. The only safe approach is to assume that an EPC is required and that MEES applies until a court decides otherwise. Is there a “voluntary EPC” loophole? MEES applies only to properties that have a valid EPC. This makes it advantageous for owners of let buildings that are potentially sub-standard to delay obtaining an EPC for as long as possible. In that way, it will be unnecessary to consider whether any energy efficiency works need to be carried out as a result of continuing that letting after April 2020 or 2023 (as the case may be).  [caption id="attachment_898820" align="alignright" width="397"] Given that owners often start by asking whether or not MEES applies to them, this series of standard initial questions is a useful starting point. There are very detailed rules setting out the complex exemptions and other acceptable reasons for not undertaking any works, for which space does not allow a full analysis.[/caption] The EPC regulations dictate when an EPC must be commissioned. There are two situations in which an EPC may be obtained when there is no obligation to do so. These are informally called “voluntary EPCs”. And in some cases, but not all, voluntary EPCs that show the property as sub-standard will not trigger MEES. The first situation is where “the property was not required, and was not part of a building which was required, to have an EPC…” (MEES regulation 20). Regulation 5 of the EPC regulations lists properties that are never required to have an EPC, including places of worship, temporary buildings and (possibly) listed buildings. Everyone agrees that, if a “voluntary EPC” is obtained for such a property (perhaps to assess its energy efficiency as part of a portfolio), it would not bring the property within MEES. However, “voluntary EPC” is also used to describe an EPC obtained in circumstances where there is no legal requirement to obtain one because none of the trigger events (sale, letting or major works) applies. There is a school of thought that says such a “voluntary EPC” is never an EPC for the purpose of regulation 20, because the property was not “required to have an EPC” at the time when the EPC was obtained. So (the argument goes), any sub-standard rating disclosed by that voluntary EPC will never trigger MEES. Some comments in the MEES guidance might seem to support this, but they are ambiguous. It seems unlikely that the government intended all let properties with “voluntary EPCs” of the second variety to remain outside MEES. If that were right, it would follow that all property owners should be advised now to obtain voluntary EPCs for all their properties. These would supersede any existing EPCs, and whatever the EPC rating, the properties would remain outside the MEES net for the next 10 years (assuming no new EPC is obtained). This is such an absurd suggestion that it cannot be right. At the very least, where those properties are let or sold, using the “voluntary EPC”, that trigger should mean that the EPC is no longer a “voluntary” one, meaning that (if the property has a rating of F or G) MEES will then apply. But ascertaining whether an EPC was originally voluntary, or, if it was voluntary, that it is no longer voluntary, is going to be very difficult. A realistic adviser might say a voluntary EPC of the second type will always lead to a sub-standard property being subject to MEES, regardless of why it was originally commissioned. Will MEES apply to lease renewals? The MEES regulations expressly state that MEES applies to lease renewals if the property already has a valid EPC. If that shows the property as sub-standard, the landlord may be entitled to a six-month grace period to comply (under MEES regulation 33(2)) but only where it is possible to say that the renewal lease was “granted pursuant to Part 2 of the Landlord and Tenant Act 1954”. The meaning of that phrase is unclear, given that many leases are renewed by agreement between the parties, even if a notice under the 1954 Act was served at the outset. However, MEES will not apply on a lease renewal if there is no EPC. So the key question is whether an EPC is required for a lease renewal. The EPC guidance states that no EPC is required for a lease renewal, even though such an exception is not contained in the EPC regulations or in the underlying EU directive. This is strange, because EPCs are required on a “letting” and a lease renewal is undoubtedly a type of letting. The logic may be that an existing tenant does not need to be told about the energy efficiency of the property, since it is already in occupation. In contrast, the MEES guidance contains at least one case study that states unequivocally that an EPC is required on a lease renewal. So now landlords have two guidance documents to follow, one telling them that an EPC is required on renewal and the other that it is not. Yet again, we will have to wait for a court to determine which is correct. In the meantime, landlords of potentially sub-standard buildings without EPCs where lease renewals fall due after 1 April 2018 will need to consider which of the two guidance documents they favour.    Peter Williams is a real estate professional support lawyer at Shoosmiths and Sue Highmore is a writer and trainer Penalties for non-compliance The potential penalties for failure to comply with the MEES regulations are: Commercial property Where a breach has lasted for less than three months: up to £5,000 or (if greater) 10% of rateable value, with a maximum penalty of £50,000 Where a breach has lasted for three months or more: up to £10,000 or (if greater) 20% of rateable value, with a maximum penalty of £150,000 Residential property Where a breach has lasted for less than three months: up to £2,000 Where a breach has lasted for three months or more: up to £4,000 These penalties are for each breach of the regulations, so (for example) granting two leases in breach of the regulations could result in two separate penalties. For both commercial and residential property, there is also the possibility of publication of transgressors’ names on a publicly accessible part of the exemptions register for at least 12 months (which the MEES regulations call “the publication penalty”). There are also penalties for registering false or misleading information on the exemptions register and for failure to comply with a compliance notice issued by the local authority. Definitions “The EPC regulations” means the Energy Performance of Buildings (England and Wales) Regulations 2012 (2012 SI No 3118).  “The MEES regulations” means the Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015 (2015 SI No 962).  “The EPC guidance” means the document entitled “Energy Performance Certificates for the construction, sale and let of non-dwellings” dated December 2012.  “The Domestic MEES guidance” means guidance for landlords and local authorities on the minimum level of energy efficiency required to let domestic property.  “The Non-Domestic MEES guidance” means guidance for landlords and enforcement authorities on the minimum level of energy efficiency required to let non-domestic property. “The Clean Growth Strategy” is available here. Pic credit: Klaus Wagenhauser/Imagebroker/Rex/Shutterstock