Minimum Energy Efficiency Standard

A Catalyst guide to the new MEES (Minimum Energy Efficiency Standard) for developers, investors, landlords and lenders.  Starting in April 2018, a new legal standard will apply to rented commercial buildings. The MEES, or (Minimum Energy Efficiency Standard), brings a challenging opportunity for many property owners, developers, lenders and freehold investors.

This guide reviews how the MEES will be implemented, what impact the new legal standard will have on the future and which steps need to be taken now in order to prepare for its implementation.

Minimum Energy Efficiency Standard at a Glance

The MEES was introduced in the Energy Efficiency (Private Rented Property – England and Wales) Regulations in 2015.  Although these regulations were officially released in March 2015, the MEES Regulations originate from the Energy Act of 2011.  This Act contained the previous Coalition Government’s package of energy efficiency policies, such as the Green Deal.

Beginning on April 1st, 2018, all landlords that fall within the scope of the MEES regulations are prohibited from renewing existing tenancies and accepting new tenancies.  The regulation states that these prohibitions will be removed later if the landlord’s building acquires a Minimum EPC rating of E or if the landlord registers an exemption.

After 1st April 2023, any landlord that wishes to continue their tenancies must do so in a building that has an EPC rating of E or higher, although exemptions are still admissible even after this date.

The purpose behind the MEES

Building environments have been identified as a major contributor to Greenhouse Gas (GHG) emissions. These GHG pose a threat to the UK’s ability to meet the carbon reduction targets set for 2020 and 2050. It has been estimated by the Government that an estimated 18% of commercial properties hold the lowest EPC ratings of F and G.

MEES takes on the task of improving older building’s EPCs and bringing the energy efficincy standard up to scratch.

Any new buildings are already covered  under stringent Building Regulations on any new build properties,  to ensure that they meet a certain level of energy efficiency standards as well.  It is very important to note that due to this, the minimum standard could potentially rise in the future.

How to know if the MEES applies to you

Figuring out whether or not your building and tenancy will fall within the scope of MEES regulations is a bit tricky.

If you meet the following criteria, the MEES does NOT apply;

  • Industrial sites, workshops, non-residential agricultural buildings with low energy demands, temporary properties, holiday lets and a few listed buildings are not required to have an EPC
  • Any building that has an EPC over 10 years old
  • Tenancies that last less than six months and do not renew
  • Tenancies over 99 years

To determine whether or not a building and tenancy are within the MEES scope requires owners to compare the MEES regulations to the Energy Performance of Buildings (England and Wales) 2012.  The interplay between the two sets of regulations is complex and thus creates viable loopholes that may be efficiently utilised.

MEES Exemptions

All landlords can continue to maintain tenancies regularly, even if their MEES regulated building falls below the Minimum Energy Efficiency Standard. This is only possible, however, if one of the following exemptions apply;

  • Golden Rule – If an independent assessor determines that all energy efficiency improvements have been made or that the relevant improvements would not pay for themselves through energy savings within seven years.  A few of these ‘relevant’ improvements include double-glazing and pipework insulation.  Furthermore, wall insulation measures are not required if an expert determines that the insulation would damage the fabric of the property.
  • Devaluing of Property – If an independent surveyor determines that energy efficiency improvements recommended are likely to reduce the market value of the property by more than 5 percent.
  • Third Party Consent – Where consent is not given with conditions that are reasonable to comply with from a tenant, superior landlord or planning authorities.

All of the aforementioned exemptions must be registered with the central government PRS Exemptions Register. To date, an amendment has been tabled to delay the registration to April of 2017. Originally, it was set to go live in October 2016.

These exemptions are landlord and property specific for only five years. This means that if a building receives a new landlord, they will need to acquire their own exemptions for the same building.

Penalties for non-compliance

MEES Regulations are to be enforced by LWMAs (Local Weights and Measures Authorities). LWMAs will have the ability to impose civil penalties which are set by reference to each property’s rateable value.

The penalty for renting out a property that is in breach of the MEES Regulation vary based on the duration of the tenancy.  If the rental period is less than 3-months, the charge will be equivalent to 10 percent of the property’s rateable value or a minimum of £5,000. The penalty maximum is capped at £50,000.

If the tenancy runs longer than 3-months, the penalty doubles to 20 percent or a minimum of £10,000 instead. The maximum charge that can be issued is £150,000. Where a building is let despite breaching the MEES Regulations or where a penalty is imposed, the lease will remain valid between the landlord and the tenant.

How to prepare for this challenging opportunity

Landlords will presumably be the ones who feel the effects of the MEES Regulations, as all of the key obligations and restrictions discussed in the MEES fall squarely on their shoulders. The largest threat to landlords when the MEES starts being implemented is the financial cost of upgrading non-compliant buildings and the potential loss of income from a property that can no longer be rented out.

Provisions in already existing leases may have an effect on the statutory obligations of landlords under the MEES Regulations and may alter landlords position in how they deal with the new legal standard.

Consider the following examples;

  • For landlords hoping to delay compliance for as long as possible, their standard leases may no longer contain sufficient restrictions on tenants subletting. This could trigger the landlord’s obligations under MEES.
  • A landlord may not be able to recover the capital expenditure required for improvements from the tenant’s lease provisions on service charges, yielding-up, statutory compliance and rent reviews.
  • The landlord’s rights to enter may not extend to entry for installing energy efficiency improvements.
  • There may also be restrictions in a head lease to consider as well.
  • There are opportunities for landlords to engage with tenants in order into enter green leases.
  • This kind of lease would allow for environmental management and costs of the property, such as energy efficiency improvements or utility bills, that are shared by both parties.

Property Upgrade – Energy Efficient Improvements

Explore the potential to increase rental and asset value through upgrading your property with energy efficient improvements. Combining these additions with other refit upgrades may benefit you and your tenants early on.

As a landlord, evaluate the situation clearly and prepare with the following checklist.

  • Audit your portfolio to understand which of your properties are within scope of the MEES Regulations and if you qualify for exemptions
  • Perform the energy assessments to see what EPC rating your properties have and that they are up-to-date
  • Review how lease terms, planned refit periods, break and renewal dates fit into the MEES timetable
  • Understand your rights as a landlord and go over your leases

Preparing for MEES as a Freehold Investor or Developer

Investors who own reversionary freehold assets are not considered landlords within the MEES Regulations where the term of the head lease is over 99-years. However, the regulations will still have an impact.

A key issue to remember is that there is a threat of value reduction of any property assets that do not meet the minimum energy standard.

Furthermore, freehold investors may struggle to find new tenant landlords that are willing to sublet a property if they are required to carry out the energy efficient improvements.

If you are a freehold investor with tenant landlords already in place, however, the MEES will have a different effect. You will actually benefit from having energy improvements made to your reversionary asset, due to the energy saving additions being paid for by your tenant landlords.

As a freehold investor, you may be a landlord in the MEES Regulations if your head lease is less than 99 years. In the event that a property has more than one landlord, the person who is required to pay for the energy efficiency installation is likely to depend on the head lease.

Developers that own freehold assets awaiting development may face similar issues as the freehold investors.

MEES Regulations may have an effect on the timetables of future development programs as well. On the bright side, the new legal standard may provide developers a way to create a profitable opportunity for themselves through the reduction of acquisition costs of property below the minimum standard.

Prepare now by auditing your portfolio, identify which properties may be within the scope of MEES Regulations, and understand how the terms of the head leases and future development programs fit with the MEES timetable.

MEES impact on lenders

Many lenders will also feel the impact of the MEES Regulations.

These regulations are a threat to lenders who have a building that does not meet the minimum standard. This can lead to a reduction in the value of their security and ability to let their properties. This will have an effect on the landlord borrower’s ability to make repayments due to the loss of rental income and any additional capital expenditure costs.

Another threat to lenders occurs when the possession of a property is taken during a default.

During this time lenders can become freehold investors or landlords, making them vicariously subjected to the MEES Regulations.

The absence of a Government scheme to provide finance for landlords (an intention of the Government in 2011) and the MEES Regulations give a unique opportunity for lenders when a landlord needs to borrow money to bring their properties up to the minimum standard.

Lenders may prepare today by reviewing their lending criteria and conditions with the following checklist.

  • Obtain sufficient information on the value of the asset.
  • Understand the impacts of MEES on their security.
  • Correctly price the risk and cost of borrowing.
  • Monitor the risk adequately.

Adapt loan monitoring procedures to take in a valid account of the potential risks. For example, mandate that EPC certificates are provided by the borrower on all non-exempt lettings. Or request borrowers to provide a MEES audit or strategy plan before 2018.

Find out if facility agreements provide suitable protections and rights against borrowers who fail to comply with their statutory obligations under the new legal standard.

Preparing for 2018

As of June 30th, 2016, the Government officially made changes to the law that released the data of commercial property’s EPCs.

Making this data publicly available in bulk was intended to encourage everyone in the property industry to compare the energy efficiency ratings of buildings, as well as influence the decisions that tenants, landlords, investors and lenders make in their property choices.

We are likely to see the beginnings of the market response to this information with the approaching MEES Regulations implementation.

The Energy Performance of Buildings (England and Wales) Regulations 2012 had Amendments added to it in 2015, that require local authorities to report to Government annually on enforcement activities undertaken in relation to EPCs.

Overall, this may deliver more interest in EPCs as well as more active enforcement from LWMAs in the future.

Doubts have been raised as to whether the Government will actually implement MEES since the General Election in May 2015.

This is due to the opposition the policy received from the property industry. Furthermore, Brexit may provide the opportunity to repeal the Energy Performance of Buildings (England and Wales) Regulations 2012, where the MEES Regulations are underpinned, as these were implemented in the EU Energy Performance of Buildings Directive 2010.

Keep in mind, however, that the MEES Regulations originated in the UK and not the EU.

This means that the MEES Regulations remain on the statute books and parties should, therefore, assume that the new legal standard will become official on April 1st, 2018.

Those who have been following the development of the MEES Regulations will be aware that the Government intends to issue detailed guidance on the new legal standard’s application. Many parties, such as the Law Society, are waiting for this guidance before issuing revisions to their current form leases.

Be prepared now for the MEES Regulations to be implemented.

Failing to understand the MEES timetable and ignoring solid advice in regards to the new legal standard can be devastating.