MEES: how are landlords preparing?
Off the starting blocks
24 January 2017
Emma Mulliner and Louise Kirsten look at how landlords in England and Wales are preparing their portfolios for MEES
The Minimum Energy Efficiency Standards (MEES) present significant implications for landlords (see the related feature: MEES: know the risks). However, it is not clear how much progress has been made by those seeking to mitigate risk in this regard.
This feature summarises the findings of a survey of commercial landlords that seeks to establish how they are preparing for the standards.
It should be stressed that the results obtained are representative of larger organisations (see Table 1); 44% of respondent landlords owned portfolios of more than £1bn. Despite attempts to include smaller landlords in the survey, no responses were obtained from those with portfolios of less than £1m. Their lack of participation may indicate that they are less familiar with or concerned about the prospect of the MEES and have yet to make significant preparations.
|Value of respondent’s property portfolio|
Table 1: Participant background information
Preparation for MEES
MEES could adversely affect a property’s income stream and require capital expenditure to achieve compliance. Planning ahead will thus be critical if investment values are to be maintained. Landlords of all sizes should now, at least, be reviewing their assets to assess current energy performance and establish the extent of exposure to substandard properties. Where necessary, mitigation measures should be considered, and existing leases may need to be reviewed to determine liability for bringing properties up to standard.
But how much progress is being made in practice? In order to understand the current level of preparation, various steps that could be taken ahead of 2018 were listed, and commercial landlords indicated whether they currently engage in these on 'all stock', 'some stock', or 'will be doing so in the near future' or 'not on any stock' (see Figure 1).
Figure 1: Landlord preparations: management and investment
The level of preparation was varied, although most landlords appear to be actively engaged in some activity. In particular, landlords are becoming aware of the sustainability profile of their stock. The survey found that 77% of landlords are checking energy performance certificates (EPCs) for either all or some of their assets, and 72% are checking EPC recommendations to establish the cause of low ratings.
In anticipation of more stringent MEES in the future, 57% of landlords are assessing risk exposure to E-rated buildings for at least some of their assets. It is also possible that this is being considered, as existing EPCs may not be accurate thanks to variations and updates in assessment methodologies.
Once risk exposure and necessary improvement works are established, the costs and timing of works need to be assessed. More than half of landlords are undertaking cost–benefit appraisals to assess the financial implications of upgrading some or all stock, and a further 27% are considering doing so in the future. For at least some of their stock, 59% of landlords have started putting plans in place to improve energy efficiency where assets are F- or G-rated.
In terms of timing works, 85% of landlords are proactively considering options to improve energy performance when repairing, upgrading, altering or during routine maintenance, and 60% are currently taking advantage of voids or lease breaks to make improvements before 2018 for all or some stock. Sixty per cent of landlords are also using an asset management strategy to seek to improve operational performance on all or some stock.
However, decisions to dispose of poorly rated assets, particularly those where upgrades would not be viable, are less prevalent at present, with only 35% of landlords having already considered this. It is likely that this level will increase as 2018 approaches.
MEES are having an impact on some landlords’ investment decisions; 74% are beginning to consider the MEES when making acquisition decisions, and 65% are building in the cost of necessary works for some or all new property when buying. A further 15% are thinking about building in such costs in the future.
MEES will undoubtedly prompt fresh energy efficiency issues for both new and existing leases. The survey asked landlords to indicate their level of preparation with regard to lease provisions for managing MEES risk ahead of 2018 (see Figure 2). Respondents could indicate the following engagement levels: 'yes', currently engaged; 'no', not engaged, 'but will be doing so in the near future'; or 'no', not engaged.
Figure 2: Landlord preparations: lease provisions
In terms of altering leasing provisions before 2018, many landlords were mainly considering making changes in the future, with fewer having actually already done so. Preparations already made primarily concerned landlords specifying the nature of tenant improvement works so that they will enhance rather than diminish energy efficiency, with 41% suggesting that they already do this, as well as including green lease covenants in new leases, which 38% of landlords already do and a further 44% intend to do in future.
The recovery of costs for energy efficiency improvement works through service charges could be contentious, particularly in the absence of clear wording, because tenants are generally liable for the cost of repairs but not improvements. Thirty-one per cent of landlords have begun inserting so-called ‘sweeper’ provisions in an attempt to cover for additional costs relating to environmental works.
Depending on the nature and wording of the particular sweeper provision, there may be a case for suggesting that the cost of energy-efficiency improvement works designed to ensure compliance with MEES falls under such a provision and is thus recoverable. However, this is likely to be challenged by tenants and lead to disputes between parties until case law sets precedents.
Landlords are becoming aware of the sustainability profile of their stock
A small proportion of landlords have begun inserting lease clauses regarding the maintenance of certain EPC ratings by tenants. Twenty per cent of landlords currently include reinstatement clauses that require tenants to return property with the same EPC rating as at lease outset, but a further 26% are considering doing so in the future.
Only 18% of landlords already insert clauses that penalise tenants if they do not maintain a certain EPC rating; more than half of landlords surveyed are notconsidering doing this. Fewer landlords – 13% – currently incorporate an EPC disregard in rent review clauses, such as 'any detrimental effect by the tenant on the EPC rating is disregarded' or 'any effect upon rent arising from an EPC rating is disregarded', but a further 54% are considering this for the future.
Aside from new leases, 28% of landlords are currently making amendments to existing leases to satisfy the MEES, while a further 46% are considering this. A very limited number of landlords – just 5% – are presently in the process of renegotiating existing leases prior to 2018 to try to avoid the implications of the MEES, but 59% are considering doing so.
Implications for the market
The survey also collected information on landlords’ level of agreement with a number of statements related to the impact the MEES may have on market demand (see Figure 3).
Figure 3: Impact of the MEES on demand in the market
While robust evidence of price premiums for sustainable property is not yet firmly established in the UK, 74% of landlords feel energy-efficient buildings will increasingly have a competitive edge in the marketplace. Coinciding with this, 70% of landlords think there will be increased difficulties selling properties with low EPC ratings, unless upgraded, after 2018.
However, fewer than half of the landlords are concerned that substandard buildings will result in a ‘brown discount’ as 2018 approaches, and buildings will subsequently face obsolescence. Finally, despite warnings of penalty fines for non-compliance with the MEES, 64% of respondents believe that many landlords will continue to let substandard properties after 2018.
While there is no definitive evidence for a general ‘green premium’ with sustainable property, it is clear that there will potentially be a negative impact on the value of assets that do not fulfil MEES requirements – primarily due to income lost as a result of inability to let non-compliant property, the capital expenditure of having to upgrade it and financial penalties.
With the implementation of the MEES less than 2 years away, there is only a brief time frame for property owners with assets subject to the regulation to seek to minimise risk and maintain investment values. It is clear that some progress is being made in this regard, but for those who are yet to begin forward planning it is important to act now.
Dr Emma Mulliner is a senior lecturer at the Department of the Built Environment, Liverpool John Moores University
Louise Kirsten is senior lecturer at the Department of the Natural and Built Environment, Sheffield Hallam University
- Related competencies include Landlord and tenant, Leasing/letting, Sustainability
- This feature is taken from the RICS Property journal (November 2016)