Non-Domestic MEES announcement ‘brings needed clarity for landlords and lenders’

The government said the improvements to the minimum energy efficiency standards would support businesses that rent larger premises by helping to save energy and reduce costs. The move is also intended to reduce energy demand on overall energy systems.

Under the plans, published as an interim response to previous consultations in 2019 and 2021, all private rented non-domestic buildings of more than 1,000 square metres (sq m) would be required to reach the higher standard of energy efficiency of an EPC B by 2031.

For buildings below 1,000 sq m, the minimum standard would continue to be EPC E, “with no set deadline for going beyond this level”. The announcement also made clear that there would be no interim uplift requiring an EPC C, and that the existing seven year payback period test and the existing exemptions would remain in place.

Siobhan Cross, a property and sustainability expert with Pinsent Masons, said the announcement would provide long-awaited certainty for landlords and commercial property investors.

“The top of the market has largely already responded to the direction of travel in the earlier consultations and implemented programmes to transition assets to an EPC B, but the inordinate delay in confirmation of the proposed uplift in non-domestic MEES was beginning to undermine continued efforts,” she said.

“While we have yet to see evidence of the impact of limiting reform to the proposed size threshold, by focusing on larger properties, the regulation may be capturing a large majority of the carbon emissions from commercial property.

“Like other regulatory regimes related to climate change and carbon emissions - such as the EU Carbon Border Adjustment mechanism –moves to restrict the scope of the regulation may still capture the majority of emissions and, in this case, at the same time reduce the regulatory burden on smaller landlord businesses.

“It is progress - albeit not on the scale some may have hoped for.”

Annabel Davey, a real estate finance expert with Pinsent Masons, said lenders would feel that while the announcement offers clarity, it may not address longer-term viability risks in relation to properties which fall beneath the proposed size threshold.

“For lenders, this concentrates risk rather than reducing it, as larger assets – which will typically underpin core lending exposure, are now the primary focus of regulation,” Davey said.

“There is a growing divergence between regulatory compliance risk in this area, and what banks might regard as obsolescence risk in the same area. Credit analysis in the wake of this decision will need to address both.

“Lenders should be forward-looking to consider whether the asset remains viable and financeable taking into account risks of further increases in EPC requirements or market driven ESG requirements.”

A full response to the previous consultations is promised, which will set out further details of these measures with the aim of introducing the necessary legislation and updating guidance at the earliest opportunity, with an expectation it will clarify other issues covered in earlier consultations.

Cross added, from the limited information available so far, it appears the size threshold will apply on a per building basis rather than to the size of let units within a building – meaning the proposed requirement for an EPC B on letting would affect letting and sub-letting of smaller units in an in-scope building.

The uplift comes in the wake of the government’s response to the EPC reform consultation that confirmed there would be no changes to non-domestic EPCs, which will continue to have ratings driven by a single carbon metric. Heritage properties would now not be treated specially in terms of requirements for an EPCs on the usual triggers.

That response also promised a further response on the proposal that a valid EPC would be required at all times when a property is let.

Catherine Howe, a property sector expert with Pinsent Masons, said the announcement would provide a clear direction for financial markets over the impact of the planned changes.

“While it is not yet law, the policy direction is now sufficiently clear that valuers, investors and lenders can already begin, if they haven’t already been, pricing EPC B risk into transactions, and business plans can be tested against compliance requirements for 2031,” she said.

However, Cross warned, even with the removal of the 2027 interim deadline, property owners still faced a ticking clock in order to prepare for the uplift in MEES requirements.

“2031 is not a long way off in terms of lease structures and landlords of properties within scope of the MEES uplifts should now review their properties with a view to planning improvements in available voids, understanding what improvements will be required, whether they can be carried out with tenants in situ,  the extent to which exemptions are available and whether they wish to rely on these,” she said.

“Landlords should also consider carefully the impact of tenant fit-out plans on an EPC rating.  In the case of heritage properties, where works to achieve an EPC B may be more complex, it remains to be seen whether the government will introduce the new negative impacts exemption which they have proposed for uplifted domestic EPCs, or indeed import any of the other domestic MEES changes such as extended exemption periods into the non-domestic MEES regime.

“Giving landlords further certainty on the full package of MEES changes as soon as possible will be important to allow the market to constructively prepare for the changes.”