Property deals derailed by failure to meet stricter energy standards

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New Minimum Energy Efficiency Standards (MEES) are already impacting prices and liquidity in the commercial property market, according to new research from Cushman & Wakefield.

MEES, due to come into force in April 2018, will make it unlawful to rent out a business property with an EPC rating of ‘F’ or ‘G’.

According to Cushman & Wakefield, nearly a fifth of commercial property buildings in England and Wales could be barred from being let in the future because they do not comply with new Government energy standards. A further 19% are rated ‘E’ and sit just above what will be the legal cut off. In total, nearly 40% of all properties could face a significant performance risk.

MEES marks a significant tightening to current legislation. At present, all commercial properties over 50 sq m require an EPC when sold or rented, although there is no legal obligation for landlords to carry out any efficiency improvements.

With just a year to go, failure to bring buildings up to speed is already having a significant impact on the market and the viability and pricing of transactions. Cushman & Wakefield has detected that MEES has driven a number of impacts in the commercial property market, including:

  • Discounting of rent to reflect the EPC rating of properties;
  • Investment transactions falling through or price cuts due to EPC risk uncovered during the due diligence process;
  • Investors redrafting standard lease clauses to allow for recovery of compliance costs and to prevent occupiers from making any kind of alternations to a property without demonstrating there would be no negative impact on EPC rating;
  • Leasing transactions aborting due to poor EPC ratings appearing late in a transaction;
  • Occupiers screening potential and existing buildings for poor EPC ratings, producing minimum building standards and challenging landlords on how they plan to deal with compliance in affected buildings;
  • Banks and other debt finance providers producing detailed guidance on how valuers must account for MEES risk within the valuation process.

In February, the government released guidance on MEES to give practical advice to help building owners and occupiers. The guidance reinforced the fact that compliance is the responsibility of landlords and that occupiers who sub-let become landlords for the purpose of the regulations. As such, it is currently unclear whether landlords will be able to recharge the cost of any improvements to tenants.

Alan Somerville, Head of Energy, Infrastructure and Sustainability at Cushman & Wakefield, said: “We have highlighted previously the serious potential economic and market impact of MEES. However, we now have a large weight of evidence that significant market impact on value and liquidity is occurring already, despite the fact the regulations are still 12 months away.

“A key aspect is that occupiers are now also considering the risk of non-compliance. This is a double-whammy for landlords as previously they might have thought they could slowly work towards compliance – that’s no longer possible if occupiers are demanding improvements.

“Owners must also bear in mind that occupiers are now increasingly setting minimum building standards including higher EPC-rated buildings. Occupiers now demand efficient buildings which provide an optimal workplace. ”