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Walking the green mile...the big energy shake up for commercial landlords By: Malcolm Dowden, Consultant at Charles Russell LLP

The UK government has stringent targets for greenhouse gas reductions, energy security and transition to a low carbon economy. For commercial real estate, indications are that compulsion is likely to play a far more significant role than incentive, extending to direct interference in the market as a blunt instrument to force improvement. Once in force, Energy Act 2011, s.49 would require regulations barring the letting of premises with poor energy efficiency. Those regulations must be in place by April 2018, although they could be brought in sooner.

These regulations would prevent the letting of commercial premises until the landlord has carried out improvements sufficient to secure an energy performance certificate (EPC) with at least the rating specified in the regulations – likely to be an E. Crucially, s.49(4) allows the government to define letting not only as the initial grant of a lease but as continued letting. If fully implemented, that provision would affect, and potentially invalidate, existing leases – including many being negotiated or renewed now.

The prohibition applies only to letting. It does not affect sales. Consequently, there is potential for enhanced market activity if freeholds are snapped up by landlords with the means and vision to effect energy improvements, whether to secure new lettings or to obtain increased capital value by ‘regearing’ existing leases.

Unfortunately, s 49 may stifle a similar market for long leaseholds. If the regulations were drawn to preclude continued letting, then there may be too much doubt over the status of existing long leases to support a viable market. There is a strong case for restricting the regulations to occupational leases, leaving those held as investments potentially available for sale and improvement.

Shades of green
Landlords’ ability to improve energy efficiency depends on their ability to fund the necessary improvements, or on the willingness of existing tenants to cooperate and, possibly, to contribute to those costs. While Energy Act 2011 contemplates green deal funding it also allows for other financial arrangements, which may require landlords to pay at least a proportion upfront.

Green leasing is unlikely to provide the answer to funding issues. There is no such thing as a standard green lease. The term reflects a range of approaches characterised as light, medium and dark green, but all focused on behaviour rather than capital improvements.

Dark green leasing involves the imposition of landlord and tenant covenants. They generally relate to actual energy use, adding operational requirements to supplement EPC asset rating, which simply identifies a building’s potential efficiency. They may also extend to waste, recycling and water efficiency targets.
Light green provisions rely on cooperation and voluntary adoption, often in a memorandum of understanding. Often, the tenant simply undertakes to do nothing that would prejudice energy performance.
Medium green provisions may be brought into the landlord and tenant relationship through tenants’ handbooks, building or estate regulations. Again, they generally relate to ongoing energy use rather than the costs of improvement.

So what's the incentive?
Landlords seeking to improve premises in order to secure new lettings will almost certainly have to fund energy improvements themselves. Current justification would be the possibility of achieving a higher rent on new lettings plus ongoing benefits in terms of lower energy bills (and, if it continues, lower CRC Energy Efficiency Scheme costs). If s.49 is brought into force, that incentive would become an imperative. No improvement would equal no rent.

For landlords with existing leases approaching expiry, the answer may be to regear the lease. That involves the grant of a new lease extending beyond expiry of the current tenancy. For the landlord, the principal benefit is that it extends the income stream, at least supporting and possibly enhancing the value of the landlord’s interest. Negotiation of a new lease also provides the opportunity to introduce at least darker green clauses. Whether the result is an appreciable increase in the value of the landlord’s interest or its preservation from the steep decline often observed as leases approach expiry, the tenant may credibly claim to have provided the landlord with sufficient benefit by committing to a longer term, and by unlocking capital value, to count as its contribution towards the costs of energy efficiency improvements.

 Malcolm Dowden, Charles Russell LLPAbout the author

Malcolm Dowden is an environmental and regulatory lawyer, specialising in the clean technology and telecommunications sectors. He has experience of both contractual and legislative drafting relating to renewable energy and energy performance. He has been a member of expert panels convened by the UK Department for Communities and Local Government and by the Department for Energy and Climate Change to identify and address barriers to improved environmental performance in the UK real estate sector. He also drafted amendments to Communications Act 2003 and was a member of an expert panel convened by the UK government to advise on implementation of energy efficiency regulations for commercial buildings.   

Features July 2012

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