MEES, ESG and the Landlord and Tenant Relationship

About 8% of commercial properties in London do not have an EPC rating of E or above, according to analysis from BNP Paribas Real Estate. Savills has estimated that about 185 million sq ft of retail space across the country is graded F or below. The Government still plans to review the current minimum rating upwards and if The Minimum Energy Performance of Buildings (No2) Bill is progressed, it will increase the minimum for non-domestic property to at least grade B by 2030.

In January, we explained the MEES Regulations and the implications for commercial landlords from 1^st April 2023 when it became unlawful to continue to let a non-domestic property with an EPC rating lower than “E” (being a “substandard” property) without being able to demonstrate an exemption. MEES, as well as Environmental Social and Governance (“ESG”) now play a huge part in the conversations during commercial lease negotiations and here we consider some of the practical issues arising between the landlord and tenant relationship in this regard.

Tenant’s Works and Reinstatement

Current leases usually now contain (i) specific EPC clauses where the tenant must not do anything to the property that reduces the EPC rating and (ii) reservations that allow a landlord to carry out EPC assessments during the term of the lease. If tenant works have reduced the rating, the landlord will need to ensure that those works are reinstated at lease expiry. Conversely, if these works have improved the rating, it may well be in the landlord’s interests for those works to remain in situ and therefore minimising the risk of being in breach of MEES at expiry when it comes to re-letting. General blanket reinstatement provisions within leases may need to be reconsidered and active engagement with the tenant in advance of lease expiry, is crucial.

Rent Review

The traditional open market rent review requires an assumption of an open market letting of the property by a hypothetical willing landlord to a hypothetical willing tenant on the rent review date. If we apply the MEES Regulations to this assumption, is the hypothetical property to be treated as sub-standard? Even if the actual property is sub-standard, it does not necessarily mean that the hypothetical property would be. More often than not, the tenant’s improvements are disregarded at rent review. Yet, tenant’s fit out works can be responsible for reducing the EPC rating so does the fit-out need to be removed from the hypothetical equation so that the property will no longer be considered as sub-standard? Granted, it is an offence to let a sub-standard property but the lease itself is still valid – what is the impact then on rental value if the lease is still effective? At this point (and perhaps more so given the record high energy costs) it seems obvious that a sub-standard property would be worth less in rental terms than a more energy efficient one. Disputes on this issue seem inevitable.

Service Charge

ESG is now a very important issue in commercial property for both landlords and tenants alike with many modern leases starting to contain specific clauses addressing ESG issues and in particular, energy efficiency and how the costs of energy improvement works to a property are to be met. Where the lease is silent on this though, a landlord may look to try and charge the tenant for the cost of any required energy improvement works through the service charge on the basis that the tenant will benefit from having reduced energy bills to pay once the works have been carried out. However, the tenant may consider that such improvement works will increase the overall value of the landlord’s investment and future prospects of letting the premises, so those costs should be met by the landlord. The recoverability of these costs will in part no doubt also be determined by whether those works impact the demised property itself or any common parts.

Lease Renewal

Landlords cannot refuse consent to renew 1954 Act leases on the basis that the property is sub-standard in respect of its EPC asset rating. However, the obligation to improve the property will arise on renewal, and the landlord must either carry out the works or consider one of the exemptions. Tenants may also not want to consent to the works being done if it would disrupt their business but they may capitulate if a concession (rent free period or alternative premises for the duration of the works) were offered.

Irrespective of the MEES position, it is still open to a landlord to refuse a new tenancy if it can make out one or more of the grounds set out in section 30 of the Landlord and Tenant Act 1954.

Where ESG provisions were once a “nice to have”, these are now becoming a non-negotiable. There is now a greater emphasis on “green” leases with co-operation between landlords and tenants essential. There is speculation too that the MEES Regulations may become more rigorous so it is essential that proper specialist advice is taken at the outset.

If you’re concerned about MEES Regulations and ESG or think you might own a commercial property that is substandard, then contact either Joanne McIvor or a member of the Commercial Property team to discuss any of these issues further.

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