Improving Energy Efficiency – The Real Cost to Commercial Landlords

Date: 09/02/12

Since coming into power last year, the Government has been clear about its intention to be the greenest ever UK administration. The Energy Act 2011, which received Royal Assent on 18 October 2011, has put a plan of action in place that will help it achieve its ambitious targets over the next decade.
 
The Act contains provisions, due to be implemented in stages over the next few years, aimed at achieving CO2 emission reductions of 34% by 2020 and 80% by 2050. New regulations will affect all property owners including commercial landlords of warehouses and distributions centres. 

The most onerous requirements for commercial landlords are planned to come into force no later than 1 April 2018.  If a landlord fails to achieve and maintain at least a specified minimum level of energy efficiency for their properties they will not be allowed to let the property and may also be subject to fines. There is a suggestion that this level will be set at Energy Performance Certificate rating 'E'.

Improving energy efficiency

The deadline may seem like a long way off, but, in reality, the sheer volume of improvements which may have to be made in facilities such as warehouses means that landlords have the choice of implementing considered and cost effective solutions now, or risk having to rush expensive renovations as the deadline approaches.

Commercial landlords should be thinking now about how they can ensure their portfolio of properties meets future energy efficiency requirements, without the improvement costs eating into their profits.

Look towards the service charge

A building’s service charge is one way in which a landlord can attempt to balance their investment. However, it is important to identify which aspects of the improvement programme are actually recoverable under the service charge.

Existing leases

Landlords will, of course, be constrained by the conditions contained within existing leases. A standard service charge clause is likely to include provision for “…maintaining, repairing, amending, altering, rebuilding, renewing and reinstating” parts of the building, apparatus, plant and machinery. However, arguing that this covers expenditure on energy efficiency improvements could be seen as stretching the intended meaning.

Improvements required by law

A standard service charge clause is also likely to allow landlords to pass on the costs incurred when carrying out work required by law. Therefore, a landlord carrying out renovations to make the building more energy efficient may be able to recover the costs of the works under such a clause.

In addition, it could be argued that the tenant should carry out and pay for the required works themselves, if a tenant covenant such as “the tenant must comply with Legal Requirements” already exists.

However, in either case, the viability of these options will depend on whether up-coming regulations from the Act actually make the installation of energy efficiency improvements a legal requirement as opposed to just preventing lettings without such improvements.

Negotiating new leases

If a new lease is required, landlords and tenants in the UK are free to negotiate the terms of service charge as they wish, and landlords could use this in their favour to pass more costs on. However, the following points should be taken into consideration when drawing up new arrangements:

1. According to the Royal Institute of Chartered Surveyors’ Code of Practice for Service Charges in Commercial Property, service charges should not include improvements above normal maintenance, repair or replacement fees or future redevelopment costs

2. In terms of distinguishing between ‘improvements’ and ‘repairs’ in service charge agreements, landlords should look to existing case law for assistance. For example, the Fluor Daniel Properties Ltd v Shortlands Investments Ltd [2001] case held that a landlord could not recover the costs of replacing an air conditioning system through the service charge as the original system was still in good working order.

The RICS Code does give landlords some hope by confirming that improvement costs could feasibly be recovered through service charges if the landlord can prove that the improvements are reasonable and cost-effective over the term of an occupiers’ lease, following a rigorous cost-benefit analysis. The length of the lease, or the amount of time left to run on the term, can play an important part when considering the costs which the tenant may have to pay for – but this needs to be taken on a case by case basis.

Alternatives to the service charge

Reference is made in the Act to the funding of “relevant energy efficiency improvements” by way of the Green Deal. The Green Deal is an upcoming funding initiative whereby certain energy efficiency measures can be installed with no upfront charges, and repaid by way of additional instalments in a building’s energy bills.

Although it is anticipated that Green Deal will be of more relevance to residential landlords, they may, in the right situation, also be of use to commercial landlords to spread the costs of improving their buildings.

What does this mean for commercial landlords?

The Energy Act has far reaching implications for the commercial real estate market. Whilst the timescales for implementing the regulations seem a long way away, the potential costs to landlords could well present new challenges to a sector that is already struggling in the current economic climate.

However, the best thing that commercial warehouse landlords can do to mitigate future costs is to consider their options now, working with their tenants to agree the best course of action, and putting in to place a long-term plan to deal with upcoming changes.