BUILT ENVIRONMENT JOURNAL

What higher EPC requirements mean for landlords

With higher EPC rating requirements proposed for commercial leases, how far will landlords be able to make dilapidations claims to cover the cost of necessary improvements to buildings?

Author:

Christopher Sullivan

15 June 2021

In December, the UK government published the Energy white paper: Powering our net zero future, which sets out how the UK aims to reach net-zero carbon emissions by 2050.

For commercial property, perhaps the biggest implication of the white paper is the shifting in energy performance certificate (EPC) targets. The minimum present requirement on commercial property is an E rating on new leases since 2018 – and on leases from 2023 – will be upgraded to a B rating for all commercial leases by 2030. Based on data from July 2020, this means that 80–90% of all commercial property will require improvements.

The introduction of Minimum Energy Efficiency Standards in 2015 was seen as a significant change for the property sector. However, once the dust settled the EPC rating targets were regarded by many as an inconvenience that could be circumvented by taking a creative approach to the rules.

Efficiency and expense

As a society, though, we are in a very different place to where we were just a few years ago. Carbon reduction is at the forefront of the global agenda, and cutting emissions is a worldwide priority. This mood change can also be seen among commercial property owners and occupiers, with an active desire to improve the energy efficiency of building usage.

The fact that the vast majority of commercial property stock currently falls below a B rating means, in essence, that almost every lease coming to an end in the next ten years will need improvement. The big question for landlords is less what needs to be changed, more what can justifiably be charged to outgoing tenants.

Dilapidation claims are a landlord's tool for repairing a property and making good in order to be able to relet it to a new tenant. However, what has always been clear is that a dilapidations claim is not intended to be a way of funding building improvements.

Significantly improving a building's energy efficiency will most likely entail substantial technical changes. Mechanical and electrical equipment is designed to last for decades, so there is a high chance that items that are still in good condition but consume a lot of energy will need to be replaced by more efficient alternatives. This is an expensive process, and not necessarily one for which dilapidations can be claimed.

How to secure a B rating

To help us understand at Hollis what is involved in achieving a B rating, we recently modelled a typical office block – see below. The steel-frame building constructed in the late 1990s was approximately 3,000 sq m in size, with a large glass atrium, multiple floors and a current EPC rating of D. We looked at what features would need to be changed to improve the energy efficiency and secure a B rating.

'Carbon reduction is at the forefront of the global agenda, and cutting emissions is a worldwide priority'

Table 1 shows our hypothesis of the original state of the test property, the fit-out works that would be needed to improve energy efficiency sufficiently, and the expected cost of those works.

Table 1: Costing energy efficiency upgrades to a modelled building

	Original building	Fit-out improvements	Costs
Construction type	Steel frame with a brick and block cavity wall system to the ground and first floors. A metal cladding system above. A full-height, glass-fronted atrium dominating the centre of the property	No significant changes to the fabric can be made, other than to install a solar control film to the full-height atrium glass windows to reduce reflection and increase energy efficiency	£5,000
Existing building services	Low-temperature hot water (LTHW) boiler serving radiators	Variable-refrigerant-flow heating, ventilation and air conditioning	£375,000
Hot water	Served by the LTHW boiler with large central store	Individual A-rated water heater on each floor	£6,000
Lighting	Compact fluorescent luminaries throughout, with basic lighting controls	LED luminaries with an average efficacy of 110 lumens per Watt throughout	£160,000
Lighting controls	Limited to occupancy sensing	Fully addressable lighting with daylight sensing and dimming, plus occupancy sensing throughout	£8,000
EPC rating	D80	B31	£554,000

Table 1: Costing energy efficiency upgrades to a modelled building

	Original building	Fit-out improvements	Costs
Construction type	Steel frame with a brick and block cavity wall system to the ground and first floors. A metal cladding system above. A full-height, glass-fronted atrium dominating the centre of the property	No significant changes to the fabric can be made, other than to install a solar control film to the full-height atrium glass windows to reduce reflection and increase energy efficiency	£5,000
Existing building services	Low-temperature hot water (LTHW) boiler serving radiators	Variable-refrigerant-flow heating, ventilation and air conditioning	£375,000
Hot water	Served by the LTHW boiler with large central store	Individual A-rated water heater on each floor	£6,000
Lighting	Compact fluorescent luminaries throughout, with basic lighting controls	LED luminaries with an average efficacy of 110 lumens per Watt throughout	£160,000
Lighting controls	Limited to occupancy sensing	Fully addressable lighting with daylight sensing and dimming, plus occupancy sensing throughout	£8,000
EPC rating	D80	B31	£554,000

Can the costs be claimed?

In excess of £500,000, the necessary upgrades would cost a not insignificant sum. Realistically, how much could a landlord claw back through a dilapidations claim?

In general, to work out whether or not a claim can be made, we need to assess each element of the required works against the Dowding and Reynolds five-stage analysis.

Is the item being replaced within the demise?
Is the item damaged or deteriorated?
Does the damage fall below the standard of repair expected?
What repair works would be required?
Does the work needed go beyond that contemplated in the lease?

If we ask these questions of the works needed to get our model building from a D to a B rating, we will see that there is not much scope for the majority to be included in a dilapidations claim. This can be demonstrated on an item-by-item basis.

Building fabric: Although the solar film on the glass windows could be considered to fall under demise, it is unlikely that a defect is present that this could remedy.
Building services: A 25-year-old boiler system is very likely to be in need of some repair, or even replacement, while generally the radiators and pipework are designed to last for longer. However, it would be hard to justify the replacement of a boiler that could be repaired with an entirely different and considerably more expensive system.
Hot water: If it is more expensive to replace a broken central low-temperature hot water boiler system than it is to put in individual water heaters on each floor, then there may be a greater argument for its inclusion in a dilapidations claim.
Lighting: We can assume that it is likely that compact fluorescent light fittings will have failed, and as they are being phased out as a viable product this could be argued to be a replacement that could be claimed, albeit only where fittings are defective. The controls, however, would be unlikely to pass the Dowding and Reynolds test unless there were a major defect.

Factoring costs in elsewhere

In our scenario, it will not be possible to recover the vast majority of the dilapidations claim contractually, let alone at a valuation level. Claims are going to be much harder to make and defences will be quickly put up by tenants' surveyors and legal teams.

Landlords therefore need to be finding ways of factoring in these costs over the coming five to ten years. This may well lead to increased rents and changes to leases and leasing structures, not to mention a few disputes.

With COP26 due to take place in Glasgow in November, the UK government continues to push the climate change agenda. A consultation to introduce a new step requiring all commercial properties to achieve an EPC rating of C by 2027 closed on 7 June, with no doubt more proposals to follow.

Whatever a green recovery from the pandemic looks like, though, change is on the horizon – with plenty of opportunities for surveyors to help make the property sector more energy-efficient.

Christopher Sullivan MRICS is a partner at Hollis
Contact Chris: Email

Related competencies include: Legal/regulatory compliance, Sustainability