What has changed?
New Minimum Energy Efficiency Standards (MEES) in force from 1 April 2023 make it unlawful to continue to let commercial property with an energy performance certificate (EPC) rating below ‘E’ unless a specific exemption applies. Nearly 8% of inner London commercial stock are expected to be affected by this month’s EPC ‘E’ requirement, and a further 43% by the EPC ‘C’ minimum due in April 2027.
What are the implications?
Landlords and tenants bear the immediate burden. However, only properties that require an EPC are affected, and specific exemptions may apply. A portfolio audit is indispensable, and the implications of the changes run the gamut, from due diligence to lettings and transactions, and assessing the options for so-called ‘sub-standard’ properties.
For non-exempt properties, improvement works may be required to reach an EPC rating of ‘E’ or above. This can be onerous and expensive. However, construction contracts are a vital tool for reducing improvement works costs, managing risks, and ultimately securing return on investment.
1. Funding
Loan agreements are increasingly offering reduced costs and preferential terms, where defined EPC and related sustainability metrics are met. This can offset upfront and overall finance costs of complying with the new rules. However, to harness the advantages, careful matching of the funding conditions and the construction contract terms is required.
Construction contract terms requiring a specific EPC rating at practical completion or incentivising sustainable building practices should be geared to specific, achievable pricing triggers defined in the funding conditions. Useful tools for this include amendments for the JCT suite*, and tailored provisions based on NEC’s latest standard construction contracts.
Attention to the contractual detail pays – it is the gateway to optimising the balance between works pricing, reduced finance costs, and the value of the finished asset.
2. Pricing
EPC and works requirements should feature from the outset of procurement. This allows works to be tendered robustly, and pricing to be stress tested pre-contract. This is useful to minimise the risk of increased costs, unexpected delays and/or disputes mid-project.
Accurate pricing may also inform decisions on whether an exemption may apply. For example, the ‘Seven Year Payback’ exemption, where expected savings on energy bills over 7 years are less than the cost of improvement works.
3. Design and build responsibility
Design and building work both contribute to the EPC rating achieved when the works are complete, and it may not be workable for these responsibilities to be split. For example, where a works only contractor cannot control the design work required to achieve a specific EPC rating, or vice versa.
4. What if the EPC requirement is not met?
If the EPC rating is not met when the works are finished, this can present a significant risk in terms of asset and portfolio value. It can also expose landlords to significant financial penalties of up to £150,000.
A useful approach to address this is to allocate responsibility for additional works costs caused by a shortfall in the EPC rating at practical completion of the improvement works. Typically this is to a defined value, often 10% of the construction contract. However, terms to this effect must adequately cover the remedial works cost risk, and be clear and enforceable to effectively reduce price variability, and risks of disruption, delay, and disputes mid-project.
Relationships can also be under pressure at practical completion of the works, so it is important that this is addressed up-front in the contract.
5. Futureproofing?
A degree of future-proofing may reduce or avoid costs driven by upcoming changes. The key dates for commercial property are:
- 1 April 2025: Requirement to register a valid EPC for letting commercial property (generally);
- 1 April 2027: A minimum EPC rating requirement of ‘C’ or higher; and
- 1 April 2030: A minimum EPC rating requirement of ‘B’ or higher.
Previous reports to Government indicated ‘a trajectory and minimum energy standard for commercial properties of EPC B by 2035.” The shortening of this timeframe by five years from 2035 to 2030 illustrates the impetus on regulatory side.
6. Change management
The trajectory of EPC changes is reasonably clear. However, fluctuations in energy prices, emerging technology, and changes in energy efficiency measurements less so. These are critical factors, because they dictate how energy will be cost effectively generated, delivered, and consumed. They have all radically changed, even in the recent history of the EPC system, so has the EPC assessment measure itself. Further change is inevitable as energy efficiency technology becomes increasingly commercialised, and methods of measurement and regulatory requirements change in response.
The ‘base-date’ system in the JCT suite of contracts offers a degree of certainty on works pricing for landlord, employer, and contractor. For example, where additional work is required due to regulatory change, and works costs increase as a result. However, astute negotiation and contract drafting is required to manage these risks, and capture the potential upsides. For example, where the current EPC rating is based on an obsolete measure, or where value engineering decisions or emerging technology present a lower cost route to achieving an EPC or energy efficiency metric.
7. Practical considerations
Works to address the EPC ratings should be considered holistically, alongside related factors such as fire-safety, structural load on external walls, carbon output of the finished building, ESG requirements for the works, and relevant planning constraints. Alongside the EPC rating, these are a recurring theme in proposals for future regulatory change.
What is the outlook?
EPC requirements will continue to be a hotbed of change. The pipeline of EPC changes is reasonably clear, and landlords, developers and construction parties need to ensure that the underlying construction contracts are used to manage the costs, risks and opportunities presented by the MEES changes, and upcoming regulatory interventions.
*E.g. The Chancery Lane Project’s ‘Mary’s Clause’ for the standard JCT suite, see https://chancerylaneproject.org/climate-clauses/build-contract-energy-efficiency-clauses/ , and “Modern Methods of Construction (MMC) and Net Zero Provisions for Construction or Development Agreements”, https://chancerylaneproject.org/climate-clauses/modern-methods-of-construction-mmc-and-net-zero-provisions-for-construction-or-development-agreements/