From 2018, the Energy Act 2011 will put in place minimum standards of energy performance that private landlords will have to achieve before new leases can be entered into. This briefing outlines some of the key considerations and how the costs might be relieved through the tax system and in particular through capital allowances.
The MEES regulations As provided for in the Energy Act 2011, there are now regulations in place for the minimum energy efficiency standards of private rented property (MEES regulations), which came into force on 1 April 2016. The regulations will affect both commercial and residential property from 1 April 2018, although many are concerned with the impact on commercial properties and the cost mitigation.
Subject to certain exemptions, it will be unlawful for landlords to let commercial properties that do not have an energy performance certificate (EPC) rating of ‘E’ or above from 1 April 2018. Whilst the regulations do not directly cover sales, they will obviously impact the marketability of properties for sale because when the existing lease of the property expires then the regulations will apply to the reletting.
The Department of Energy & Climate Change (DECC) estimates that approximately 19% of commercial properties with energy certificates have an EPC rating of ‘F’ or ‘G’, with the number of properties having a minimum “E” rating making up a further 16% of certified properties.
Therefore, bearing in mind the changes to the Building Regulations that came into force on 6 April 2014 concerning the downgrading of existing ratings on reassessment, some 35% of all commercial properties with EPCs are at risk from the MEES regulations.
If a landlord is found to be in breach of the MEES regulations, the Local Authority can serve an enforcement notice imposing a financial penalty. If in breach for less than 3 months, the penalty is the greater of £5,000 or 10% of the rateable value of the property, up to a maximum of £50,000. If in breach for more than 3 months then the penalty is the greater of £10,000 and 20% of the rateable value of the property, up to a maximum of £150,000.
The exemptions
It will not be unlawful for a landlord to let a property which does not meet the minimum EPC rating of ‘E’ in the following situations:
· Where the landlord is a new purchaser of a property or a new lease is granted, the landlord has 6 months to improve the property or to prove that another exemption applies.
· The work needed to bring the property up to an ‘E’ rating would result in more than a 5% reduction in the value of the property.
· The tenant or another relevant third party does not agree to the work.
To be entitled to make a claim for an exemption, landlords will be required to pre-register their exemption on a centralised register (the Private Rented Sector Exemptions Register). The details of the exemption must be registered together with supporting documentation.
Bearing in mind that energy efficiency measures would not normally be expected to reduce the value of a property and that a tenant’s agreement would not be an issue in the case of a new letting, the main exemption for landlords relates to the works being cost effective. The landlord is not required to carry out works beyond the scope of what is cost effective, even if the rating remains below ‘E’ after the cost effective works have been completed.
The Opportunity
In order for the above criteria to be met many commercial landlords will have to incur substantial expenditure on thermal insulation, new and more efficient boilers, double/triple glazed windows and more.
The good news is that many of these items can actually be claimed under current capital allowances legislation by way of enhanced capital allowances for energy saving technologies such as solar thermal systems, ground source heat pumps and air to air recovery, or through plant and machinery allowances for any items of plant outside the current ECA regime such as standard LTHW boilers, pipework insulation and certain types of thermal insulation.
Pair the above with the annual investment allowance currently set at £1,000,000* and you could write the all of this expenditure off within the current year even if no plant falls under the ECA regime, meaning your tax bill will be non existent or substantially lower than anticipated.
*updated as per the 2019 autumn budget.