The Minimum Energy Efficiency Standards (MEES) for commercial and residential properties in England and Wales were introduced on 1 April 2018, making it illegal for landlords to grant new or renew existing tenancies for non-domestic properties with an Energy Performance Certificate (EPC) rating lower than E.
The standard will be extended over the next five years to include all domestic properties and finally all leases, including where a lease is already in place.
It is valuation practice to consider the sustainability of a property as part of the due diligence process. However, the introduction of MEES could mean it becomes market practice to explicitly reflect the EPC rating in the market value.
With at least 20% of properties having an F or G EPC rating, not all will be able meet the new requirements as ‘continued lettings’ are phased in. In many cases the cost to raise the standard will be minimal, having a negligible effect on market value. But it is important to consider the few real estate assets where the cost of upgrading will be significant.
The key risk to value is the possibility of current or future void periods due to unlettable properties. This would invariably result in the interruption of the rental income stream coupled with the prospect of associated non-recoverable landlord costs, such as service charge shortfalls and empty rates. Similarly, valuers may factor in capital expenditure to undertake the requisite upgrade to an EPC rating of E or above or may make an upward adjust to the equivalent yield to reflect the negative EPC situation.
Another factor that may affect value is related to commercial lease renewals and rent reviews. Where the leased property fails to comply with the MEES regulations, tenants may leverage this as a bargaining position in negotiations with their landlords. Some studies have estimated that this could affect rental valuations by up to 10%. Lower rental income streams would in turn affect the market value.
Although these risks do exist, it is important to note that the market has been aware of these changes for the past seven years, so it is expected that many prudent real estate funds, property companies, developers and professional investors will have prepared their portfolios for these key dates.
However, there are uncertainties around the impact of these new regulations. The approach to valuation will evolve to reflect these changes but in the meantime, it is important for all lenders, borrowers, investors and occupiers to be aware of the potential issues that may arise as a consequence of a low EPC rating.