Australia: Spotlight on Environmental Upgrade Agreements in New South Wales

Last Updated: 3 November 2015
Article by Andrew Flannery
Focus: Environmental Upgrade Agreements
Services: Property & Projects
Industry Focus: Property

This month, we shine a spotlight on an issue that will spark the interest of building owners in New South Wales – the revitalisation of 'Environmental Upgrade Agreements' (EUAs). Partner Andrew Flannery shares some views on EUAs, including some insights gained through recent discussions with the NSW Office of Environment & Heritage (E&H) which indicate that EUAs are poised for a reboot.

What is an Environmental Upgrade Agreement?

An EUA is an innovative funding model which allows landowners to make improvements to the resource efficiency or environmental sustainability of their buildings (thereby increasing the buildings' value), and recover a substantial part of the costs from their tenants over time. Further, landowners can borrow the upfront cost of doing this work via long term funding at highly competitive interest rates, without it impacting their borrowing capacity.

Financial provider Eureka has put together a short video which provides a great summary of the value proposition for EUAs. It is a highly worthwhile watch and can be accessed on Eureka's website.1

Key points to note about EUAs:

EUAs are available for non-strata commercial and light industrial buildings, as well as strata residential buildings with more than 20 lots.

EUAs may be used for works to "improve the energy efficiency, water or environmental efficiency or sustainability of the building".2 The definition is very broad, and could include things like improving energy or water efficiency, reducing waste and greenhouse gas emissions, recycling, pollution prevention or reduction, renewable energy projects and reducing car use by putting in an 'end of trip' facility to encourage activities like walking and cycling.

The image below, accessible on the E&H's website and reproduced here with permission, provides a helpful overview of how an EUA operates.

An EUA is generally entered into by the Building Owner, Finance Provider and Council, and works like this:

  • The Building Owner obtains money from the Finance Provider under an arrangement that looks a lot like a loan (for example, there is a loan term and provisions for repayment with interest).
  • The Finance Provider makes funding available but takes no security over the property and has no recourse against the Building Owner. The repayment obligation rests with Council, although Council is not required to make payments until it has funds to pay.
  • The Council agrees to strike an Environmental Upgrade Charge which corresponds with the monies payable to the Finance Provider, plus a fee to Council. These are then recovered from the Building Owner as Council rates, and are paid on to the Financer Provider (less the fee).
  • If the Building Owner fails to pay the Environmental Upgrade Charge, Council must recover the arrears, using its general powers to enforce payment of rates (which can eventually lead to a forced sale of the property). However, this only applies to arrears, and the repayments are not accelerated.

Further detail about EUAs and their operation is available on the E&H's website, where there is an excellent Factsheet for building owners. 3

Why are EUAs a good funding option for landowners?

  • They provide innovative funding for works which can improve NABERS (National Australian Built Environment Rating System) ratings, and make buildings more attractive to tenants. In the process, they increase building value.
  • They allow for a long borrowing term and competitive rates. Finance Providers who understand EUAs realise that they effectively get the security enhancement of the statutory priority available to Council for payment of rates. This ranks above just about everyone - even the first mortgagee - so the terms available for these loans can be very good.
  • EUAs involve unsecured borrowing - there is no security over the property and no personal liability for the landowner.
  • Because EUAs are not loans, they do not impact on the loan to value ratio.
  • EUAs can run with the land. On sale, the purchaser can elect for the Environmental Upgrade Charge to continue to run with the land, or alternatively elect for the vendor to pay out the Charge at a discount to face value and the Charge will be released.
  • They allow for cost recovery from tenants. Generally landlords cannot recover capital costs from tenants. However, because the Environmental Upgrade Charge is a recurrent expense, it is recoverable under normal outgoings provisions which allow recovery of rates and taxes (subject to the restriction that the recoverable amount is capped to the cost savings available to the tenant).

Why are EUAs becoming an even more compelling funding solution?

When EUAs were introduced in NSW in 2010 4, significant excitement was sparked among property lawyers who anticipated that there would be a flood of new EUAs. However the uptake of EUAs has been glacially slow – indeed, in the five years since they were introduced, there have only been a handful of EUAs put in place.

Earlier this year, my partner Jane Wild and I spoke with E&H for a briefing on EUAs. We had the chance to express some concerns about the complexity of EUAs and discuss the reasons why they might be failing to gain traction. E&H acknowledged that there were issues, but the message was clear: the reinvigorated Baird Government was committed to getting EUAs on track.

E&H have done great work and have now addressed most of the key pitfalls of EUAs (and in my view, have set them up as a great funding option). Some of those pitfalls, and the way they are being turned around, are outlined below.

  1. Council involvement

Without active Council interest, enthusiasm and commitment, EUAs simply will not work. Councils have been slow to get behind EUAs. This is partly because the work required from Council has been reasonably heavy. Councils generally did not have staff or processes in place to deal with this, and the role and responsibility of Councils was not well understood.

The E&H as has taken a two-pronged approach to addressing this:

  • Rather than try to lobby and convince all Councils of the value of EUAs, the E&H has worked closely with a coalition of the willing: City of Sydney, Parramatta, North Sydney, Lake Macquarie and Newcastle. These Councils are supportive of the EUA process, and now have processes in place to deal with EUA applications quickly and efficiently. Indeed, I understand that Parramatta Council is so keen that it is currently waiving all fees.
  • Initially, Councils were in charge of producing the required documentation for each EUA and it just did not happen. The documentation package is now being prepared by the financiers, saving Councils from most of the administrative work.

It appears that a number of other Councils in NSW are actively watching the space, and are likely to step on board when they see successful EUA projects.

  1. Financier participation

While there has been definite interest from financiers in the EUA space, there has been little active participation. That is changing. For example, ANZ funded the major EUA for Central Park and the NAB has also funded in this area. Eureka is now gearing up strongly [5], and it is understood that funding is also being made available through the Clean Energy Finance Corporation and the Sydney Renewable Power Company.

I also understand that Moody Kiddell & Partners are putting together financing packages using EUAs, which is indicative that interest is growing!

  1. Documentation barriers

Historically, the documentation required for an EUA was long and complicated. E&H called for an overhaul of that documentation and we understand that a slimmed-down and vastly improved version should be released shortly.

  1. Recovery of costs from tenants

Landlords can recover the cost of building upgrades from tenants if they are done under an EUA. This is because the "loan repayments" are made by way of rates payable to Council, and rates and taxes can be recovered from tenants under a net lease.

This applies to the extent that tenants can be shown to be saving money by the building upgrades, and where the lease allows recovery for these rates. Note this will not be possible under leases with gross rent provisions (ie where outgoings are not payable by tenants).

Our concern has been whether the lease had to make specific reference to EUAs in the outgoings clause. We understand that E&H's view is that a plain vanilla net lease outgoings recovery clause in a lease is all that is necessary to allow landlords to recover EUA contributions from tenants, and we expect E&H to state this as its position shortly.

  1. Onerous administration

As the NSW Government wanted to monitor the success of its EUA initiative, it mandated quite weighty reporting requirements about how the EUA projects are tracking. However, there is little value in trying to track success when it is the tracking mechanism itself that is off-putting. It is understood that the E&H is conscious of this difficulty, and it is expected that the reporting requirements may soon be reduced and standardised (and may only apply where there is recovery from tenants).

Conclusion

While there has been general interest in EUAs, their uptake has been stalled by issues like those outlined above and it has been difficult to point to a major success story. However, the ANZ funded EUA for the Fraser development at Central Park, is a major initiative for a high profile site – and will no doubt be a leading example of many more to come.

E&H has been working hard to find solutions to the problems that have been associated with EUAs, and we hope to see a formal announcement about improvements to the EUA regime by the end of this year.

This is an exciting initiative, with tremendous potential.

Footnotes

1 See http://www.eurekaeuf.com.au/.
2See s54E, Pt2A Local Government Act 1993 (NSW).
3 Visit http://www.environment.nsw.gov.au/business/upgrade-agreements.htm to view further detail about EUAs. Of particular interest for landlords will be the 'Building owner' resource for building owners, which you can find at the bottom of the webpage under the heading "Frequently Asked Questions".
4 EUAs were introduced by the inclusion of Part 2A in the Local Government Act 1993 (NSW).
5 For more on Eureka, see the interesting video currently available on Eureka's webpage entitled "Funding upgrades through energy savings" - see http://www.eurekaeuf.com.au/.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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