UK: Investment Risk For Poorly Performing Properties

Last Updated: 27 May 2011
Article by Paul Sheridan, Valentina Keys and Kathy Mylrea

The Energy Bill received its Second Reading on 10 May 2011 and included some significant changes to the Green Deal.  These related to the introduction of new regulations that will, from April 2016, allow tenants of domestic properties to request their landlords to carry out energy efficiency improvements and landlords be required to comply with reasonable requests coupled with a ban, starting in April 2018, on letting domestic and business premises with an "F" or "G" energy efficiency rating.

This was followed, on 17 May, by a Ministerial announcement that the Government will be signing up to a Fourth Carbon Budget. The Fourth Carbon Budget will propose setting a legally binding interim target to reduce emissions by 50% by 2027 from 1990 level and the Green Deal is noted specifically as a policy that will be a part of achieving these targets.  On 23 May the Deputy Prime-Minister confirmed that the Green Investment Bank will be set up under legislation to give it independence from ministers and may be used to help finance the Green Deal. 

The Green Deal has been described as a flagship coalition policy and is part of the UK's legislative response to the 2010 recast of the Energy Performance of Buildings Directive.  The introduction of minimum energy standards in particular is likely to have far-reaching repercussions on the value and marketability of real-estate and may strengthen the commercial value of Energy Performance Certificates. 

The Green Deal

The Green Deal is the Coalition Government's national plan of home improvements to make houses and businesses cheaper to run through better energy efficiency. From 2012, households and businesses will be able to access finance to pay for the upfront cost of work which will be paid back through savings on lower fuel bills. The Green Deal offer of no upfront costs for energy efficiency measures will also be available to landlords, both domestic and commercial. One distinguishing feature of the Green Deal is that the repayments plan would be attached to the property rather than the individual.

'Split incentive' problem

One crucial barrier to cross-sectoral success of the Green Deal and the subject of much debate has been the 'split incentive' issue, namely, the difficulty of incentivising private landlords to partake in investments, the benefits of which would be reaped by tenants. In a bold attempt to address this issue the Government has now announced plans to introduce regulations to encourage and, if all else fails, force landlords to invest in energy efficiency measures by setting minimum energy efficiency standards to be achieved with the help of Green Deal financing.

Tenants' 'reasonable' requests for energy efficiency improvements

From April 2016, in relation to the domestic sector only, powers now contained in the Bill will empower the Secretary of State to require landlords to honour reasonable requests from their tenants for energy efficiency improvements, where financial support is available so that there are no upfront costs to the landlord. It is yet to be clarified what is meant by a 'reasonable request" and potential detail of the necessary regulations is yet to be confirmed.

Rental of F and G Rated Buildings

From April 2018 the proposal is that government could regulate to make it unlawful for landlords of both domestic and business premises to rent out "F" and "G" rated buildings (based on the Energy Performance of Buildings Directive rating.) Landlords with the worst performing properties would have to complete a Green Deal assessment and then implement a sufficient number of the cost-effective improvements identified to bring the energy performance of the property up to the required threshold. It is understood that listed buildings are to be excluded from the ban, but there may be further building types which will be deemed out of scope.

The ban on letting F and G domestic and non-domestic buildings from 2018 will still be subject to the exemptions provided for in the Bill. The ban would not apply if:

(a) Green Deal would not improve the building to the required "E" rating. However, Landlords improvements would still have to be carried out within the scope of Green Deal financing.

(b) The Landlord is unable to obtain the necessary consents and permissions to be able to partake in the Green Deal.

(c) Compliance with the regulations would have a negative impact on the value of the property.

Marketability and Value

The proposed minimum energy standards for buildings are likely to devalue old building stock unless it is speedily up-graded to meet the new standards. Valuation methodologies in the real estate sector will need to reflect to change and no doubt the marketability of properties will be increasingly linked to their energy rating. 

The introduction of minimum energy standards is in line with the EU Energy Performance of Buildings Directive, recast on the18 May 2010, which, amongst other things, not only requires Member States to introduce measures to ensure that all new buildings meet the 'nearly zero energy' standard by 31 December 2020, but also requires Member States to ensure that when buildings undergo major renovation, the energy performance of a building or the part that is being renovated is upgraded to meet the 'minimum energy performance requirements set in accordance with Article 4'. Importantly, Article 4 of the Directive provides that the minimum requirements have to be 'cost-effective over the estimated economic lifecycle'. This is also known as the 'cost-optimal' level. This concept (akin to life-cycle costing) is not a feature of most to current real estate financial modelling and is certainly alien to the private rented sector.

Full details of what "cost-optimal level" entails is not yet available but it is shaping up to be have some game changing implications (Cost-optimal has been the subject of earlier Law Nows and will be the subject of future articles).

The Fourth Carbon Budget

The Climate Change Act 2008 (the 'Act') sets a target to reduce greenhouse gas ('GHG') emissions in the UK by at least 80% from 1990 levels by 2050. The Act also requires Government to set carbon budgets, specifying limits on GHG emissions in the UK, for consecutive five year periods. The first three years carbon budgets were set in 2009 in accordance with advice from the independent Committee on Climate Change. The fourth carbon budget is due to be set in law in June 2011 and it is proposed that net GHG emissions over the 2023-2027 period should equal to a 50% reduction from 1990 levels.  The target is, however, contingent on the European Union agreeing to embark on an equally significant emissions cut by early 2014. Should this fail, then the UK carbon budget will default to the EU average and UK could end up lagging behind European Union leaders in this area.

Revised Carbon Plan to follow Carbon Budget

Once the fourth carbon budget is set in law, the Coalition Government will be required to publish a revised carbon plan later in 2011 in which it will set out how the existing and proposed policies and proposals will help meet the interim and long-term targets. Some of the significant existing policies include the reform of the electricity market, ensuring that homes are built to a higher energy efficiency standard, the roll-out of electric vehicles, the set up of the Green Investment Bank and the financing of energy-efficiency upgrades to properties through the Green Deal which is due to be launched in 2012.

Comment

The proposed legislative changes are intended to educate and financially incentivise consumers and landlords to retrofit existing building stock, which is estimated to account for around 40% of UK carbon emissions, with energy efficiency measures. It is hoped that with the backing of the banking and retail sectors the 'Green Deal' will help UK to meet the legally binding medium and long term Climate Change Act 2008 targets of greenhouse gas emission reduction. Notwithstanding that the proposed changes are still in the early stages of development and further detail, prudent horizon-scanning property owners and property investors could benefit from treating the above proposals as an opportunity to review potential for upgrade their properties ahead of regulation and with (or without) the assistance of the Green Deal financing.  The inclusion of "F" rated buildings in the letting ban and the link to the Energy Performance Certificates were not widely anticipated and the valuation, letting and marketability issues this raises need to be well managed.  It does not seem too difficult to envisage that "C" and "D" properties will be the next targets.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 24/05/2011.

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