Who Pays for Going Green in commercial leases?

‘’Sustainability’’ and ‘’ESG’’ are now buzzwords in commercial real estate and occupiers are starting to insist that their building has minimum social impact. Landlords are seeing increased demand for healthy buildings and millennial occupiers in particular are expecting their employers to secure workspaces for them that have at least a neutral effect on the environment. Tenants are increasingly concerned about the environmental and social impact of their business operations. Key points for occupiers include: reputation risk, attracting and retaining the best employees, customer interest, the impact of increasing environmental legislation and financial savings.

Net-zero carbon by 2050?

In the UK, the Government has committed to reaching net-zero carbon by 2050. Buildings account for nearly a quarter of the UK’s greenhouse gas emissions and therefore the Government is targeting the decarbonising of them. A 30% reduction in building energy use by 2030 (compared with 2015 consumption) is anticipated to be needed to hit that target. As an estimated 80% of buildings that will exist in 2050 have already been built, refurbishment must also play a big part in this. Reduction targets cannot be met by simply improving the efficiency of new buildings.

Buildings such as high-tech manufacturing plants, technical buildings, medical buildings and laboratories require far greater ventilation and house extremely energy intensive equipment, which is often operational 24/7. Laboratory research, and the buildings which facilitate it, consume 5-10 times more energy per square meter than other buildings. Owners and occupiers are starting to seek to work together to reduce the negative environmental effects of such buildings.

The Minimum Energy Efficiency Standards (MEES) Regulations

The MEES Regulations aim to improve the energy efficiency of buildings and now require landlords to ensure that their properties have a minimum energy efficiency standard EPC rating of ‘E’ before new leases can be granted, unless an exemption applies. 

From 1 April 2023, it is proposed that this will extend to a landlord not being able to continue to let a commercial building, even under an existing lease, unless the building has an EPC rating of ‘E’ or above, subject to certain exemptions. It is likely that for commercial properties these rules will be tightened over time, so that it will be unlawful to continue to let commercial property with an EPC rating of below ‘B’ by 2030. The Government indicates that it proposes a phased implementation of the ‘B’ minimum rating, with an interim minimum rating of ‘C’ imposed in 2027. It is estimated that the implementation of the EPC ‘B’ target will cover around 85% of the UK’s commercial buildings. Given that the minimum rating will be changing to an EPC ‘C’ rating and then to a ‘B’ rating in a short timeframe, landlords will be looking at which of their buildings might need improvements, how they can be programmed cost effectively and looking at their leases to see who will pay for it.

Is there a quick fix to reduce operational energy consumption?

Factors that could reduce operational energy consumption would include improvements to air tightness, insulation, timber cladding, predictive building automation providers, the glazing performance of windows and doors, more efficient heating systems, the use of advanced metering technology using smart controls and energy efficient lighting. For landlords, more sustainable buildings have increased rental value and shorter void periods. The additional costs involved in making improvements are likely to be recouped long term through associated increases in rental and capital value. For tenants, financial savings should be made from reduced operational costs. 

The Government has also released its Heat and Buildings Strategy (HBS) in late 2021 to help reach net zero by 2050. Heating an estimated 30 million buildings mainly with natural gas produces high carbon emissions. To remove fossil fuel heating from them all by 2050, the HBS sets a minimum target of 600,000 heat-pump installations each year from 2028, increasing to 1.7 million annually from 2035. It is recommended that gas boiler sales should end by 2030-33 for commercial properties. Under current proposals, new gas boilers or replacements may be banned in existing properties as of 2035. The target is that all heating methods used in buildings should be low carbon by 2050.

Given the importance for a net-zero solution for landlords, tenants and the planet, these initiatives are encouraging, however replacement of gas boilers and the implementation of energy efficiency improvements to buildings within these timelines will be expensive.

In our next article we will look at how the cost of “going green’’ is increasingly being specifically covered in leases.