New energy requirements turn up the heat in the commercial property market in Scotland

Posted Oct 24, 2016

New energy performance regulations that came into force in Scotland last month (September 2016) could have significant financial implications for owners and tenants of commercial property.

On the one hand, the regulations will add costs for owners and tenants. On the other, owners or tenants who do their homework can manage the cost and even benefit from the change – perhaps through negotiating advantageous deals, perhaps through reduced future energy bills.

The regulations came into force on 1 September, without much fanfare. Given the dryness of the subject-matter and name (the Assessment of Energy Performance of Non-domestic Buildings (Scotland) Regulations 2016), the low-profile debut is not surprising. But dry does not mean unimportant.

With regulation that is so new, the full commercial implications for landlords and tenants remain to be seen. But as well as adding costs, their consequences could include a strengthened bargaining position for existing tenants; increased dilapidations costs for tenants who fail to carry out energy efficiency improvements; and new considerations to include in lease negotiations and service charge calculations.

The regulations may also tip the balance in landlords’ decisions about whether to lease or sell an existing commercial property or redevelop the site. Clearly, some homework is in all parties’ interests.

The regulations in brief

Under the new regulations, owners of commercial property are responsible for improving the energy efficiency of their buildings when they sell the property or grant a lease to a new tenant.

They apply to non-domestic buildings with a floor area of over 1000 sq m (that’s about four tennis courts). A few 1000+ sq m buildings are exempt, including some agricultural buildings, and buildings improved under the Green Deal.

For all buildings covered by the new regulations, owners must prepare an action plan setting out a programme of measures to improve the energy performance of the building and to reduce its greenhouse gas emissions. This plan must be provided to a prospective tenant or buyer free of charge. The works must be completed within three and half years of the issue of the action plan, and could include improvements to lighting, heating, insulation or boilers.

As well as specifying improvement measures, the action plan should set energy improvement targets for the building. Improvements need only be carried out where the energy savings over seven years would exceed the cost of the works.

An alternative to carrying out the improvements is for the owners to measure, report and display operational ratings for the building. This can be cheaper than carrying out works, but is not a do-nothing option: owners still need to obtain and exhibit a display energy certificate (DEC) showing energy consumption and emissions, and to renew it annually.

The commercial implications

That’s a brief outline of the regulations (though of course there is plenty more detail). The decisions and consequences for each landlord and tenant will depend on their financial position, bargaining power and the state of the property, among other factors, but here are a few possible implications to consider.

First, the requirement for an action plan is triggered only by the sale of the property or grant of a lease to a new tenant. No action plan is required for a renewal of a lease to an existing tenant. Therefore, the case for renewing a lease will become stronger, with commensurate increases in the bargaining power of the tenant.

Secondly, any sale or new lease negotiations should now include discussion of who will be responsible for effecting the improvements specified in the action plan.

Thirdly, whilst only owners selling or granting a new lease are required to prepare an action plan, this doesn’t release other owners from thinking about possible future costs arising from these new regulations. For example, service charges may need to rise in advance in order to fund future improvements, well before a sale is considered.

It’s too soon to witness the market consequences of the new regulations, but we do know that market mechanisms will evolve to absorb them. This could involve anything from higher service charges to longer rent-free periods, or lead to more owners of energy-inefficient buildings opting for redevelopment.

All of this is yet to emerge. But what’s certain is that owners and tenants who are clever upfront and well prepared are most likely to weather, or even benefit from, these new regulations.