You’ve probably heard about green mortgages and green loans being used by lending banks to incentivise buyers, but green clauses are also increasingly being used in leases between commercial landlords and tenants.
Not always legally binding, they’re more of an agreement aimed at reducing a building’s environmental impact. These clauses sometimes stipulate that tenants report on its environmental performance and keep track of the cost of utilities as a way to achieve better energy efficiency and lower running costs – they’re also a good way for landlords to prove their environmental credentials.
Globally, some 34% of occupiers already have green lease clauses to make sure their building’s energy efficiency is maintained or even improved, while a further 40% plan to sign them by 2025, according to JLL’s Decarbonizing the Built Environment report. Some countries are ahead of the curve, such as France, where green lease clauses are mandatory for all large commercial leases, with data-sharing, regular reviews of a property’s environmental performance and a commitment to a programme of improvements.
There’s some evidence that buildings with green credentials are even attracting a premium, both in capital value and in rental income, and could well become more popular as the government continues down its path to net zero. However, one potential drawback is that as with a traditional lease, tenants need to reinstate a property to its original state at the end of the term, which might put them off making any improvements.
Using green clauses, tenants are allowed to make alterations, but by having an energy assessment, there’s a stipulation that the EPC for the fit-out can’t be worse than the EPC that had been registered on behalf of the landlord to market the building. That’s fine, as long as the EPC is based on the correct parameters. But if the landlord’s EPC was registered on an erroneous basis or doesn’t follow the EPC Convention, this could cause a problem for the tenant. This may bring into question whether the green clause is valid.
Murton & Co act for both landlords and tenants but we aim to be impartial and provide clear guidance on the regulations, so we recommend that tenants review the EPC carefully to ensure that it correctly reflects the building they are about to commit to occupying. The same advice is given to landlords as the tendency may be to rely on the EPC that was registered several years ago – and there may have been material changes to the building since the EPC was registered. Also of significance is the change in the methodology used to calculate EPCs that could mean the EPC is out of date and not an accurate reflection of the current energy efficiency credentials.
A particular issue we have been battling with over the past few months relates to shell and core. This is where a building is constructed as a shell with no services installed but the building envelope is ready for a tenant to fit out and connect to the utility and drainage infrastructure which will have been brought to the building and capped off. The developer will need to construct the building in accordance with building regulations, and as such an assessment of the energy efficiency should be conducted using SBEM (Simplified Building Energy Model) methodology which is the same methodology that generates an EPC. The energy assessor will run the calculations with known entities of the size, orientation and specification of the building fabric, but will need to make assumptions for the building services that may be installed by a prospective tenant. When the energy calculations for a shell are conducted, we’re assuming there’s going to be a heating system. We could legitimately enter any reasonable form of space heating, fuel type and the seasonal efficiency of the system as we see fit. The same goes for hot water, lighting and ventilation as we’re aiming to enter a reasonable performance value that will comply with building regulations. By reasonable, there should be a product on the market that will achieve the performance value entered into SBEM.
We have carried out many assessments on shell and core buildings over the years for both developers and tenants. They can be quite challenging, especially where the assessment is conducted for a tenant’s fit-out and where another energy assessor has undertaken the SBEM calculations for the shell on behalf of the developer to satisfy their building regulations application. It is imperative that all the information for the building as-constructed is obtained so that the baseline assessment before running the fit-out assessment is similar to that of the developer’s shell assessment. This includes a copy of the developer’s Energy Assessor BRUKL Report which would have been submitted to the building control officer to demonstrate compliance with Building Regulations Approved Document L. We have seen some spurious entries which we have successfully challenged and obtained a revised (corrected) BRUKL Report when acting for prospective tenants.
Unfortunately, there will be energy assessors who haven’t a clue about lighting performance values, for example. Last week, I saw one assessment where the lighting was noted as 436 lumens/watt when I’m sure it’s not even possible to achieve a lighting spec much above 140 lumens/watt and the norm for an average lighting performance in a building is about 110 lumens/watt. In a case like this, it means that the landlord gets an EPC with an artificially high rating, making it very difficult for the tenant to achieve the same or better rating – and it limits their ability to comply with the green clause. The correct position is that the lighting performance when registering the EPC on a shell and core building should be the worst allowable under building regulations. This may be considerably lower than the value entered to achieve compliance the Criterion 1 on the BRUKL Report and will also have the effect of lowering the EPC rating. This is OK because the tenant’s fit-out is likely to provide an enhancement on the EPC.
Where the air permeability rate has been entered with a value of less than 15 m3/h/m2 (and this may be required to achieve compliance with Criterion 1 on the BRUKL Report), it will need to be proved. Dropping the air permeability rate can be another factor that improves the EPC rating. This is OK, so long as it is based on reality and can be proven by an air test. An air permeability rate of less than 15 m3/h/m2 requires an air test even on the shell. This relates specifically to building regulations in England. There are different rules for Scotland, Wales and Northern Ireland, so energy assessors do need to check the relevant regulations. This is another area where we find there is confusion, yet it is clearly written in the Approved Documents as to the air permeability requirements and testing.
We have also found there is a lack of understanding of the requirements for when an EPC should be registered. While the EPC may not be required to be registered for building regulations for a shell and core new build, it most certainly is for the marketing and subsequent letting or sale. The EPC is a legal document provided to any prospective tenant or purchaser. It has been governed by the Energy Performance of Buildings Regulations since 2009, but even in 2022, transactions are still taking place without it. While these regulations may not have been actively enforced by Trading Standards, this does not absolve the landlord from receiving a fine for a breach of the regulations. Let’s not forget the Minimum EPC Regulations which set a minimum EPC rating to be achieved before a landlord can grant a new lease and carries a threat of fines for any breaches. It is perhaps this regulation that has driven the trend for green clauses in the UK.
The ramifications of these inconsistencies could be pretty dramatic. If a tenant doesn’t comply, a landlord could then foreclose on the lease, sue the tenant for breach, or take matters into their own hands and charge the tenant for the cost to remedy the breach. There’s also the potential for professional indemnity claims against energy assessors, especially those not following the protocol and producing incorrect EPCs on shell and core buildings.
Accreditation schemes frankly aren’t doing enough to clarify the situation and there needs to be a cross parity of advice. There are six accreditation schemes for energy assessments and so it is not helpful when they provide conflicting advice to their members.
Assessors need to wear two hats when entering performance values into the SBEM software report demonstrating compliance with building regulations: one for compliance and one for EPC. So, for compliance, you would model the building with a fit-out that is likely for the building type which will be based on its planning permission. You would initially do the modelling using the minimum values within the Non-Domestic Building Services Compliance Guide and gradually notch everything up until the building emission rate (BER) and target C02 emission rate (TER) match or the BER becomes less than the TER.
A shell and core building isn’t classed as a low energy use building and hence requires SBEM calculations if it is a new-build and an EPC when marketing for a sale or letting. The EPC shows a prospective buyer or tenant what the likely rating would be with a fit-out that’s the worst case allowed under building regulations. But as there’s no target for an EPC to meet under building regulations. It is the Minimum EPC Regulations that stipulates a minimum rating for the grant of a lease or lease renewal. The key point here is that the BRUKL Report and the EPC at shell stage have different values entered for the building services elements: the model used for Building Regulations compliance and hence the BRUKL Report will have better values than the model used to produce the EPC. The EPC based on the compliance model will be higher (i.e. better) than the EPC for the sale or letting. It is of course tempting for the energy assessor to present the more favourable EPC to their developer/landlord client, but those with a keen eye acting for the tenant will undoubtedly pick this up and challenge it.
We understand that Elmhurst (the UK’s largest accreditation scheme for energy assessors) is in the process of drafting a guidance document on shell and core buildings. Let’s hope it’s soon, otherwise green clauses will have landlords, tenants and assessors all seeing red.