Over 80 per cent of commercial buildings could be unlettable 

Commercial landlords are facing a nightmare situation; a race to upgrade their energy efficiency standards, many with an uncertain outcome.

New energy efficiency regulations are fast becoming one of the biggest challenges facing commercial landlords. Recent research from the British Property Federation (BPF) finds that there are around 83% of UK commercial buildings currently falling below EPC C and B, meaning they risk becoming unlettable by 2030. 

Upgrading older offices, shops and industrial units to modern standards is proving expensive and, in many cases, economically unviable. Landlords must also juggle the practicalities of refurbishing an occupied building, dealing with asbestos in older buildings, and navigating complex lease provisions to recover some or all the costs. 

While some government incentives exist, they mostly fall well short of what’s needed to fund widespread commercial building upgrades. With the market already discounting “brown” buildings and rewarding sustainable ones, and those with good facilities, landlords need to be acting now if they want to stay competitive. 

Landlords should start with a full survey of their properties to establish requirements and costs and to start engaging with tenants on planned and phased improvements. 

For some, unfortunately, the numbers simply won’t stack up. There will be some hard choices about sell, redevelopment or otherwise risk compliance delays with heavy penalties for missed deadlines - fines of up to £150,000 per building..

The high cost of green compliance

The research from the British Property Federation (BPF) paints a bleak picture for UK commercial property, much of which is older property presenting a real challenge to bring them up to EPC C or B standard.

The BPF research identifies around 83% of commercial buildings in seven major UK cities that currently hold an Energy Performance Certificate (EPC) below a B rating. The evidence shows that many of these buildings will be at risk of becoming unlettable by 2030 under the UK’s increasingly stringent energy efficiency rules.

2030 isn’t all that far away, just over 4 years, and 2027 even closer. Unless the rules are relaxed in the future it’s a major challenge for landlords today. There are many ageing buildings whose configurations present real difficulties when upgrading: office blocks, high street stores, industrial units, and mixed-use portfolios, where upgrading to meet the future EPC B standards could be prohibitively expensive.

As the government pushes forward with its Net Zero by 2050 commitment, it means the commercial property market is entering a period of rapid change. While the legislative aim is to create “greener” buildings, in practice the financial implications for landlords are huge. To the extent that in some cases buildings become a liability where continued ownership is economically unviable, landlords have some hard decisions to make.

This article applies primarily to England and is not a full interpretation of the rules. Always seek professional advice before making or not making decisions. Use this guide as the starting point for your research, not an endpoint.

Note: As things stand, ‍requirements are for commercial Energy Performance Certificates of C ratings from 1^st April 2027. However, MEES requirements beyond 2027 are still unclear for the non-domestic sector. Under current plans, building owners and landlords should be preparing for an interim target of EPC C by 2027, and EPC B by 2030, however some of this is yet subject to change, pending a consultation response.

What are the EPC rules 

At present, landlords can’t legally grant a new commercial lease (or renew an existing one) unless the property achieves an EPC rating of at least E. That’s been in force since April 2023. But under the government’s proposed timescale, all commercial property will need to achieve EPC C by 2027 and EPC B by 2030.

This is a tall order. Thousands of buildings, particularly older stock constructed before the 1990s were not designed with energy efficiency in mind. According to recent analysis carried out by JLL, the cost of upgrading to EPC B varies widely:

Modern office and retail buildings built after 2000 may need relatively simple and inexpensive upgrades, for example lighting and Heating, Ventilation, and Air Conditioning (HVAC) upgrades cost from £30 per m².

However, older property stock is a different story. Many buildings will require full HVAC replacements, double glazing, insulation, and even internal or external wall facings. These sorts of upgrades will push costs to between £250 and £500 per m², or even or more in some cases.

This is fine for some properties with premium rents, but for secondary offices, shops and industrial units with low rental yields, and no real prospects of increases, the upgrade costs involved will easily exceed the property’s capital value uplift, meaning the improvement works are just simply uneconomic.

Stranded assets and declining values

Commercial tenants increasingly look for premises that are energy efficient and provide modern facilities, so buildings that fall short of the EPC B standard could become what the industry jargon calls “stranded assets”. These are buildings that won’t attract quality tenants or institutional investors. 

So, energy efficiency will become a key investment criterion, particularly for those companies putting a great deal of store by their ESG (Environmental, Social, and Governance) credentials. Some financiers and occupiers are under corporate sustainability mandates which affect their investment decisions.

The BPF’s research shows that the trend is set. Even if the regulations were delayed or softened, the market has already started to discriminate against low-rated buildings. Tenants in future will be increasingly reluctant to sign long leases on inefficient premises, not just for “green” image either, but because energy costs are a material factor in their running costs. 

The result is a “green premium” which is widening the gulf versus the “brown discount”. Prime sustainable offices and shops in city centres are already letting quicker and commanding stronger rents, yields which older energy-inefficient buildings cannot compete with, and they are seeing rising voids and capital value erosion.

The refurbishment dilemma

For landlords, upgrading a commercial building isn’t just about investment — it’s also about managing the disruption for tenants already in occupation. Energy efficiency retrofits typically involve major works. Replacing HVAC systems, upgrading glazing, installing insulation, external wall upgrades and overhauling lighting and controls can rarely be achieved without major disruption. It may be possible to phase and manage access but managing the process will be a nightmare, so in most cases this level of work will require vacant possession.

That’s where the difficulties arise, where the commercial reality bites. Many landlords face a choice of attempting intrusive works during occupation, with all the hassle, the noise and disruption this entails resulting in tenant dissatisfaction and even claims for damages.

Or they can wait until leases expire, which means potentially missing the compliance deadlines and facing penalties. Redeveloping or selling are other options if the financing is available and the numbers stack up. But this means vacant possession.

Even where tenants are cooperating in full, the logistics will be complex. Upgrading to EPC B could involve major works to common parts and shared capital equipment with the danger of triggering service charge disputes, unless the leases are watertight on cost recovery.

Government assistance

Though most support schemes have been focussed on the domestic property market, commercial landlords can seek support through various schemes, such as the Energy Company Obligation (ECO4) for properties with lower energy efficiency ratings (E, F, or G) and the Boiler Upgrade Scheme (BUS) and the Industrial Energy Transformation Fund (IETF) which offers grants for replacing fossil fuel heating systems with low-carbon alternatives like heat pumps. 

Local authorities may also run schemes, and the government has other programs such as the Great British Insulation Scheme (GBIS). The government is said to be planning to introduce a grants scheme for Energy efficiency support to assist businesses in enhancing the energy efficiency of their assets. 

The Department for Energy Security and Net Zero (DESNZ) has indicated that a scheme is expected to roll out in 2025 in England and Wales. Funding can be put towards investing in new machinery and equipment, improving manufacturing processes, and other features such as insulation and lighting.

Enhanced Capital Allowances (ECA) may apply to certain energy-saving plant and machinery, allowing landlords to claim 100% tax relief in the first year and some local authorities and devolved governments (particularly in Scotland and Wales) offer grant programmes for decarbonisation, including retrofitting of commercial premises.

However, many landlords are finding these schemes piecemeal in nature, rather bureaucratic, and insignificant when weighed against major retrofit costs.

Recovering costs: service charges and lease clauses

Improving energy efficiency standards benefits tenants by way of energy savings and comfort but recovering upgrade costs depends on the wording in the lease. Most older leases predate the current sustainability regime so will provide for limited if any scope to charge tenants for “improvement” works. Generally, only repairs and maintenance items will be covered.

Recent case law suggests that landlords need to tread carefully on this issue. Upgrading to improve energy efficiency generally does not qualify as repair, so landlords can’t pass the costs onto the tenant through the regular service charge route unless the lease expressly allows for this. 

If they have not already done so, landlords should have started inserting “green” lease clauses into their new leases, clauses which will in future enable them to recover some or all the sustainability-related costs. Landlords should be looking to cooperate with tenants on achieving environmental targets, but this task is made more difficult in multi-let buildings with common spaces, as aligning everyone’s interests can also be challenging.

Strategic options for landlords

Faced with these challenges, increasing materials costs and uncertain returns, landlords are exploring several strategies:

Landlords should focus on the biggest hit, the easiest and less disruptive energy inefficiency savings first. For example, lighting, controls, HVAC to move the EPC rating D/E to C. This is a viable stopgap measure before the EPC B requirement comes in.

In the worst cases landlords may look to dispose of assets, perhaps taking some losses on those marginal properties, marketing the properties or selling to occupiers, or looking to alternative uses before the “brown discount” really takes hold. 

Redevelopment is an option worth considering. In some cases, full redevelopment and change of commercial use and conversions from commercial-to-residential under permitted development rights may offer better prospects than retrofits.

Dealing with tenants

Navigating a major retrofit with tenants in situ will involve careful handling and cooperation from the tenants if things are not to go awry. While the energy regulations target landlords, tenants benefit and need to play a crucial role. In multi-let buildings, collaboration is essential to minimise disruption, so landlords should try to align improvement programmes with lease cycles.

The far-seeing landlords will be engaging tenants early, offering transparency on cost implications and exploring how joint funding or phased works can benefit both parties. Landlords may offer concessions such as rent-free periods or stepped rents in exchange for increased access and to compensate for disruption during work.

Where tenants directly control energy systems and repairs / maintenance under full repairing and insuring (FRI) leases there may be restricted control and influence by landlords. Landlords should seek legal advice from their solicitors to determine how best to navigate these legalities.

Is EPC B realistic?

There’s been a growing debate about whether the 2030 EPC B target is realistic given the challenges posed particularly by heritage buildings, large industrial buildings and older secondary shops and office buildings. 

Some industry bodies, including the BPF and RICS have been calling on the government to be more flexible and to recognise the “best endeavours” or partial compliance where full upgrades are structurally or economically unviable or not feasible.

Without some flexibility, thousands of commercial buildings could be condemned as unlettable and face early obsolescence. This will be particularly the case in secondary towns where rental values cannot justify major capital outlays. The end result could be premature demolition of perfectly serviceable buildings. It would undermine the aims of the sustainability regulations, the rules that were meant to advance it.

Conclusion: 

Many landlords will find themselves in a difficult position over the next few years, trying to strike the right balance between compliance with the regulations, deciding on the economic viability of upgrades or other options, and maintaining good relations with tenants.

The drive to more efficient buildings is necessary and inevitable, but the present tight schedule imposes a heavy cost on many commercial building owners, and in particular small-scale investors. In some cases, the burden may be unsustainable without broader and more substantial financial support.

As the 2030 deadline approaches, every landlord should be looking now to survey their buildings to assess their upgrade costs. They also need to start opening conversations with tenants and their lenders. Waiting until the new rules hit could be a costly mistake.

References:

Non-domestic private rented property: minimum energy efficiency standard - landlord guidance

The Non-Domestic Private Rented Property Minimum Standard

Energy Performance Certificates for your business premises

Department for Energy Security and Net Zero (DESNZ), “Minimum Energy Efficiency Standards for Non-Domestic Property,” consultation updates, 2024.