Real Estate Visions 2022: The real estate race to net zero

Real Estate Visions 2022: The real estate race to net zero.

The real estate race to net zero

The UK Government has committed to reaching net zero carbon by 2050. Towards the end of last year, in the run up to COP26, it published several documents including the Net Zero Strategy, the Energy White Paper and the Heat and Buildings Strategy. These contain details of the measures the government intends to introduce to help meet the net zero target. With buildings accounting for nearly a quarter of UK greenhouse gas emissions, it is not surprising that a major focus of the government’s strategy is on decarbonising the built environment.

Broadly seen as being slow to adapt to the environmental agenda in the past, no part of the real estate sector will be left untouched by the government’s current intentions. Below, we explore some of the key measures that will impact landlords, occupiers, developers and lenders both now and in the longer term; and the role the sector can play to help meet the ambitious 2050 target.

Heat and Buildings Strategy

The Heat and Buildings Strategy recognises that virtually all heat in buildings (commercial and residential) will need to be decarbonised if the net zero goals are to be met. The strategy focuses on delivering a decarbonised power system by 2035. To achieve this, the strategy strongly favours the use of electric heat pumps. Gas boilers will be banned from new builds by 2025 and new gas boilers will no longer be available for sale by 2035. A decision on the use of hydrogen gas in heating systems has been delayed until 2026.

Sustainability is at the heart of new build construction so developers must take heed. Under new regulations in force from June 2022, carbon emissions from new build homes must be approximately 30% lower than current standards and emissions from other new buildings, such as shops and offices, must be reduced by 27%. London based developers will already be aware that the London Plan holds them to an even higher standard. New developments must therefore include modern heating systems, smart meters and energy storage in order to help reach the government’s targets.

The challenge of retrofitting new heating systems into older buildings is a separate issue. Building improvements are labour-intensive and involve highly skilled jobs, so will be costly for investors and landlords. However, decarbonisation measures do result in lower operating costs, in particular where heating and cooling are concerned, so ultimately retrofitted buildings should be attractive to tenants and command higher rents.

Minimum Energy Efficiency Standard (MEES) for leases

Building owners will be aware that since 2018 (subject to certain exemptions) a landlord must not grant a new lease (or renewal lease) of a commercial building without a valid EPC rating of ‘E’ or above. Failure to comply risks a fine of up to £150,000 for the landlord. From 1 April 2023, this requirement will extend, so that (again, subject to exemptions) a landlord cannot continue to let a commercial building under an existing lease unless the building has an EPC rating of ‘E’ or above (for domestic properties this rule has applied since April 2020).

The government’s ultimate intention is to raise the minimum EPC rating for domestic properties to a ‘C’ rating by 2028 and for commercial properties to a ‘B’ rating by 2030. However, some commentators believe that the proposed changes will still not deliver the results that the government hopes for and so additional regulation or removal of exemptions could be required, posing further challenges in future.

Landlords are most likely to bear the burden of MEES. The main compliance obligations fall to them and the most likely strain will be the financial burden of upgrading non-compliant assets coupled with a potential loss of income where a building is unfit to be rented. On the flip side, energy efficiency improvements may offer potential to increase rent. There may also be opportunities for investors to acquire new assets, below the minimum standard, at a reduced cost.

Lenders should also beware. Where a building does not meet MEES, the value of the lender’s security could be reduced. Indeed, where a lender takes possession following default it could become the landlord responsible for compliance with MEES. Further, government targets for lenders to improve the average energy performance certificate rating of their lending portfolio are in the pipeline. On the plus side, lenders could take advantage of the lack of government support for landlords to finance energy efficiency improvements by opening a new stream of business.

Electric vehicle charge points

The Net Zero Strategy includes a £1.5bn commitment to fund the installation of electric vehicle (EV) charge points on streets, motorways and at workplaces and homes. Given the government’s plan to end the sale of new petrol and diesel cars in the UK by 2030 and the relatively slow installation of EV charge points compared to the increasing demand for electric cars, this new investment is essential.

New regulations in force from June 2022 require new homes with on-site parking to have an EV charge point; and new non-residential buildings with over ten on-site parking spaces to have at least one charge point and cable routes for one in five spaces. Also, there are requirements for residential and non-residential buildings undergoing major renovation with on-site parking to have a certain number of EV charge points and cable routes. These regulations will make considering the installation of EV charge points unavoidable for many landowners and developers, as is already the case for many developers in the capital who are subject to the London Plan.

The installation of EV charge points at any building is expected to make it more attractive to tenants, which may result in increased rents or land value. However, landlords in particular must consider an array of factors – is planning or any other consent required for EV charge points? Who will front the initial cost of installation and is any existing electricity supply sufficient? Once installed, who will maintain the charge points? How will the electricity be recharged to tenants? Will the EV charge points impact rent reviews?

Legal drafting

Landlords, developers and lenders certainly have their work cut out over the next few years, and the legal industry is taking steps to help with this.

The Chancery Lane Project - a collaborative, non-profit network of legal professionals, with expertise across a range of sectors and industries - is developing model climate clauses for incorporation into legal documents to help organisations achieve net zero goals, including in the real estate sector. For example, the project includes a clause designed to be incorporated in a lease, to encourage landlords and tenants to re-use goods and materials where parties are under obligations to repair, alter, yield up or decorate premises.

Now is also undoubtedly the time to implement ‘green lease’ provisions. A green lease incorporates provisions encouraging all parties to reduce the environmental impact of the property being let, with the aim being to allow a property to be occupied and managed in a more environmentally friendly way and ultimately to reduce a property’s environmental footprint. There are also options if parties to an existing lease wish to ‘go green’; they can enter into a separate agreement setting out steps to improve the environmental performance of a property. The provisions which we often see used are those set out in Better Buildings Partnership’s green lease toolkit. These provisions are not new - the green lease toolkit was developed in 2013 – so they have been ‘tried and tested’ in the market to a far greater extent than the model clauses developed by the Chancery Lane Project. Given the pressure to meet the net zero target, these provisions are rapidly becoming the norm.

The challenge

The government’s net zero target and the policies that the government intends to implement to achieve this target mean that changes will be forced on developers, landlords, lenders and occupiers. In the past, the real estate sector has been slow to adapt to the demands of the environmental agenda, but like many other industries the sector has no option but to get up to speed now.