In April 2023, The Law Society issued Guidance on Climate Change for Solicitors (you can read our article on this here) which aimed to offer guidance to solicitors, particularly those advising real estate clients, on ’climate-related risks’ and the steps solicitors should be taking to advise their clients.
But what are these risks arising from climate change, and how can they affect your property and the value of your investment?
The Law Society Guidance splits climate-related risks into three types:-
- physical risks for example, flooding or coastal erosion;
- transition risks for example, changes required to meet the Net Zero target;and
- liability risks the risk of not advising a purchaser of a physical and/or transition risk.
This article will focus on physical and transition risks, with some useful examples and considerations for both property owners/investors and professional advisors.
Climate change is having an impact on our planet – warming our oceans and changing our weather – with more extreme weather events such as storms, floods, droughts, and heatwaves expected as a result. These events have the potential to impact an area’s natural and built environments. Properties in areas which were previously not prone to flooding may now be classed as high risk for flooding or on a (new or extended) flood plain.
Any of these events could have a significant impact on the cost and availability of insurance and mortgage finance, the saleability of the property, and reduce the value of the property. The impact could be prolonged and recurring.
Business operations could be affected, using flooding as an example the obvious risk is the property and/or business assets being damaged making the property unusable or the business assets (such as stock, machinery, or equipment) not fit for purpose. Beyond the property itself, flooding could also restrict or prevent access to the property (employees/customers/deliveries) or the area, adversely affect key business needs such as telecommunications. As a consequence, property owners/investors would need to deal with the inconvenience, cost and stress of insurance claims.
Considerations for property purchasers/investors and professional advisors as to physical risks:-
- The impact of physical events on property owners’ businesses, for example on a property acquisition. Consider the supply chain, outputs and financing
- How any physical risk could have an impact on emission reduction targets, and how the property may be adapted to meet, for example, sustainability targets
- Agricultural property affected by these physical risks could experience reduced output, for example, loss of buildings to store livestock.
As we know, the Government has set a target for the country to reach ‘Net Zero’ on all greenhouse gases by 2050. It proposes to ban the sale of new petrol and diesel cars from 2030 and, with buildings being responsible for almost 40% of the UK’s energy consumption and carbon emissions, it has introduced a series of regulations relating to the energy efficiency of buildings.
The transition risk for property owners is to not keep up with regulations brought in to combat climate change which affect their property and their ability to sell or let the property, and, ultimately, the value of their property/investment.
Most people who have sold, rented or constructed a building will be familiar with Energy Performance Certificates (EPC): certificates which detail the energy efficiency of that building and give it an overall rating. There are various rules as to when an EPC is required but, generally speaking, for a building to fall within the requirement for an EPC, it must have a roof and walls and use energy to condition the indoor climate. The Government introduced regulations imposing minimum energy efficiency standards (MEES) for both domestic and non-domestic properties and which require a certain EPC rating and impose restrictions on a property owners’ ability to let a property where the minimum standards are not met (currently an E rating for both domestic and non-domestic properties).
Set out below is a summary of the requirements for domestic and non-domestic properties by way of an aide memoir.
Other climate-related legislation or regulations to keep up with could include:-
- Disclosure and reporting requirements and investments labels – the Financial Conduct Authority consulted on this issue as they were concerned that firms were making exaggerated or misleading sustainability-related claims about their investment products, their policy statement is due to be published in Q3 of 2023
- Greenwashing regulations – greenwashing is when companies do things that are harmful to the environment while saying they care about climate change and is a type of marketing to make products more appealing to customers who care about the environment.
- Ultra-low emission zones (ULEZ) – expanding across all London boroughs on 29 August 2023 with cost implications for property owners unable to comply with the requirements (a scrappage scheme is in place)
- Advertising and marketing standards – Ryanair’s claim that their airline had the lowest emissions in Europe was banned by the Advertising Standards Agency
Property owners would be wise to go further than to simply ‘keep up’ with the current regulations and to keep an eye to future changes, such as further MEES regulations, and be ahead of the game. Using energy efficiency of buildings as an example, property owners would do well do educate themselves on what energy efficiency improvements can be made to a property to increase its EPC rating now and proactively implement the improvements. The work required to improve an EPC rating can be as simple as installing the right lighting, or even researching the construction of the property to give as much detail to the EPC assessor as possible.
Whilst climate change has been a current issue for some time now, its affects are still becoming known and the Government and organisations like The Law Society are releasing more and more climate-specific guidance. Property owners must keep themselves appraised of new guidance and regulations, as well as the climate related risks which could affect their property.
When acquiring a property, purchasers should consider not only the physical risks which could impact their investment but the transitional risks, both now and in the future.
For example, is the property they are purchasing capable of being improved to have a higher EPC rating (a rating of C will be required from 2027) and at what cost? Is the cost proportionate to the purchase price of the property? If not, what is the potential impact on the value of their investment?
Professional advice should be sought at an early stage.
Summary of MEES requirements
The Domestic MEES Regulations set a minimum energy efficiency level for domestic private rented properties and apply to all such properties that are:
- let on an assured tenancy (for example an Assured Shorthold Tenancy (AST) (which most tenancies will be), a regulated tenancy or a domestic agricultural tenancy; and
- legally required to have an EPC (if it has been marketed for sale or let or modified within the last ten years).
Since 1 April 2020, a property covered by the MEES Regulations can only be let or continue to be let if it has an EPC rating of E or above (unless a valid exemption is in place). To let a property with an EPC rating of F or G (without a valid exemption) is now unlawful.
There are a number of exemptions to these requirements – for more information click here. Two exemptions are:-
- ‘all relevant improvements made’ exemption. If no improvements can be made to the property or the property is still below the EPC rating E after improvements have been made to the cost cap of £3,500 (including VAT);
- no improvements can be made to the property because the cost of installing even the cheapest recommended measure would exceed the £3,500 (including VAT) cost cap.
The MEES Regulations are stricter for non-domestic properties, with fewer exemptions available and an obvious expectation for non-domestic property owners to invest in their property – with no cost cap.
They were also introduced earlier. On 1 April 2018, a landlord of a non-domestic rented properties could only grant a new tenancy, or to extend or renew an existing tenancy, if their property had at least an E rating (unless they had registered a valid exemption).
However, the regulations have been tightened further and since 1 April 2023 all non-domestic landlords must obtain at least an E rating for their property, even when there has been no change in tenancy. Therefore, to continue to let a property with an EPC rating of F or G (without a valid exemption) is unlawful.
These regulations will be tightened further in the future, with the Government paying close attention to non-domestic properties in their fight to reach Net Zero within the next 25 years. Under proposals within the Government’s UK Energy White Paper, all non-domestic properties will need to benefit from at least a C rating before they can be let from April 2027, and at least a B rating from 1 April 2030.
For a full list of the exemptions click here. Two of these exemptions are:-
- ‘7 year payback’ exemption. Where a recommended measure is not a ‘relevant energy efficiency improvement’ because the cost of purchasing and installing it does not meet the 7 year payback test. Where the expected value of savings on energy bills that the measure (or package of measures) is expected to achieve over a period of 7 years are less than the cost of repaying it, the test will fail and this exemption may be available;
- ‘all relevant energy efficiency improvements made’. Where a landlord has made all the relevant energy efficiency improvements that can be made (or there are none that can be made), and the property continues to have an F or G rating