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Streamlined Energy & Carbon Reporting (SECR) – a Hillbreak perspective

May 15, 2019/in Insights /by Lucy Matchett

The UK Climate Change Act 2008 was one of the earliest comprehensive framework laws on climate change globally, setting a goal of an 80% reduction in carbon emissions (from 1990 levels) by 2050. On the advice of the Committee of Climate Change (CCC), the UK government responded by putting in place successive, five-year carbon budgets that run to 2032.

Progress was initially strong, but the CCC’s most recent report (June 2018[i]) suggests the UK is on track to miss the fourth (2023-27) and fifth carbon (2028-32) budgets. The report notes that emissions have fallen 43% since 1990, but that “progress so far has been driven by the power and waste sectors, while emissions from transport, buildings and agriculture have plateaued”.[ii]

These sectors, therefore, present an ongoing risk to missing future carbon budgets unless progressive incentives and policy changes decisively commit them to emissions reduction programmes. Indeed, emissions from the buildings sector in real terms actually increased by 1% between 2016 and 2017.[1] [iii]

The CCC recommends the building sector increases the insulation of homes (insulation rates were 95% lower in 2018 vs 2012[iv]), upgrades as many homes as possible to at least a C-rated EPC by 2035, and phases out all high-carbon fossil fuel heating. It also flags the need to widen the use of operational data for benchmarking in the public and commercial sectors and references the introduction of Streamlined Energy and Carbon Reporting Scheme (SECR) for businesses.

SECR – a burden or a blessing?

SECR, which came into effect on 1^st April 2019, is designed to simplify and align policies relating to energy efficiency. It replaces the Carbon Reduction Commitment (CRC)[2] Energy Efficiency Scheme, with a view to widening the incentive for more organisations to save energy through energy efficiency: around 2,000 companies participated in the CRC, while SECR mandates reporting for almost 12,000 companies.[v]

Acting alongside the Climate Change Levy, the SECR opens up reporting requirements to a wider group of energy consumers which, in theory, should increase transparency and shared intelligence to help drive energy efficiency across a range of sectors.

Organisations required to comply with SECR will include quoted companies, ‘large’[3] unquoted companies and ‘large’³ LLPs. The Companies (Directors’ Report) and Limited Liability Partnerships (Energy and Carbon Report) Regulations 2018, which came into force on 1 April 2019, require these organisations to include the new reporting requirements[4] either within their Directors’ Reports or, if a ‘large’ LLP, through a new Energy and Carbon Report.

Reporting requirements, which need to be addressed in the Annual Report & Accounts, include disclosure of:

energy use – electricity, natural gas, self-supplied energy and transport;
all carbon emissions;
an intensity metric (e.g. normalised against FTE, turnover, floor area etc.); and
all principal energy efficiency measures taken throughout the financial year.

Arguably, the implied ‘streamlining’ of energy and carbon reporting is a bit of a red herring. The requirements are actually rather extensive in scope.

Reporting efficiency measures marks a notable change for those previously participating in CRC or mandatory GHG reporting, particularly given that organisations must also declare publicly if no such measures have been implemented within the reporting year. The requirement to disclose whether or not action has been taken should amplify the pressure on continuous improvements being made at the source of consumption, ensuring that those benefiting from the decarbonisation of the grid, and other external factors, are also taking on the responsibility in-house to mitigate against rising carbon emissions. Given the groundswell of public attention being focused on corporate climate action, particularly by the Extinction Rebellion movement, the ultimate outcome should be progressive improvements across a range of sectors, including those yet to contribute positively to the UK’s carbon budgets. It is quite likely that financial services and related companies will be in the spotlight.

The fiscal escalator….

Another key change being brought into effect is the significant increase in the energy consumption tax – the Climate Change Levy (CCL) – which will offset the revenue lost to the Exchequer from the withdrawal of the CRC, and will sit alongside the introduction of SECR.

In contrast to previous increases of less than 3% annually, from 1^st April 2018 to 1^st April 2019 the Government raised the CCL by 45% for electricity and 67% for natural gas[vi] (see table below). Although there is no indication of plans to raise the rate further, there are strong indications that further increases will occur in future fiscal years.

This increase in the CCL is designed to continuously incentivise energy performance across a wide group of businesses and to encourage the continued substitution of gas energy for electricity, thereby reducing associated emissions. This change could prove to be a powerful driver towards improved energy efficiencies, especially for those organisations not previously captured by the CRC.

Table 1: Main rates for the CCL as of 1^st April 2019[i]

This increase could add a sizeable amount to an organisation’s annual energy bill[i]. For example, a CRC non-participant who consumes 1,000,000 kWh of electricity and 1,000,000 kWh of natural gas each year, with an energy bill of roughly £140,000 annually, could expect an additional £4,000 of CCL charges through the current CCL changes.

Will it have the desired effect?

A landmark report[ii] authored by Jon Lovell and Miles Keeping in 2014 during their time at Deloitte, on behalf of the Green Property Alliance and the Green Construction Board, found that policy instruments which have a broad impact by amplifying the price of energy consumed, or which require processes to be undertaken (such as reporting) without imposing a clear obligation for positive action, are found to be relatively ineffective. This is due to the relative inelasticity of energy demand within the commercial property sector and the lack of a direct incentive for operational implementation.

However, one must now question whether the significant hike in CCL will provide a greater degree of stimulus, particularly given stronger emphasis on the net operating income performance of UK investment property than has been the case historically. Certainly, a clearly programmed and transparent price escalator over successive fiscal years would likely make a real difference, much in the same way as the Landfill Tax did for the waste sector. Equally, in the age of Greta Thunberg, #youthstrike4climate, and the Extinction Rebellion movement, the reputational implications of greater disclosure will undoubtedly be stronger than has been the case hitherto as well.

Collectively, SECR and CCL can therefore be expected to compel a wider pool of organisations more strongly than has been the case with preceding arrangements – including building owners and their occupier customers. Implementing the requirements should be more straightforward in the context of leased property that the CRC too, which may overcome some of the disapproving sentiment that was particular apparent within the UK real estate industry.

Official estimates suggest the introduction of SECR and the changes in the CCL rate will result in energy savings of £2,856m – as well as improvements in air quality, carbon savings and a reduction in noise pollution[i]. £262m of annual bill savings are also expected as an indirect result of reporting. The actual effect of the combined new arrangements remains to be seen, of course.

Climate change is unquestionably one of the most urgent and intractable issues currently facing the world, presenting an ongoing and increasing risk to communities, investments and businesses globally. With the scale of change required – particularly within the built environment and other sectors yet to contribute to the UK carbon budgets – SECR and CCL feel like progressive sticks to get the market moving in the right direction towards a low, perhaps even zero, carbon economy by 2050.

References:

[1] Accounting for adjustments relating to annual winter temperature increases.

[2] A levy on those companies with at least one settled half hourly electricity meter (sHHM) and used 6,000 megawatt hours or more of qualifying electricity supplied through settled half hourly meters.

[3] Large is defined as having two or more of the following: >£36m turnover; >18m balance sheet; >250 employees.

[4] All starting on their first financial year on or after 1 April 2019

[i] Committee on Climate Change (June 2018) Reducing UK emissions, 2018 Progress Report to Parliament. Accessed 30/04/19 https://www.theccc.org.uk/wp-content/uploads/2018/06/CCC-2018-Progress-Report-to-Parliament.pdf

[ii] Carbon Brief (28^th June 2018) ‘Worrying trend’ in UK emission cuts beyond power and waste, says CCC. Accessed 30/04/19 https://www.carbonbrief.org/worrying-trend-uk-emission-cuts-beyond-power-waste-says-ccc

[iii] Committee on Climate Change (June 2018) Reducing UK emissions, 2018 Progress Report to Parliament. Accessed 30/04/19 https://www.theccc.org.uk/wp-content/uploads/2018/06/CCC-2018-Progress-Report-to-Parliament.pdf

[iv] Committee on Climate Change (June 2018) Reducing UK emissions, 2018 Progress Report to Parliament. Accessed 30/04/19 https://www.theccc.org.uk/wp-content/uploads/2018/06/CCC-2018-Progress-Report-to-Parliament.pdf

[v] Ecoact (6^th February 2019) Ten things you should know about the new energy and carbon reporting regulations. Accessed 30/04/19 https://eco-act.com/2019/02/ten-things-you-should-know-about-the-new-energy-and-carbon-reporting-regulations/

[vi] Carbon Credentials (13^th September 2018) Impact of Changing CCL rates. Accessed 30/04/19 https://carboncredentials.com/impact-of-changing-ccl-rates/

[i] Department for Business, Energy & Industrial Strategy (18^th July 2018). Streamlined energy and carbon reporting framework. Accessed 30/04/19 https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/725912/SECR_and_CRC_Final_IA__1_.pdf

[i] Carbon Credentials (13^th September 2018) Impact of Changing CCL rates. Accessed 30/04/19 https://carboncredentials.com/impact-of-changing-ccl-rates/

[ii] Deloitte (March 2014) Carbon Penalties & Incentives. Accessed 11/05/19 https://www2.deloitte.com/uk/en/pages/real-estate/articles/carbon-penalties-and-incentives-report.html

The trouble with Science Based Targets

May 9, 2018/in Insights /by Jon Lovell

Background

Formally-approved Science Based Targets (SBTs) are a scheme of the Science Based Targets Initiative (SBTi), a venture of the UN Global Compact, CDP, World Resources Institute and WWF. They have been gaining much attention and some traction amongst corporates and institutional investors; at the time of writing, 105 companies have in place targets formally approved by the SBTi.

In essence, these are targets adopted by companies to reduce emissions proportionately in line with the level of decarbonisation required to meet the <2^oC global warming goal of the Paris Agreement on Climate Change.

Certainly, SBTs have useful application at a macro or portfolio level. For example, they can be a tool for policy-makers to establish future carbon budgets and related policy instruments for individual economic sectors, or they can assist investors in setting climate mitigation goals across their respective investment universes. However, a principal benefit often cited of SBTs is that they provide evidence-based pathways against which to pin the carbon reduction strategies of individual entities, including within sector-specific contexts. This, we challenge.

Whilst SBTs have their place, including a welcome shift in thinking towards corporate climate action being proportional to associated global impacts, we question their role and utility at the individual entity level in the absence of sector-wide agreements to meet the necessary pathways.

Indeed, rather than being a force for rapid progress on the urgent need to mitigate climate change, they may actually have an unintended and dangerous dampening effect on the rate and extent to which individual companies – and sectors – achieve their full carbon reduction potential.

Of the various methodologies recognised by the SBTi, the Sectoral Decarbonisation Approach (SDA) is the most applicable to real estate organisations, with a normalisation approach based on floor area and a carbon intensity pathway of 55 percent by 2050 from a 2010 baseline.

Driven by perceived or directly expressed investor requirements, a number of real estate organisations have established formal SBTs to demonstrate their commitment to the <2^oC goal of the Paris Agreement. They have, understandably, received plaudits and achieved enhanced brand profile for taking an early stance in line with their market leadership on responsible property investment.

A race to the bottom

Aside from certain methodological limitations (including, in particular, on the question of how best to deal with Scope 3 emissions in a real estate context), we have a more fundamental concern with SBT-compliance being assumed by the industry as a badge of leadership for responsible investment when the SDA pathways represent the average level of decarbonisation needed of individual sectors. If organisations at the front of the ESG agenda are adopting targets based on the global sector average, the chances of those sector pathways being realised – and the goals of the Paris Agreement as a consequence – become very remote indeed.

There will be many real estate organisations with portfolios centred on advanced jurisdictions, such as the UK, where very little or no real action will be required of them, either because the continued decarbonisation of the grid will essentially do the job of achieving SBT-compliant trajectories for them, or arrangements can be made to purchase 100% of electricity from renewable sources at rates competitive with brown electricity. Worse than that, the efficiency of portfolios could actually regress, and an SBT could still be realised. There may also be unintended consequences relating to technology selection.

A problem amplified

In addition to specific investor requirements, the rationale for establishing SBTs at a house or entity level has been amplified by their positive recognition in the latest assessment framework of the Global Real Estate Sustainability Benchmark (GRESB), the most widely utilised portfolio-level barometer of attendance to ESG issues for the industry. By attaching ‘points’ to compliance, GRESB participants will have an added incentive to pursue formal SBT accreditation. Recognition is similar in the latest edition of the CDP Climate Change Module.

It means that schemes such as GRESB and CDP will be of limited effectiveness in driving the necessary sector-wide performance because they will be rewarding participants for setting out to achieve what should be considered a floor-level trajectory. In those cases where entities can rely entirely on grid decarbonisation in the jurisdictions in which they operate, this amounts to nothing more than recognising and rewarding an administrative process, albeit one that has involved a good deal of technical work undertaken in good faith by those wishing to demonstrate leadership. Perhaps this does warrant some time-limited credit, but the impact of true portfolio performance indicators on industry benchmark positions will be diluted in the meantime.

A better approach for investors

Investors that recognise the risks of climate change to capital market stability and investment performance, are, quite rightly, motivated to use their engagement activities with investee funds and companies as a means of positive influence to help drive decarbonisation. Requiring or encouraging the adoption of SBTs by those entities in which they are invested is, therefore, a seemingly obvious responsible investment tool. Interestingly, their widespread application across the asset classes may actually help to reinforce the merits of increasing capital allocations to real estate as part of comprehensive portfolio decarbonisation strategies.

However, we contend that, especially in mature markets, investors should not treat SBT compliance by individual entities as a marque of responsibility. Instead, they could aim to move towards science-based targets being a ‘lowest common denominator’ indicator for their allocations, complemented by stipulating clearer requirements on real estate companies and funds to demonstrate how, and by when, they will achieve (net) zero carbon status.

Towards net zero

In the meantime, and depending on case-by-case circumstances, we will continue to recommend and support our real estate clients’ efforts to pursue SBT compliance because of the increasingly clear demands for them to do so by investors and analysts. We will do this, however, with full acknowledgement of the limitations of the SBT approach, and will typically be encouraging greater emphasis on total decarbonisation pathways as part of a positive investor engagement and climate risk management journey.

This article was authored jointly by Jon Lovell, Co-Founder & Director of Hillbreak, and Dave Worthington, Managing Director of Verco.

Potential £10bn rental bombshell just twelve months away

April 14, 2017/in News /by Jon Lovell

London – Friday 14 April 2017

Potential £10bn rental bombshell just twelve months away in buildings failing green standards

Research on the impact of new green standards has estimated the value of failing commercial property in England and Wales could be as much as £10bn in annual rents.

The estimate is based on data included in a major new report by global advisory, broking and solutions company Willis Towers Watson, which calls for radical policy measures to green the UK’s building stock.

Willis Towers Watson – Real Estate Climate Risk Report 2017

The report, to which Hillbreak was a principal contributor, contains research by big data firm DealX showing that nearly a fifth of commercial properties in England and Wales are currently failing the Minimum energy efficiency standards (MEES) due to come into force from April next year.

The research has found over 115,000 commercial buildings – 17.5 percent of those rated – in England and Wales have Energy Performance Certificates (EPC) rated F or G. Landlords will be forbidden from re-letting commercial buildings with EPCs below E from next April.

Analysis of the figures by property consultancy Daniel Watney LLP based on the EPC data and the new business rates valuations estimates that the equivalent annual rental value of F or G-rated commercial buildings could be as much as £10bn. Figures released by the Investment Property Forum last year estimated the annual 2015 value of UK commercial property rents to be £55bn.

The Willis Towers Watson Real Estate Climate Risk Report brings together major listed firms and high street names including British Land, Land Securities, Lendlease, NatWest and the John Lewis Partnership to examine how to best bring property up to standard and help the UK meet the targets enshrined in the Paris Agreement, the world’s

The listed firms say that while they can leverage their economies of scale and the latest technology to achieve substantial energy efficiency gains, the key challenge will be to get smaller businesses to green their buildings.

Recommendations in the report for greening real estate include:

Government funding for a mass retrofitting programme
Ratcheting up the minimum energy efficiency standard to an EPC D rating by 2020
The industry-wide adoption of Display Energy Certificates
Potentially combining DECs with science-based targets in future legislation to drive ongoing emissions reductions

The report also details the potential harm to real estate if action is not taken to limit climate risk, proposing tougher stress testing and increased translation of climate risk to balance sheets. Many firms are not adequately insured against extreme weather events, as seen in the wake of the UK’s 2015/16 winter floods, which caused £600m in uninsured damage.

Paul Chetwynd-Talbot, managing director of the real estate practice at Willis Towers Watson, said:

“Buildings create 40% of carbon emissions and the fact than one in five properties are falling short of standards is worrying. Investors – many of whom are pension funds – increasingly recognise the risks associated with climate change. But we need to see more affirmative action from Government to help retrofit older buildings and drive forward take up of renewable energy.”

Miles Keeping, co-founder and director of sustainability consultancy Hillbreak, said:

“It is of course impossible to identify the precise value of the total rents at risk due to MEES. But relying on rateable value data gives us a very tangible sense of the money landlords are putting at risk if they do not attend to their EPC-related risks appropriately and very soon.”

Martin Siegert, co-director of the Grantham Institute for Climate Change and the Environment at Imperial College London, said:

“The need to decarbonise our economy is critical. It is going to be a profound change: the developed world will need to have no net carbon emissions by 2050. Ending emissions from our electricity system, manufacturing, transport and supply chains will be challenging enough for our larger companies, but we will need all of our smaller companies to achieve this too.”

Sarah Cary, head of sustainable places at British Land, said:

“Retrofitting old buildings on a mass scale requires a far more complex solution than simple tax incentives to replace boilers or windows. Retrofitting should be set as a priority for a national infrastructure programme.

“The benefits would be twofold: it would be a boon for job creation, and it would work wonders in helping reach energy goals.”

Paul King, managing director of sustainability at Lendlease Europe, said:

“We need to make sustainability easier for everyone to engage with – both in terms of consumers and companies. An industry-wide agreement to have LCD screens on the front of every building showing real-time energy use would be more than welcome. Just as with the example of energy labelling on white goods, while it may not directly cause many consumers to switch from one business to another, the incentive to a CEO to avoid having a negative label compared with a competitor could generate real results in driving businesses to retrofit their buildings.”

Caroline Hill, head of sustainability at Land Securities, said:

“Changes in technology and the ability to access growing pools of data have allowed us to set increasingly ambitious commitments to reduce both energy intensity and emissions by 40% per square metre by 2030. If more leading businesses agreed to using 100% renewable power, this could provoke a serious step-change in how society approaches the challenges we face.

“Giving property owners a hard stop deadline to improve buildings or lose the right to rent them out has clearly had some positive effect. Ratcheting MEES so all buildings must be at least D grade by 2020 would provide the impetus for inefficient buildings to get the investment they need.”

Andrew McAllan, managing director of Oxford Properties Group and chairman of the Canadian Green Building Council, said:

“Most ‘Tier 1’ companies – those with the greatest capital reserves and profits – are by and large already taking the necessary action on making their buildings greener and making more efficient use of energy. It’s that next level down of ‘Tier 2’ companies that need engaging and support. Mandatory reporting of energy consumption would be useful: what gets measured gets managed.

“The best sustainability strategies are built on a foundation of good data, and there are ways of bringing in these measures without making them onerous for smaller businesses. Once you have that compulsory recording in place, smaller businesses then see the easy efficiencies they can make on their utility costs. Combined with something like carbon pricing to add impetus to the need to invest in more efficient installations, that is how we can effect the change we need.”

Richard Garner, head of commercial agency at property consultancy Daniel Watney LLP, said:

“As our research into the value of England and Wales’ F and G rated buildings shows, many investors in commercial property face a ticking timebomb with their properties being potentially unlettable from April next year – this is particularly the case in the office hotspots of Westminster, Kensington and the City, which have commercial space with a collective annual rental estimate of nearly £800m currently not up to standard.

All the evidence demonstrates that adding sustainable features to offices adds value and drives worker productivity and satisfaction, advantages that will serve landlords well over the long term.”

Jon Lovell, co-founder and director at sustainability consultancy Hillbreak, said:

“It is important that that the government clarifies some of the glaring gaps in the confusing regulations. Many large fund managers and REITs are on top of them, but we have a real concern for the long tail of smaller landlords, businesses and family trusts, who own a disproportionate amount of F&G rated properties and will suffer if they don’t get their acts together very quickly.”

— ENDS —

Contributors to the Willis Towers Watson Real Estate Climate Risk Report 2017 included Hillbreak, British Land, Land Securities, Lend Lease, Oxford Properties, John Lewis Partnership, Nattiest, Hermes Investment Management, Blackstock, Grantham Institute for Climate Change & the Environment and DealX.

For more information, please contact Blackstock Consulting / Tyron Wilson / tyron@blackstockpr.com / 07725 197364

Notes for editors

Daniel Watney LLP is not a contributor to the report, but their research on the value of F + G-rated property is based on the DealX data within the report. The rental estimates are based on the latest rateable values used to calculate business rates, calculated using the average rateable value in each local authority and the number of F + G-rated buildings in each district.

About Willis Towers Watson

Willis Towers Watson (NASDAQ: WLTW) is a leading global advisory, broking and solutions company that helps clients around the world turn risk into a path for growth. With roots dating to 1828, Willis Towers Watson has 40,000 employees serving more than 140 countries. We design and deliver solutions that manage risk, optimize benefits, cultivate talent, and expand the power of capital to protect and strengthen institutions and individuals. Our unique perspective allows us to see the critical intersections between talent, assets and ideas – the dynamic formula that drives business performance. Together, we unlock potential. Learn more at willistowerswatson.com.

About Hillbreak

Hillbreak is a unique training and advisory firm that helps organisations seeking competitive advantage in a changing urban world. Its mission is to expedite the transition to a sustainable policy, business and investment environment by bringing intelligence, challenge and inspiration to its clients and stakeholders. Please visit hillbreak.com for further information or follow us on Twitter, Facebook, and LinkedIn.

Hillbreak verdict on Government “MEES” guidance

March 3, 2017/in Insights /by Miles Keeping

The Government recently published its guidance to landlords on Minimum Energy Efficiency Standards for non-domestic property, a matter on which much confusion and uncertainty has prevailed. So, have the outstanding issues now been resolved, or do material unknowns continue to cast a headache for the real estate industry? Miles Keeping, who chaired the succession of commercial property groups which advised Government on the regulations, provides his comprehensive take on the new guidance.

Brief background

The Energy Act 2011 (the Act) introduced the concept of MEES in England & Wales. As we know, this introduced a timetable to make unlawful the letting of privately rented property which failed to meet a minimum energy standard of efficiency. In its wisdom, the government decided that energy efficiency should be measured by virtue of an Energy Performance Certificate (EPC) rating, and the minimum standard would be an E (on a scale of A (most efficient) to G). The timetable is:

1^st April 2018 New non-domestic leases and lease renewals
1^st April 2020 All residential privately rented properties
1^st April 2023 All existing non-domestic leases

New guidance was issued by the government on 23^rd February 2017.

Uncertainty & doubt

At the time of the publication of the Act, there was a deal of uncertainty as to whether subsequent regulations would actually be enacted – that it would all be too difficult to organise and that the necessary political will would fall away in response to business opposition. Indeed, at the time, there was seemingly a lot that needed to be arranged if regulations were to be forthcoming. The then Department for Energy & Climate Change (DECC) reached out to the commercial and residential property sectors to ask how best to frame the regulations. I was asked the chair the commercial property group and, with significant support from Patrick Brown at the British Property Federation, populated the group with a range of environmental, commercial, legal and technical specialists. The group worked hard, efficiently and openly to support DECC officials.

The regulations (inconveniently named the “Energy Efficiency (Private Rented Property) (England and Wales) Regulations 2015”) arrived and, barring certain issues, were a decent attempt to incorporate a balance of policy intention and commercial practicality. What was clear, however, was that guidance was certainly required in order to put some flesh on the bone in terms of how the regulations should be applied – to get Rumsfeld about it, there were definitely some unknowns, both known and unknown. Some of those concerns related to factors such as how the regulations might apply with regard to Listed Buildings, buildings with whole or partial EPCs and where voluntary EPCs had been registered. There was also confusion as to how MEES might be affected by other law, e.g. the 1954 Landlord & Tenant Act and would MEES apply to licences or just leases?

The commercial property sector reached out to government and offered to pen some guidance. I again chaired the working group which delivered draft guidance to government, after which there was a long hiatus that inevitably refuelled the doubters into voicing opinions that the regulations wouldn’t be implemented. And then, last week, the guidance was published unheralded.

So what does this new guidance tell us that we didn’t already know?

Perhaps the key question to ask is whether the guidance addresses the known unknowns? Well, it does a bit. Let’s have a look at issues settled by the guidance… and where some confusion still exists…

First to remember is that the guidance only covers the non-domestic property regulations; we’ll have to wait for the residential counterpart. Secondly, it only covers England & Wales, Scotland’s s.63 Regulations and Northern Ireland’s 2014 Energy Efficiency Regulations being quite different kettles of fishes.

“Sub-standard property”

The guidance sets out its stall early on by noting that a property which fails to meet MEES is to be known as “sub-standard property”. A small point perhaps, but it’s a phrase which would no doubt stick in the craw of most letting agents; how many landlords would want to go to market with sub-standard properties?

MEES relies on EPCs

Yes, I know you know that, but what some still perhaps don’t appreciate is that MEES only apply to properties where a valid EPC is in place for the property in question and that this has implications in the following situations:

Voluntary EPCs: Some buildings have EPCs which were commissioned for general asset management purposes (i.e. were not procured because they were legally required such as for a letting of a property). The guidance states that in such circumstances, the existence of a voluntary EPC will not trigger a MEES compliance requirement. Clearly, this will only be relevant at the 2023 trigger date.
Where whole building EPCs exist but only part of a building is being let: Some buildings, e.g. shopping centres, have EPCs to cover the whole asset as well as for individual units. In such cases, the guidance states that where a whole building EPC exists, only the property being let (e.g. a retail unit in a shopping centre) needs to be improved.
Listed Buildings: The guidance notes that there is a misconception that listed buildings or those in a conservation area do not require EPCs, because they do unless energy efficiency improvements would unacceptably alter their special character. This is a significant issue and many landlords have chosen to ignore MEES in listed buildings – more about this below.

MEES applies to lettings

I know you know that too, but what constitutes a letting? The guidance is both clear and unhelpful when it states: “the PRS Regulations only apply to properties which are let under a tenancy, non-domestic properties which are occupied under other arrangements, for example properties let on licence, or ‘agreement for lease’ arrangements, are unlikely to be required to meet the minimum standard”. “Unlikely”… What makes it “unlikely”? We need to know whether marketing a property for occupation under a licence would trigger MEES or not? I think we can take it that licences are out of scope of MEES. But what about tenancies at will, for example? Again, our discussions with legal specialists suggest that these would also be out of scope, but a more definitive line from government on such matters would be welcome.

Other exemptions

Other exemptions from MEES exist and it had been thought that an exemption of any nature could negate any need to comply with MEES. The guidance carefully explains that this is not the case – a thread running through various of the exemption categories is that exemptions must be considered as individual issues, rather than in blanket terms. For example, if a suggested improvement measure to a building would have the effect of devaluing the property sufficiently to trigger that exemption, other measures which would not have that effect would have to be undertaken (provided no other exemption applied). Whilst we’re on devaluation, the guidance makes it clear that claiming devaluation will be a rarity.

Another exemption exists when legally required third party consent to undertake improvements cannot be received, such as from a planning authority, superior landlord or tenant; some leases require landlords to obtain a tenant’s consent to undertake improvements within their demise. In such circumstances, the guidance states that landlords must “make, and be able to demonstrate to enforcement authorities on request, ‘reasonable effort’ to seek consent” and thereafter register the exemption in that they “could not carry out the proposed improvements without the consent of the tenant or tenants of the property, and one or more of the tenants refused to give consent”.

Such an exemption would only be temporary, lasting for up to five years or until a tenancy change enabled a new tenant to be approached regarding the improvement. A question which landlords would need to ask themselves is whether the lease provides for them to be able to enter the property to make improvements – presumably, if so, such an exemption would be negated.

Part 2 of the Landlord & Tenant Act 1954 provides security of tenure provisions to tenants at lease end. The guidance is clear that sub-standard property status does not provide a complete exemption from MEES in such circumstances but does allow for a six months exemption from renewal for necessary works to be undertaken. Equally, landlords cannot refuse a renewal nor tenants prematurely terminate a lease because the property is sub-standard.

Landlords and tenants seeking to let or sublet sub-standard properties will need to be aware that whilst any measures which fail the seven year affordability payback test will not need to be undertaken (but registered as such, with three quotes from suppliers and calculations which prove that point) but any measures which do meet the affordability test will have to be undertaken. In other words, one expensive measure does not negate the need to undertake cheaper measures, so landlords will need to ensure they check all potential measures included in their energy assessor’s reports. Furthermore, assessors may suggest that measures which individually fail the affordability test be packaged together such that they then pass the affordability test. However, landlords are not required to install packages if they opt to install a discrete measure instead.

Registration of exemptions

All exemptions must be registered on the publicly available PRS exemptions register – importantly, this must be undertaken prior to an exemption being relied upon. It is also worth noting that should an affordability exemption be relied upon, its registration must be made before any price changes (e.g. in energy or potential improvement measures) have the effect of making potential measures affordable.

Those registering exemptions will need to provide evidence to support their view that an exemption is appropriate and in some cases this might be quite extensive. For example, exemption from undertaking potential measures because they would fail the seven-year payback affordability test will require the submission of a spreadsheet of calculations for all suggested measures and quotations from three suppliers/installers with cost information to support the exemption case.

So where are we now?

The new guidance does give us some clarity relating to how MEES will need to be implemented but it also throws up some new uncertainty. I feel certain, for example, that landlords with listed buildings will be rightly unsettled by the guidance which reminds us of the poorly drafted EPC regulation: It’s a nonsense, impractical and open to differing interpretations. I’m also sure that the uncertainty in the guidance about licences being “unlikely” to be required to meet MEES will delight the legal profession but not landlords and tenants. There will no doubt be some confusion about which EPCs might be considered as “voluntary” and those relying on exemptions will perhaps be surprised by the amount of work which will have to be undertaken for these to be able to be relied upon.

What should landlords be doing?

Example of a Hillbreak dashboard highlighting F&G rated properties within an investment portfolio

As in most circumstances where there is uncertainty or doubt, landlords facing the prospect of MEES will be best placed if they can reduce the potential impact of uncertainties. In this regard, ensuring that they have as much relevant information as possible will be vital and to do that, landlords must review their portfolios with a view to understanding where there MEES risks lie at individual asset level. Having high quality information is vital, as is drawing upon sufficient expertise to undertake risk-based thinking which accounts for EPC data in the context of factors such as rental income at risk due to lease events, lease types and provisions as well as forthcoming asset management activities. Savvy landlords will also review their leases to better understand how they can provide protection of rental income from MEES risks.

Final thoughts

The MEES regulations rely upon EPCs which are not an ideal basis for such regulations given their all-too-frequent inadequacies. The blame for this can be spread far and wide but should in part land on those who procured EPCs very cheaply and got sub-standard results – they are now reaping what they sowed. There is a role for landlords, the property industry generally and for government in dealing with inevitable mess:

Landlords must attend to the risks in their portfolios by procuring high quality advice and data reviews;
the property industry, principally professional and accreditation bodies, must ensure that EPC provision improves radically and quickly; and
the government must clarify outstanding and confusing issues with competent guidance, keeping an eagle eye on how MEES is rolled out.

Listed Real Estate lags on CRC emissions reduction

December 21, 2016/in Insights, News /by Jon Lovell

Introduction

The Environment Agency, the administrator of the UK Government’s CRC Energy Efficiency Scheme (“the Scheme”), has published its Annual Report Publication (ARP) covering the first 2 Compliance Years of Phase 2 of the Scheme. Hillbreak has analysed a selection of the data with a particular focus on real estate sector participants, especially those in the listed sub-sectors.

Key findings

Listed real estate companies are underperforming the wider economy when it comes to reducing carbon emissions. Whilst all participants in the Scheme yielded an average reduction in their emissions of 9.7% last year, the average reduction across listed real estate participants was only 0.48%.
Although the energy consumption data of each participant has not been published, it can be deduced that energy procured by listed real estate companies (a proportion of which may have been supplied to tenants) increased over the two Compliance Years, with all of the carbon reduction realised by the companies arising from improvements in the emissions factors attributed to grid electricity and natural gas.
Analysis undertaken by Hillbreak also shows wide variations in both the year-on-year carbon performance of listed property vehicles, as well as in their relative carbon intensity by market capitalisation.
The Exchequer generated a little under £1bn of total revenue from the sale of allowances in the 2015/16 Compliance Year, of which over £5.2m* came from the 18 listed real estate companies that are participants in Phase 2 (an average of £290,760 per organisation).

*Based on a blended allowance price of £16.25 per tonne of CO₂.

Emissions trends

The chart below shows the absolute CRC emissions for each of the listed real estate companies that are participants in Phase 2 of the Scheme. It shows that emissions vary significantly between individual companies within each of the sub-sectors. This is unsurprising given differences in the scale and composition of their respective portfolios.

The change in emissions reported between the two Phase 2 compliance years is more revealing, as the graph below indicates. It shows an increase of nearly 50% at one end of the spectrum (a REIT with a heavy weighting towards central London offices) to a reduction of nearly 20% at the other (a REIT with a diversified portfolio, focused on London and the South East). The average level of reduction was only 0.48%, compared to an average across all CRC participants (in all sectors of the economy) of nearly 10%.

Carbon Intensity

The market capitalisation of the listed real estate companies varied significantly at the end of the 2015/16 Compliance Year (30 March 2016), from the largest at £8.729bn to the smallest at a little under one quarter of a billion pounds.

The variance in the carbon intensity (relating specifically to CRC emissions) is also very wide. There are five companies with a CRC carbon intensity of less than 5 tCO₂ per £1m of capitalisation value, whereas the most carbon intensive shows over 35 tCO₂ per £1m of value. The mean average is ~10 tCO₂ per £1m.

Note of caution

Whilst these trends are interesting and noteworthy, caution should be applied to drawing conclusions about the energy and carbon performance of individual entities based solely on CRC data. This is because variations in energy consumption can be influenced by a wide range of factors, many of which are likely to be outside of a landlord’s control or reasonable influence. Key examples include the impact of portfolio churn (both the buying and selling of buildings and changes to the occupational profile), and changes in energy consumption by tenants who may be procuring the energy from their landlord (and which falls into the landlord’s CRC reporting boundary).

However, responsible shareholders in the entities showing the most significant changes in year-on-year emissions, and indeed those with a particularly high carbon intensity relative to market capitalisation, may be minded to investigate the underlying causes of these performance characteristics further.

It is also important to note that CRC emissions, which are limited to those associated with the majority of the electricity and gas procured by an organisation, do not represent the total footprint of greenhouse gas emissions for an entity. Amendments to the Companies Act 2006 also require UK quoted companies to report GHG emissions in their Directors’ Reports and these should be referred to by analysts seeking a more comprehensive view of the carbon intensity of their, or their clients’, investments.

The full Hillbreak dashboard CRC Emissions of Listed Real Estate is available to view and download by clicking on the image below.

CRC Emissions Of Listed Real Estate

Concerns with s63 Energy Regulations for Scotland

September 16, 2016/in Insights /by Jon Lovell

The Assessment of Energy Performance of Non-Domestic Buildings (Scotland) Regulations 2016 (“the s63 Regulations”) came into effect on 1 September 2016.

These are effectively the Scottish Government’s alternative to the ‘Minimum Energy Efficiency Standards’ (MEES) which are due to come into effect in England & Wales in 2018. In similar vein to MEES, the s63 Regulations pose investment management considerations at the point of acquisition, throughout the leasing cycle, and when preparing for a sale. However, whilst the s63 Regulations similarly target the energy performance of existing properties at the point of a transaction, there are significant differences to MEES in terms of regulatory scope, triggers and the resultant obligations.

Summary of the s63 Regulations

The Regulations apply to the owners of buildings which have a floor area in excess of 1,000m² (on a Gross Internal Area basis) and which are being offered for sale or for rent to a new tenant on or after 1 September 2016.
Buildings and building units (i.e. a separate lettable area) with a GIA of 1,000m² or less are out of scope, although there is a possibility that the floor area threshold will be reduced in the future.
Where the property to be offered for sale or let is defined as a building unit (meaning part of a non-domestic building that is designed or altered to be used separately, such as a retail unit within a shopping centre), it is the area of the building unit, not the whole building, that is relevant when determining whether or not the Regulations apply.
Similarly, buildings that were constructed in accordance with Building Regulations prevailing from 4 March 2002 onwards are out of the scope of the regulations; the aim is to target older buildings which did not have to be built in accordance with modern energy efficiency standards.
Unlike the MEES Regulations in England & Wales, and because of the link to the Building Regulations standard to which the building was constructed, the Regulations in Scotland are not triggered by a minimum threshold of energy performance based on their EPC rating.
The renewal of a lease with an existing tenant does not trigger the regulations. Short-term leases (less than 16 weeks) are also exempt in certain circumstances.
Where the Regulations apply, building owners are required to produce an Action Plan prior to marketing the property. This must be prepared by an accredited “Section 63 Advisor”.
The building owner then has the option of either improving the energy and emissions performance of the building within 3.5 years of the date of issue of the Action Plan, or deferring that improvement in lieu of formally reporting annual energy use by way of an annual Display Energy Certificate (the first of which must be in place within twelve months of the date of issue of the Action Plan).
Compliance with the Regulations is the responsibility of the building owner; in the event of a sale, any obligations under the Regulations pass to the new owner. Unlike the MEES Regulations in England & Wales, there is no obligation to implement improvements prior to a transaction taking place.
The Action Plan must be made available to prospective buyers and tenants when marketing a property (in the same way that EPCs must be), and a copy provided on conclusion of the transaction.
The completion of improvement works needs to be formally recorded in the form of an updated Action Plan and a new EPC which confirms the rating of the improved building.
All documentation associated with these Regulations (i.e. the Action Plan, the EPC and the DEC) must be lodged on the central register by the relevant advisor/assessor.
The Regulations do not replace or alter the requirement to have a valid EPC in place for newly constructed buildings or for buildings being sold or rented to a new tenant under the Energy Performance of Buildings (Scotland) Regulations 2008; they continue to apply. However, there are significant and unhelpful consequences relating to the incompatibility of existing EPC data with the Action Plan requirements of the Regulations.
Enforcement of the Regulations will be the responsibility of the local authority for the area in which the building is situated – the same as for the arrangements currently with respect to EPCs in Scotland. Penalty charge notices with a fine of £1,000 will be issued for each case of non-compliance, with penalty charges levied retained by the enforcing authority.

Aside from creating altogether different regimes for regulating the energy performance of existing non-domestic property in different parts of the UK, there are a number of specific issues which threaten to undermine significantly the effectiveness of the s63 Regulations which is cause for major concern. In particular, we think that the two issues described below are worthy of highlight.

Incompatible systems

Where there is a requirement to produce an Action Plan under the Regulations, a specific software solution, embedded into the latest version of iSBEM, must be used to determine the appropriate improvement measures. However, to date, none of the leading proprietary software solutions that are commonly used to prepare EPCs (e.g. IES, DesignBuilder) have developed an interface for this new solution. Some have unspecified plans to rectify this, whilst others do not intend to do so at all due to the relatively small size of the Scottish market.

The consequence of this regulatory stipulation is that the modelling outputs used to underpin many existing EPCs will not be compatible with the Regulations. This is an absurd, and presumably unintended, consequence; it renders many existing EPCs obsolete in the context of the s63 Regulations. As things currently stand, this means that replacement EPCs will need to be commissioned for many assets for which an Action Plan is required.

These new EPCs will need to be produced in iSBEM which is a basic application more prone to human error. The modelling process can be improved through a proprietary graphical interface known as G-iSBEM, but EPCs produced in this way are limited to SBEM and far less useful from a design and energy management perspective than those generated by the more advanced proprietary systems, which can use both SBEM and a more rigorous dynamic simulation methodology (DSM). For more complicated buildings, the replacement EPCs may require considerably more modelling time and, therefore, cost a lot more to produce than would normally be the case. This is because iSBEM requires users to manually calculate and enter surface areas for every room (walls, floors etc.) and as there is not a graphical (3D) interface, it is easy to make mistakes as one cannot visualise these areas. This means that iSBEM is not geared up for complex geometries and zones.

Clearly, this absurdity means not only that EPCs prepared in Scotland going forward are likely to be less accurate than they otherwise would be, it also adds an additional cost and administrative burden for building owners that need to comply with the Regulations. It is likely to further disenfranchise market actors from the wider Energy Performance Certificates regime, which is already viewed by many with a considerable degree of scepticism.

Inconsequential penalties

The Regulations place a duty on all local authorities in Scotland to enforce the regulations within their respective administrative boundaries. In essence, their powers extend to the issuance of fixed penalties of £1,000 for non-compliance in the event that:

an Action Plan is not provided to a prospective purchaser or tenant within 9 days of a request for it; and
building improvement measures set out in an Action Plan have not been implemented in time.

The time limit for the local authority to impose a penalty is 6 months after it becomes aware of the breach. They must allow a minimum of 28 days for payment of a fixed penalty notice. Rights of appeal and bases for defence are also set out in the Regulations.

Notably, the Regulations appear only to provide for penalty notices to be levied on a one-off basis (although worth noting that penalties can be charged under two separate scenarios; one for not having made the action plan available when selling or letting, as well as for not implementing the improvement measures within the Action Plan).

This would mean the cost of the penalty may well be significantly less than the cost of procuring a replacement EPC where one is required, preparing an Action Plan and implementing improvement measures. However, given that the trigger for the regulations is transactional, it is likely that the Scottish government holds the view that not having the appropriate documentation in place when offering a property for sale or lease may have a negative effect on a potential transaction, and that prospect would be sufficient to deter non-compliance, at least in respect of the requirement to have the Action Plan in place at the point of marketing.

That being said, the enforcement provisions do seem, in our opinion, to be very soft. We would not be surprised if a number of asset owners elect to take the risk of a fine, rather than comply with their legal obligations. Time will tell how the market responds, and indeed what moves the Scottish government might make in the future, if any, to address ineffectual aspects of the regulations as they are observed.

Our call

In light of these issues, Hillbreak calls on the Scottish government to move quickly to correct the unintended consequences of the s63 Regulations, or risk causing significant and unnecessary frustration to the effective working of the property market, not to mention being ineffectual in achieving the policy objectives. In the meantime, Hillbreak will continue to support and advise its UK property clients on the requirements and implications of the s63 Regulations.

Addressing market failures in the building energy sector

May 30, 2016/in News /by Jon Lovell

Miles Keeping, co-Founder of Hillbreak, features in a new and detailed Property Week article on key limitations and failures in the building energy assessment market. The role of Energy Performance Certificates (EPCs), historically treated by many as merely an administrative licence to transact, has been brought into much sharper focus in the commercial and domestic real estate markets by the forthcoming Minimum Energy Efficiency Standards (MEES) regulations.

Miles comments on Hillbreak’s experience of advising clients in both transaction and portfolio risk management contexts, where examples of negligent energy assessments undertaken by third party assessors have been found. It’s a common problem in the market, the risk being for property owners that their Energy Performance Certificates will be challenged by potential purchasers and occupiers, leading to delayed deals and chipped prices. Assessors who issue inaccurate EPCs may also find that they face claims for damages arising from their negligence.

The article also announces that Keeping has been appointed to lead an industry group convened to provide the Department for Energy and Climate Change (DECC) with advice on additional guidance on EPCs and MEES, as well as to deliver training to civil servants in DECC and Department for Communities & Local Government.

Breakthrough Birmingham – City Summit Report Launched

April 26, 2016/in News /by Jon Lovell

Hillbreak was proud to be a workshop partner and facilitator of the energy efficiency worksteam at the recent UK Green Building Council “City Summit” in Birmingham.

A report of the Summit has now been published which gathers together the key opportunities and challenges facing the city, and the resulting ideas and proposals which emerged from a series of multi-stakeholder workshops.

You can download the Report here.

About the Summit

UK-GBC’s flagship annual event focuses on key sustainability challenges viewed through the lens of a different UK host city each year. The two-day conference immersesd delegates in the big sustainability issues facing cities, and delivered in-depth learning grounded in real life scenarios. Developed in partnership with Birmingham City Council, the goal was, and continues to be, helping to shape a lasting impact on the sustainability of Birmingham’s built environment, but this Summit is relevant for all those with a passion for sustainable cities and the outputs will be of value beyond Birmingham.

Addressing Minimum Energy Efficiency Standards at British Land

April 12, 2016/in News /by Jon Lovell

Hillbreak has recently completed an assessment of British Land PLC policies and systems in relation to the Government’s Minimum Energy Efficiency Standards (“MEES”). The MEES Regulations will restrict the letting of properties which have poor energy performance ratings from 2018, and are a therefore a key issue to address for responsible landlords and their investors.

We conclude that the company is well prepared for the Regulations and has proactively managed potential risks to value, albeit that continued vigilance and proactive risk management is required. An overview of our findings are captured in this blog, published by British Land.

Investor Briefing on Minimum Energy Efficiency Standards

March 30, 2016/in Insights, Resources /by Miles Keeping

Commercial Real Estate Investors need to ensure that their fund and asset managers are fully prepared to deal with the liabilities that will almost inevitably exist in relation to Minimum Energy Efficiency Standards, and that they have robust procedures in place to deal with these and any future risks. We’ve put this Briefing Note together to guide investors through the key elements and implications of the Regulations, and with the key questions they need to be asking of those mandated to manage their real estate allocations.

Hillbreak Investor Briefing On MEES (Sept 2015)

MEES Briefing Note For Investors

This is intended as a high-level and general introduction to the issues. Please contact us if you would like to discuss them in more detail. Hillbreak has helped a number of landlords to consider how factors such as lease type, lease events, tenants, income profiles and regulatory timetables present particular risks to their portfolios which could result in significant income loss, liquidity impacts or capital works being required. With careful planning, Hillbreak has been able to minimise these types of risk with its clients.

energy efficiency ARCHIVE