Understanding energy performance certificates: lending where a secured property has no EPC or a poor EPC rating.
Energy Performance Certificates (EPCs) are becoming increasingly topical in real estate finance, especially as 2018, the date set for the proposed changes to the EPC regulations, draws closer.
The Current Position
Under the current laws, EPCs are required whenever a property is built, marketed, sold or leased (but with some exceptions, such as listed buildings). Accordingly, lenders would expect to see EPCs where commercial or residential properties are acquired or leases have been granted – though it should be noted that leases granted prior to 2007 did not require EPCs.
The risk of proceeding with a loan without an EPC for a secured property in the short term is fairly limited: failure to comply with the requirement to obtain an EPC carries a maximum penalty of £200 for residential premises and £500-£5000 for commercial premises (depending upon the rateable value of the property). These penalties can only be imposed within six months from the time that an EPC was first required.
The regulations also allow residential tenants to request that landlords make certain improvements to the energy efficiency of some dwellings.
The Proposed New Regulations
From April 2018 owners of commercial and residential buildings which are rated below an ‘E’ will not be able to be rented. Further, from 2020 residential properties rated below an ‘E’ will not be able to continue to be rented under an existing tenancy agreement. From 2023, commercial properties with EPC ratings below an ‘E’ will not be able to continue to be rented under an existing tenancy agreement.
There are some proposed exceptions to the regulations, such as for certain commercial properties and listed buildings. Legal advice should be sought in determine whether the EPC laws apply in these contexts.
Risks to a Lender post 2018
The proposed fines and the requirement to improve the energy efficiency of buildings could be adverse to a lender because:
- owners will be required to make improvements to the property to enhance its energy efficiency before they can be leased or continue to be leased. Such improvements could be expensive, and may affect a borrower’s ability to repay debts owed to a lender;
- a borrower’s ability to repay loans may also be adversely effected in circumstances where their properties cannot be rented;
- it is anticipated that from 2018, substantial fines (£4000) may be imposed for entering into leases where a property has an ‘F’ or ‘G’ energy efficiency rating. The imposition of such fines could also be adverse to a borrower’s financial position and ability to service debts owed to a lender;
- if the lender were to step in as a mortgagee in possession, because the lender would assume the above liabilities (though any costs incurred by a lender in making a property compliant with the EPC regulations or paying fines imposed under the regulations could be added to the borrower’s debt); and
- non-compliance with the EPC regime may adversely affect the value, lettability and marketability of properties which a lender has a mortgage interest in.
There is limited risk associated with waving the requirement for an EPC to be produced in the shorter term. The failure to commission an EPC carries a limited penalty. In the medium term (post 2018), there is a more significant risk of exposure for a lender where there is no EPC, or where an EPC is produced but has an F or G rating, especially where the properties are to be let. In light of this, some lenders are hesitant to lend against properties where an EPC is not provided, or where EPC’s are produced which rate the secured property below an ‘E’.
Whether to lend where there is no EPC or a poor EPC is of course a decision for the lender. Lenders should consider the risks associated with the EPC regime as outlined above, but should also recall that it is a condition of most facility agreements that a borrower comply with all laws applicable to a secured property. This would include the EPC regulations when (and if) they are amended in 2018 – making a borrower’s failure to bring a property up to the minimum EPC rating an event of default!