Decarbonising is a tricky business for commercial tenants and landlords alike, especially if one party is reluctant to do so. Certain UK legislation rooted in the 1950s doesn’t help matters but we aim to break down the issue and offer some solutions.
Laying the foundations
Commercial real estate, which includes offices, retail, and hospitality, is proving to be a stumbling block for decarbonisation efforts across our society. Despite its vast greenhouse gas (GHG) footprint, there is no clarity within the sector as to who has the responsibility and means to decarbonise . This has significant consequences for landlords, tenants, and local authorities who are setting net-zero targets and action plans.
There are approximately 2 million commercial buildings in the UK. So, what is preventing us from decarbonising them?
One of the biggest challenges is the dizzying variety of ownership and leasing structures within the commercial sector, and this stems from the legislation itself. Possibly on the assumption that both parties are ‘knowledgeable businesspeople’, UK commercial leasing provides significantly less tenant-protection than residential leasing. This allows for a larger degree of flexibility in the resultant agreements which define the responsibilities of landlords and tenants when it comes to building improvements and energy supply.
The relevant legislation (Landlord and Tenant Act 1954, Land Registration Act 2002, Energy Act 2011, and Non-domestic Private Rented Sector (PRS) Regulations) currently does not address the climate emergency nor whose responsibility it is to decarbonise. In the table below, we’ve set out some of the typical factors at play across various lease types.
A key issue we have encountered at Eunomia when working with large property owners is that many of the lease arrangements fall under the ‘Low’ and ‘Medium’ owner control categories. Landlords are therefore struggling to pursue decarbonisation across their property portfolio, with considerable input and cooperation required from tenants.
This means, in many instances, the only option for pursuing decarbonisation is at the point of let (i.e., the end of a tenancy period), as retrofits, heat pumps, and onsite renewables can be installed between tenancies, or, if the tenant remains the same, there is logical grounds for building improvements to be made. However, it still isn’t plain sailing – another legislative obstacle presents itself because leases protected by the provisions of the Landlord and Tenant Act 1954 (“a 1954 Act lease”) give tenants the right to renew the lease on the same terms as the previous lease. This restricts the landlord’s ability to update the lease to incorporate decarbonisation, as the tenant can argue that these measures are not suitably similar to their previous rental agreements. Retrofits in particular will be disruptive for tenants, explaining why this is not a straight-forward challenge and why tenants might be hesitant.
Fixing a broken building
The UK government, through the 2017 Clean Growth Strategy, has set to work to try and resolve some of these challenges. There are ongoing government consultations which, if realised, will place obligations on both landlords and tenants to implement decarbonisation measures. These measures focus on energy efficiency, public disclosure, and low-carbon heating, but do not go far enough to address the issues of control and responsibility at the heart of commercial leasing.
For example, the government confirmed in the 2020 Energy white paper that minimum energy efficiency standards (MEES) for the commercial rental sector will be EPC B by 2030 (compared to EPC E today). When these regulations come into force, landlords will be responsible for ensuring their properties are compliant and can be issued fines by local authorities for non-compliance. However, many consultation responses pointed out that this is unfair on landlords whose properties have low owner control, and the government is now having to consider new primary legislation to put legal obligations on tenants to comply with MEES.
As with much of the wider decarbonisation landscape, it is members of the private sector who have been catalysing change in this space. In the UK, May 2022 saw the launch of the industry-led UK Net Zero Carbon Buildings Standard which aims to assess and certify buildings in line with science-based net-zero targets. One member of the Standard’s Technical Steering Group, the Better Buildings Partnership (BBP), has separately established a climate commitment which requires commercial property owners to set out 2050 net-zero pathways.
Figure 1: Coverage of Better Buildings Partnership’s Climate Commitment.
The BBP climate commitment specifically targets property owners, but the language used serves to highlight the limitations of such an approach. For example, it requires signatories to “disclose the energy performance of [their] portfolios, where [they] have permission to do so” and it is aware that “Members of the BBP have diverse portfolios with different ownership and leasing structures, management arrangements and occupiers – how we implement these commitments within our businesses will differ.”
Ultimately, because of the complications surrounding different lease types and different levels of ambition among tenants, the Commitment adopts a ‘comply or explain’ approach, accepting that signatories may not be able to measure and reduce GHG emissions for their whole portfolios.
Different routes, same story
So, on the one hand we have some promising government policy aiming to decarbonise commercial buildings, and on the other hand we have members of the private sector showing real leadership to go beyond what is legislatively required of them. However, both have reached the same obstacle: the policy support is not there to clarify landlord-tenant responsibilities that will enable decarbonisation. The question is therefore ‘what kind of policy is needed to ensure that landlords, tenants, local authorities, and the commercial sector can meet their net-zero targets?’
Building a low-carbon future
In the first instance, any policy solution should aim to create a level playing field. As things stand, only some landlords and tenants are targeting Net Zero, and decarbonisation has upfront costs. Landlords who pursue Net Zero will likely have to charge tenants more, putting them at a competitive disadvantage over landlords who do not pursue Net Zero. Tenants are increasingly interested in net-zero properties, but they too face financial constraints, put into sharp focus with the current cost-of-living crisis, meaning that the market demand for net-zero rental properties is not there yet to reward ambitious landlords.
Clearly, there are no silver bullets to this challenge. Nevertheless, we have identified four policy recommendations that could bring about the change required, or that would at least nudge us in the right direction. These are:
- To go beyond EPC B and mandate emissions reductions aligned to 1.5°C global warming across the non-domestic private rented sector.Without this clear commitment, ambitious landlords and tenants will continue to be unable to pursue decarbonisation, and action will continue to be delayed.
- To define who is responsible for decarbonisation.In most instances, the obligation to decarbonise buildings should fall onto landlords as they are the party with the means to decarbonise. Given that there are fewer landlords than tenants in the commercial sector, this approach also simplifies policy implementation by reducing administrative burden. However, for leases with low owner control, where landlords do not have the means to decarbonise within net-zero timescales, a different approach will be required. For these properties, it may be that the obligation to decarbonise is passed onto the tenant, or that the tenant is obliged to co-operate with the landlord. The government should launch a public consultation through which landlords, tenants, and property lawyers can advise on the best approach.
Given how diverse UK commercial real estate is, and how some properties will be much easier to decarbonise than others, it may be that a cap-and-trade style system, based on science-based carbon budgets for the sector, would be an effective policy instrument.
- To determine how costs are distributed between landlords and tenants.In most instances, landlords will need a cost recovery mechanism to pay for decarbonisation, and this will either come from increased rent prices or external private/public finance.
- To explore innovative financing mechanisms to ensure access to finance and short-term action.It will take time for policy to be implemented and have the desired impact, time that we do not have to carry on emitting as usual. In the short term, the government should explore innovative financing mechanisms, such as the ‘Net Zero Neighbourhood’ model Eunomia is developing with Bankers Without Boundaries, to encourage actions that decarbonise commercial buildings.Blended private and public finance can provide upfront capital in the form of medium- to repayment loans to landlord/tenant collaborations for those tenants on longer-term leases. These tenants have a vested interest in the long-term maintenance of the property and will recover some of the cost through decreased future energy bills. Other innovate policy measures should be sought for short-term tenants to ensure decarbonisation is not delayed.
Like the rest of the climate emergency, decarbonising the commercial sector will require people to be willing to change from unsustainable 20th century business models; it will require a shift in mindset to one of action, change, and stubborn optimism, and this might be the greatest challenge of all.