Morgan Allen, partner at Gerald Eve explains the government’s Minimum Energy Efficiency Standards (MEES) and the potentially huge impact on nurseries

The Government’s Minimum Energy Efficiency Standards (MEES) Regulations came into effect on 1 April 2018, which outlawed the renewal of existing tenancies or grant of new tenancies within buildings that have an EPC rating of less than ‘E’ (i.e. properties with an ‘F’ or ‘G’ rating).

More recently, existing leases within commercial buildings (i.e including nurseries) that do not have at least an ‘E’ rating became unlawful from 1 April 2023. The government has further released consultation regarding improving EPCs for commercial property to a ‘C’ or above from 1 April 2027 and ‘B’ or above from 1 April 2030.

Therefore, subject to the government’s consultations, the requirements are very likely to become more onerous as time marches on. There are some exemptions; including listed buildings or those used as a place of worship. Good news for the many nurseries which operate out of Listed churches.

A building can also be exempt if all of the following are true: it’s due to be sold or rented out with vacant possession (i.e. not an operating nursery), it’s suitable for demolition and could be redeveloped, and planning permission for the demolition has been applied for.

If your property has been rated ‘F’ or ‘G’, or in the absence of an EPC but you suspect it may be rated as such, it would be very prudent to allow for the likely capital expenditure to get the property into a lettable condition before you attempt to let it, sell it or re-finance your nursery. If you are a tenant, this is the landlord’s responsibility and they risk a fine if they do not comply. Whether we will see a deluge of fines for non-compliance in April is debateable (given that enforcement is by the Local Authority trading standards team), but occupiers are increasingly demanding better EPC levels as part of their acquisition requirements.

If the fines do not encourage landlords to improve their buildings, occupier demand and impact on rental levels ultimately will. There is a very real risk that poor performing buildings will become unlettable and ultimately stranded assets. Having a low EPC rating is unlikely to be a problem for the operators who are pursuing a buy-and-build strategy (such as Fennies and N Family), whose buildings are built using modern and sustainable methods of construction.

However, it could be a problem if your intention is to:

1. Use the property to secure a loan
2. Take or grant a new lease
3. Sell the property and the business
   operating out of it
4. Undertake a sale and leaseback.

Bank finance

A low EPC could make it difficult to use the nursery property for secured lending purposes either to refinance an existing loan, or for a “new to bank” loan. One of the major lenders to the sector is targeting a ratio of a maximum 50% of their mortgage book to achieve EPC ‘C’ by 2030.

They have not disclosed how they will achieve this, but we suspect it will be via a combination of:

• Not agreeing any new loans which are a D or lower
• Not re-financing existing loans which fall below this threshold; and
• Providing an EPC loan so the borrower can retrofit the building up to a C or higher.

We are aware that some lenders to the nursery sector are creating an EPC debt facility, which would be on an interest only basis and the sole purpose of the facility would be to enhance the property’s EPC rating. These “EPC loans” will be repayable on the sale or refinance of the property.

In addition, we are also now seeing lenders build in capital expenditure to bring the property into a higher EPC rating and whilst this is prudent, it can put a strain on free cash flow and may not materially enhance the nursery’s valuation.

The question for the borrower is whether (or not) the expenditure required makes the nursery business unviable in the near future.

Lease Renewal

Capital expenditure will be required on currently inefficient properties to maintain their lettability. This is generally the Landlord’s responsibility. But what happens to the nursery operation in the event the Landlord does not upgrade the property in time and the lease is then “unlawful”? Even if the operator is “holding over” the lease, the legislation includes existing leases along with new leases.

We do not currently know how the government will police this and enforce breaches. Given the chronic shortage in many areas of nursery places, we very much hope the enforcement action could include closing the nursery.

Selling the nursery

If you are selling your nursery business via a share sale (which is the most common), the property does not legally require an EPC.

That said, increasingly we are seeing buyers insist upon an EPC as part of the property due diligence, regardless of the legal requirement. This could lead to buyers reducing the offers as they will need to undertake capital expenditure to bring the property into EPC compliance.

In short, older properties which will not be compliant will likely see a smaller pool of buyers with offers reflecting the cost of upgrading the property.

Sale and leaseback

We are seeing an increasing number of nursery operators seeking to release capital via a sale and leaseback.

However, this would not be possible with a non-compliant EPC rating. Legally, a new lease could not be granted (even if you are the landlord and also the tenant; eg in a opco/propco scenario).

Generally, we are seeing investors have less appetite for freeholds with poor EPCs. One big investor into the nursery sector informed us the properties they acquire must have a minimum rating of C. If an asset is not at least a C, they have to produce a carbon reduction report/ EPC improvement plan showing a cost effective way to reach B or better in the medium term.

So, whilst your nursery property might be lettable based on current standards, it might not be within several years – in which case there may be very limited, if any, investor appetite.

Investor appetite

Whilst some nursery investors generally do not yet (!) have a blanket EPC requirement (i.e. minimum ratings), some do have a blanket requirement (i.e. minimum ‘C’). These investors are paying particular focus to the BREEAM rating of developments (i.e. relevant for new build nurseries) and EPC ratings generally.

We anticipate in time that investors will increasingly insist on better EPC ratings, with no investor appetite for poorly rated buildings which in turn could turn into a two tier market.

So, if you are hoping to release capital via a sale and leaseback or even a ground rent deal, check your EPC rating first.