Will green leases, green finance and EPCs help to reduce the property industry’s environmental footprint?

In September 2023, the UK government announced changes in its approach to reaching the country’s 2050 net zero targets. Continued uncertainty surrounding the government’s future environmental policies combined with the fact that the built environment is linked to 40% of the UK’s carbon emissions means that it is more important than ever for the property industry to take initiative and for the industry’s efforts to produce the desired impact of helping to reduce the UK’s carbon footprint.

Going ‘green’ offers valuable benefits for everyone, including reduced energy bills for occupiers, higher occupier interest for investors with grade A space and potential interest rate reductions for borrowers. We will explore three ways in which the industry is adapting to environmental pressures and whether these concepts could really result in long-term reductions to the industry’s environmental footprint.

Green Leases

Lease negotiations present an ideal opportunity for parties to work towards their environmental objectives. ‘Green leases’ incorporate provisions intended to manage and improve the premises’ environmental performance during the tenancy which is good for both landlords and tenants. Well-intentioned parties may be able to agree on an impactful approach for their premises’ environmental performance, especially over the course of longer leases.

There are many legal drafting kits available which provide examples of environmental clauses, from general obligations to cooperate and share data to stricter prohibitions on alterations which adversely affect the premises’ environmental footprint.

The final strength and content of environmental provisions in any lease will depend on the parties’ appetite for ‘green’ and the circumstances of the building. For example, it seems unlikely that ‘dark green’ drafting (which tends to be stricter and more prescriptive) would appeal to parties not already taking steps to reduce their environmental impact.

Judging by the enthusiastic reception that the revised Better Buildings Partnership’s green lease toolkit has received since it was launched in January, it seems that the label of a ‘green lease’ could start to become more significant. The revised toolkit offers a variety of light, medium and dark green clauses for parties to incorporate and lists 10 areas described as ‘Green Lease Essentials’ to be covered in any lease that is to be appropriately described as such, including sustainability, data sharing and renewable energy. The toolkit also helps to frame initial conversations between parties regarding the benefits to green leasing to help negotiations along before it comes to the drafting.

A stronger steer on what truly constitutes a ‘green lease’ is welcomed. Without it there is a risk of leases incorporating token gesture green provisions, such as obligations to adopt a particular recycling regime (which many occupiers do anyway) and presenting themselves as green without having any real effect on the environmental performance of the premises.

If green were to become a significant standard for leases (similar to the standard of an institutionally acceptable lease), parties could agree to go lighter or darker losing the ‘green lease’ label if the provisions faded too far from the standard and incentivising parties to include more environmental obligations than usual.

One hurdle for landlords looking to improve a building’s green credentials is a lack of motivation for incorporating green provisions into existing leases. It may prove difficult to incentivise long-term occupiers under leases that do not contain green provisions to agree to incorporate them by variation. For example, landlords may regret failing to reserve rights in existing long leases to enter premises to carry out works to improve their EPC rating. This is also an important consideration for prospective purchasers of let buildings which require improvements.

Nevertheless, legal drafting is just one piece of the puzzle to giving effect to good intentions in practice. The continued battle will be to ensure engagement with these provisions throughout the lease term, rather than well-intentioned legal drafting being as far as it goes. It is also not clear how any breaches of green provisions would be enforced which is an entire topic in itself.

Green Finance

The rising cost of debt has made any means to reduce interest rates a tempting prospect. Leaving Green Loans aside (which must be used for eligible green projects), Sustainability Linked Loans (SLLs) are for any purpose and promote green practices by requiring borrowers to meet Sustainable Performance Targets (SPTs). As an incentive, the loan’s rate is reduced when SPTs are met.

It is less common for interest rates to be raised as a penalty if SPTs are not met and it is easy to see how this could reduce the popularity of SLLs. However, without any monetary implication for missing targets set in an SLL, it must be worthwhile for the borrower to absorb the cost of setting ambitious SPTs and verifying their attainment. Sets of ‘light’ and ‘dark’ green SPTs could be developed for various types of borrower, with more ambitious dark green targets providing a greater discount on rates for those willing to go the extra mile.

Even the best-intentioned borrowers need the capability to record, interpret and digest data relating to their environmental performance to measure against SPTs. This entry barrier will need to be overcome before SLLs can be a realistic proposition for all. One option is to include ‘data sharing’ provisions in the borrower’s leases (as described earlier) so that a landlord borrower can access data collected by its tenants and vice versa.

Whilst access to environmental performance data will improve over time as monitoring becomes more common, it may hinder the uptake of SLLs in the near future, especially with SMEs that are less likely to have the ability to measure their environmental performance. The upfront costs of overcoming these obstacles will need to be weighed against the future rates savings that will be made if and when SPTs are achieved, making it more important for the interest savings to be worthwhile if lenders are to encourage the widespread adoption of SLLs.

EPCs

EPCs are a familiar concept to the property industry, with current requirements for non-domestic properties being a rating of ‘E’ or above. There have been government proposals to increase this requirement without confirmation of what this will mean or when. Owners’ and occupiers’ frustrations are well documented in trying to prepare for any improvements that will need to be made to remain compliant and by when. As a result, it is uncertain how relevant these regulations will remain in driving further improvements in energy efficiency.

The current regulations provide exemptions where it would not be feasible to comply with them. Exemptions include high costs of improvements (being over £3,500), devaluation of the property resulting from the measures, or if a third party consent cannot be obtained. It is arguable that these exemptions are too wide and allow for excuses. For example, the third-party consent exemption could encourage landlords not to reserve rights in their leases to permit access to carry out relevant improvement works. Then, if a tenant were to refuse this access, landlords might try and claim the exemption meaning that no improvement works would be required for the 5-year exemption period. Hopefully, an increased appetite for green lease provisions would minimise this risk.

Conclusion

There are limitations to each of the three concepts explored above, but they also present means to improve the property industry’s environmental impact to varying degrees. Given the breadth of the wider issue of climate change a perfect solution seems unlikely, especially without clarity on wider government policy.

As green leases and green finance function due to the willingness of each relevant party to implement these initiatives, they appear to have greatest potential to develop and spread organically along with the increased general awareness of and appetite to counter environmental issues.

It is less certain how concepts such as the development of EPC standards which depend on government policy will fare as environmental issues become increasingly politicised. Only time will tell.

Ella Ovenden is a solicitor in the property division of Irwin Mitchell.

This article first appeared in BE News.