This spring saw the introduction of new Energy Performance Certificate (EPC) rules that create a new landscape for landlords, occupiers, developers, and brokers to navigate to make adequate profit.
As of 1st April 2023, both new and commercial buildings with an EPC rating lower than Band E are no longer eligible to be traded or leased. We explore what the impact on the market is likely to be and outline how mortgage brokers and lenders can adapt accordingly.
The market landscape
The change comes against a backdrop of wider shifts in the commercial mortgage market.
The shift to hybrid working has had a knock on effect for the commercial property market. Companies have scaled back plans to physically expand, moved to different – often cheaper – parts of the country, with others upgrading their office spaces to tempt existing workers back to the office or attract new talent.
The post-Covid acceleration of e-commerce in the UK has also had an impact, with warehousing, distribution and logistics spaces booming, and an increasing trend in mixed use spaces.
In addition, the market is riding the rollercoaster of economic headwinds. After the shakeup of the mini-Budget in September 2022, inflation is on its way down but stubbornly, with base rate increases predicted. Â
Add into the mix the new EPC rules, and when it comes to navigating profit making in commercial real estate, the stakes are set to get even higher.
What do the changes mean?
From April 1 2023, both new and existing commercial lettings must have an EPC rating of Band E or above. Landlords will not be able to continue with an existing tenancy if the EPC is below an E ranking, meaning appetite for commercial financing could be under more scrutiny.  And there’s more; a Band C rating will be needed by 2027, and B will be the minimum from 2030.
Government estimates say this will eventually cover around 85% of the UK’s non-domestic rented stock. Property owners will want to act quickly on upgrading their commercial lots and may well stall expansion of their portfolio.
The state of play
Data from EG shows that the new rules could render 119m square feet of CRE unlettable, putting £2.5bn of rent at risk. So, which are the most secure regions to invest in now? For hungry commercial property investors, do profit hotspots still exist?
First the good news, one in five UK properties currently meet EPC Band A or B; that’s 50% of available CRE, and furthermore, it represents a second year in a row increase. The market is already adapting to sustainability requirements and expectations, and at pace.
The overall sq. ft with an EPC rating A has risen from 13% in 2018, to 24.4% in 2020 and then to 34.3% this year, and in 7 of the 11 UK regions, more than 50% of available real estate is rated either A or B. These figures show a consistent and sizeable shift to the most environmentally friendly properties. At the same time, the percentage of sq. ft with the two lowest ratings has fallen from 5.6% in 2018, to 2.4% in 2021, the year that the new mandatory standards were announced, and now to 1.7%
Looking more closely, the highest concentration of A and B ratings, by sq. ft, is Yorkshire and Humberside, with an impressive 74%. However, it is worth noting that the region accounts for only 10% of the overall UK market. Comparably, in Eastern England it is 65%, in the North West it’s 56% and in the West Midlands it’s 55%.
When adjusted to the number of properties rather than sq. ft, there are three clear leaders; London with 25.4% properties rating A or B; the West Midlands is on 22.2%; and the Southwest 17%. The lowest concentration, albeit by sq. ft, are Wales, where only 10% of properties are in A or B; the North West on 29%; and the South East, 45%.
When taking in rating C, London and the West Midlands surge ahead, on 62% and 56% respectively.
But that is now. What mortgage brokers are asked often is for predictions. Our data also reveals the percentage of CRE ‘at risk’ from future EPC standards, demonstrating the potential in areas ripe for investment. It’s important not to simply assess current ratings, while EPC standards can bring costs, they also bring opportunity. Properties may come with a discount, where owners want to cut and run rather than renovate to standard.
There is little doubt that the new minimum standard of EPC E is already having an impact on the market. In 2018 4% of sq. ft was rated F and G. This has fallen to less than 1%. While all areas have reduced their share of the lowest rated stock, three areas have demonstrated the strongest improvement against their longer-term average – Scotland, Wales, and the East of England
Despite those improvements, there are still three areas where more than 2% of CRE, by sq. ft, are rated F or G: Scotland, 5.4%; South East, 3.3%; North West, 2.5%.
For brokers asked to predict the future, one thing is certain. The share of the current market potentially at risk of the next EPC rating, due to take place in April 2027, is significantly higher. Indeed, 4 out of 11 areas have more than 25% of their CRE rated less than C. The largest shares are Wales, 68%, North East 38%, South East 30%, Scotland 25%.
Developers seeking investment opportunities may also be interested that London currently has 21% of its stock rated less than C, potentially presenting an opportunity to purchase at a discount.
Going green
Even without the legislative backdrop, commercial property owners could benefit from embracing environmental upgrades on their own initiative. Improvements made to get higher EPC ratings could eventually result in higher rents and lower costs.
Environmentally efficient commercial property could also hold a premium in the market. In the residential sector, renters highlighted they’d be willing to pay more for greener homes, while sustainable property has emerged as a top priority for Gen Z buyers. These priorities may be reflected among businesses over coming years, as companies seek out the greenest offices possible.
What this means for brokers
The changes are going to keep on coming. Tenanted buildings must now have a certification of Grade E, but it’s rising to Grade B by 2030. As the market looks ahead to 2030, and to net zero, this sustainability premium will inevitably continue to shape both demand and deals. EG Radius will capture this transition in real time.
Big decisions are being made about next steps and mortgage professionals are ideally placed to offer insight into financing options.
Michael Marciano is product director at EG
