The first half of 2023 has already seen some important regulatory milestones for the real estate sector – not least the release of the UK’s Environmental Improvement Plan (EIP), changes in the Building Safety regime and the Levelling up and Regeneration Bill. The real estate landscape is constantly evolving and, as we look ahead to the second half of the year, the pace of change looks unlikely to slow.
In this blog, our real estate and ESG specialists provide a run-down of the key changes on the horizon that are likely to impact those that own or occupy significant real estate portfolios.
Sustainable green leases
A ‘green lease’ usually means a lease with provisions that promote improved energy performance of a building. Sometimes the intention is to go further and catch wider sustainability issues, including water and waste management and other net zero objectives. There is no specific meaning or benchmark – at the moment, reference to green provisions usually means that there is some provision to address these areas.
This matters because landlords are – or will be – subject to regulatory reporting requirements (or self-imposed disclosure requirements), and lease obligations (particularly data sharing) are needed to collect data for reporting (for ESG and other purposes). At the same time, tenants need to be aware of what they are signing up to.
It’s also important to be able to identify service charge liability and recoverability issues for tenants and landlords, respectably. And from the perspective of tenants, signing up to these leases can help them to achieve their own ESG goals (see point 2).
The subject of green leases is explored in more detail in our earlier insight on what a green lease will look like in 2023.
ESG continues to be high on the agenda and is finding its way into all transactions.
Beyond the major economic pressures resulting from the cost of living crisis, energy and interest rates, we expect a growing interest in ESG, driven by regulatory, investor and occupier requirements. Implementable strategies that have a measurable impact (which can be reported objectively) will be at the forefront of the conversation – and those will largely be asset and organisation specific.
As ESG strategies mature, more organisations in the real estate sector are looking beyond ‘E’ to ‘S’ – the social agenda. Property can generally contribute social value through employment programmes and use of space. We anticipate that next year will begin to see social value increasingly given equal importance to the environmental agenda in the design, construction and management phases of schemes.
Biodiversity Net Gain (BNG) and Levelling Up are currently the key issues in planning law.
The Environment Act 2021 (EA 2021) contains provisions aimed at improving habitats and restoring our natural world. These are further consolidated in the EIP under its 10 goals, which focus on halting the decline in nature, including steps to improve natural habitats and encourage thriving plants and wildlife.
In order to ensure that habitats for wildlife are left in a better state than they were in before developments are undertaken, all planning permissions will provide for a mandatory increase of 10% BNG.
A number of options are available to a developer in order to satisfy its BNG obligations – works could be on site (if feasible) or off site (although the closer to the site the better). It will also be possible to buy units from a third party or obtain credits from the Secretary of State in order to offset any adverse impact on habitats. And it’s equally important for companies taking leases of such spaces that this may be an ongoing service charge cost.
Also, recent planning reform in the Levelling Up White Paper aims to achieve simpler and shorter local plans for England that are easier for local authorities to adopt, a greater role for design codes, and more digital planning to make the process more map-based, all of which (among other changes) will improve the certainty of the planning process.
The impact of the increased cost of energy has had direct and indirect consequences. Operators – faced with increasing energy costs associated with shared facilities – are looking to pass such costs on, but often find themselves having to balance costs with pricing pressure for their residents in order to attract and keep them.
There has also been a renewed focus on energy efficiency. The minimum energy efficiency standards (MEES) have prohibited new leases of sub-standard rated individual dwellings since 2018 – and all individual dwelling leases since April 2020. On 1 April 2023, non-domestic property will be brought within the prohibition on continuing to let (subject to exemptions). ‘Continue to let’ means simply being a landlord – either freeholder or a tenant/landlord where there are subleases (although some very short and very long leases are excluded). ‘Sub-standard’ means property with an energy performance certificate (EPC) rating of F or G (although between now and 2030, that is expected to change so that the minimum is C in 2027 and B in 2030 for non-domestic property).
In recent months, the focus has been around the implementation of the new building safety regime in the Building Safety Act 2022.
Our podcast – How We Live… Safely – Building Safety autumn update covers the latest position. This recent update on the new building safety levy and our article on the proposed gateway regime and overhaul of building control (which will be set out in detailed secondary legislation in 2023) demonstrate the pace and scope of changes. The Government’s intention is that building control becomes more outcome-focused, rather than a ‘tick box’ exercise.
Corporate clients need to be aware of the schemes in relation to different buildings, and the remediation involved – as well as the recoverability from tenants – when looking at companies that own high rise buildings, as well as how they are affected as tenants of office buildings.
Rent review in the volatile market
More thought needs to be given to the suitability of rent reviews in the high inflationary market. Depending on the asset class of a particular site, rental values are potentially falling due to market conditions. In such instances, open market rent reviews over the next 12 months are likely to yield no increases, and this will benefit/burden tenants and landlords accordingly.
Equally, rent reviews linked to RPI or CPI increases are often capped and (importantly) collared at percentage increases well below the current rates of inflation. Again, this will have mixed fortunes for landlords and tenants.
The unanswered question is what will replace these traditional rent review methods, if anything. Time will tell.
Rising and unpredictable energy costs are presenting issues for operators and owners of all assets. Those that haven’t already will be exploring ways to manage the energy elements of operational expenditure – and how this might manifest in occupational contracts or property ownership structuring.
Outside of contractual options and energy efficiency measures operators are working to influence occupier energy behaviour through education and incentives.
Various sectors have been hit by the recent market headwinds – not least retail and offices. With high vacancy rates and lowering rates of demand, owners are looking at ways to repurpose space to meet new growing demands. For example, offices contain much of the necessary building infrastructure and are located in ideal locations to be repurposed into research and development spaces.
Apart from cost, one of the main advantages of the adaptive re-use of buildings is the dramatic reduction in carbon, which is a key part of the Government’s target of being carbon neutral by 2050 – and a good way for companies to improve their own sustainability credentials.
How will these changes impact your plans?
Our Real Estate team is one of the UK’s largest, capable of delivering on all elements of transactions across the sector. Our experienced specialists in all asset classes ensure that we have the market insight and technical legal expertise to advise on any issue or opportunity you may be focusing on. With profound change taking place in the real estate sector, we offer fast moving, industry-led advice, enabling you to respond quickly and adapt your business model to the market dynamics in play
About the author(s)
Ben Stansfield is one the UK's leading lawyers practising planning and environmental law. Ben is based in Gowling WLG's London office and brings with him a wealth of experience advising clients on the consenting and regulation of their projects and their compliance with environmental regulations and reporting standards.
Chris Hunt is a leading real estate lawyer, with nearly 28 years' experience. He joined the firm in 1998 and was made a partner in 2001.
Chris is responsible for leading the firm's real estate practice, which now turns over well in excess of £80 million annually and for developing that business both nationally and internationally. He is also client relationship partner for two of the firm's largest real estate developer clients and for one of the UK's most upmarket and iconic retailers.