Capital allowances remove decarbonisation barriers for landlords

Research by leading audit, tax and consulting firm RSM UK shows that nearly one fifth of UK landlords (18%) surveyed still have commercial properties with an energy performance certificate (EPC) rating of F or G, despite new legislation recently introduced on 1 April 2023, which means all commercial let properties in England and Wales must now have a minimum EPC rating of E.

Following the 1 April 2023 ruling, the government has further ambitions to make it unlawful to let commercial property below an EPC B rating by 2030. Findings from RSM’s annual ‘Real Estate 360’ survey highlight that 52% of landlords do not think these timelines are achievable for the majority of commercial property owners.

Additionally, 40% of real estate businesses confirmed they had written plans and strategies in place relating to their environmental, social and governance (ESG) commitments, whereas 44% confirmed they didn’t have ESG strategies. Landlords also perceived the biggest barrier to de-carbonising the real estate sector to be lack of landlord willpower to invest in environmentally solutions (33%), the impact of the energy crisis (32%), and the lack of cost-effective tech solutions (30%).

Paul Smith, tax director and RSM UK’s head of specialist capital allowances services in Scotland, comments: ‘Our survey findings show that property owners are broadly aware of current requirements and anticipated future changes to EPC ratings. However, the age of UK property stock is clearly a barrier to decarbonisation and the obvious fall-out from these requirements is that property landlords are going to be left with no choice but to incur expenditure to upgrade their property portfolios to ensure compliance at an additional cost. 

‘Aside from the cash outflows for these capital works improvements, there could be considerable business interruption for tenants leading to compensation or rent reductions, renegotiated leases and right of access issues. A collaborative approach between landlord and tenant is therefore a must. 

‘In Scotland, different rules apply for EPC ratings, with ongoing consultation expected to outline revisions in line with updated Minimum Energy Efficiency Standard Regulations (MEES) legislation. Should Scottish landlords bite the bullet and immediately aim for a ‘B’ rating (based on anticipated MEES updates), the question remains if that would be cash prohibitive at this stage. Alternatively, would a ‘green premium’ be chargeable for rents in an upgraded EPC ‘B’ rated property – providing better future cash flows? There is clearly a considerable amount to weigh up and with ever-increasing ESG obligations to consider, this is a challenging issue for the real estate sector.’

He added: ‘For commercial property investors, the availability of capital allowances will play a key part in managing tax cash outflows – notably the £1m Annual Investment Allowance (AIA) and the 100% full expensing first year allowance. Such financial support may also help soften some of the impact of new regulation costs while also perhaps encouraging landlords to take steps now (rather than later) towards increased energy efficiency, removing one of the industry’s decarbonisation barriers.’ 

Claire Monaghan, partner and head of real estate and construction at RSM UK in Scotland, said: ‘EPC ratings are going to be critical to the rental market going forward and without investment by landlords we will start to see a black hole in the market. At present we are not actively hearing of landlords taking immediate action to address this issue primarily due to continued uncertainty as to where this benchmark will land but also due to lack of financial incentive to undertake retrofitting work to improve ratings. Government support is needed to provide such incentives if EPC targets are to be met and should be through allowances rather than through complex grant schemes which again are prohibitive. This also applies to the private rental market which has already been hit by the Scottish government rent cap legislation, further legislative requirements without financial support are likely to see many private landlords exit the market where shortage of supply is already a significant issue.’