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The Introduction of Minimum Energy Performance Standards (MEPS) Creates Significant Opportunities for External Financiers

The demand for Energy Efficiency Installations will be accelerated by the introduction of Minimum Energy Performance Standards (MEPS). With many building owners unable to meet their funding obligations, there will be significant opportunities for external financiers.

Under the Energy Act 2011, from April 2018, it will be unlawful to let properties that fail to achieve a prescribed Minimum Energy Performance Standard (MEPS) until qualifying improvements have been carried out. The intention of the Act is to encourage measures that will be beneficial for occupiers (by reducing energy costs) and beneficial for the wider economy and society (by stimulating cost effective investment and reducing carbon emissions).

The rating will be on a scale from A (best) to G (worst). It is expected that the minimum standard will be equivalent to an Energy Performance Certificate (EPC) rating of E. As a result, owners of properties with EPC ratings of F or G will, in some circumstances, no longer be able to let these properties until their energy efficiency has been addressed.

The non-domestic energy performance register maintained by Landmark contains details of ~500,000 EPC ratings for premises in England and Wales. Of these, 75,000 – or 15% of certified units – are currently rated F of G. Subject to a number of exemptions, these buildings will need improvements to energy efficiency if they are to be re-let post April 2018.

Looking ahead, the number of properties requiring improvements will be impacted by 2 variables – changes in methodology and changes in absolute thresholds. With regards to the methodology, studies show that EPC scoring gets progressively tighter as building regulations get more stringent over time. Hence a D property in 2008 had typically become an E property by 2013 and in many cases is forecast to become an F property by 2018. In round terms, this points towards a derating by one category approximately every 5 years. On this basis, most of the properties currently rated E will be closer to an F by 2018 and require work. The Landmark register contains a further 65,000 properties – or 13% of certified units – as E rated.

Hence, to provide some element of future proofing, the pool of properties requiring improvement can be regarded not only as the F and G rated properties, but also all the E rated properties. This virtually doubles the volume of properties requiring work from 75,000 properties to 140,000 properties.

With regard to potential changes to absolute thresholds, it is possible that the new minimum is moved to D – but with progressively tightening standards described above it would appear that enough properties will fall into the F rating each year to ensure that the energy efficiency standards continue to improve without having to move the new minimum to a D.

The cost of mandatory energy efficiency improvements will come to influence market pricing, hence landlords will have incentive to remedy the shortfall to preserve asset value. At a high level, studies suggest that in most cases the remedial costs will reduce Landlord income by 2-4% (for example, naturally ventilated buildings can be lifted to a D rating quite cost-effectively) but the impact could be as high as 15% in certain cases (for example, with regard to pre 1995 air-conditioned industrial property in low rent areas with high void levels). In cases such as the later, the measures are best completed as part of a full redevelopment.

In many cases, the landlord will not have the cash flow (or desire) to fund remedial work, which will need to be funded externally. Based upon an average project size of £50,000, the market for upgrading the 140,000 properties banded E, F and G amounts to approximately £7bn.

This offers a growing investment opportunity for Oxford Capital and other parties to provide the financing while a third party specialist (typically one of our framework partners) implements the energy efficiency initiatives. The energy savings achieved can be split between the installer, the financier, and the property owner, providing the potential for a win/win/win situation. These types of projects are typically secured against the equipment installed and financed for up to 10 years, with potential unlevered project returns over 10%.

By adding energy efficiency projects to our existing investments in UK Solar generation & UK Anaerobic Digestion generation, we broaden both the potential returns from our Distributed Energy strategy (which now range from 8% to over 10%) and also the asset duration (which now range from 10 to 20 years). As a result, energy efficiency projects have the potential to further strengthen and diversify the portfolio of assets within the Oxford Capital Distributed Energy strategy.