ESG and UK real estate: Autumn round-up

How does ESG impact the hotels sector?

On the environmental side, the ultimate goal of carbon neutrality has certainly risen up the agenda with numerous hotel brands publicly announcing carbon reduction targets. 

Environmental concerns have impacted the drafting of hotel management agreements, where it is increasingly common to see obligations on the operator/brand and the owner similar to green lease clauses, for example: cooperation clauses regarding strategies to improve environmental performance; covenants regarding the use of sustainable materials; and the procurement of energy from renewable sources. 

The drive to implement sustainable buildings has impacted the construction of new hotels, with developments aiming to reduce the reliance on concrete and steel in favour of better materials, and designs incorporating innovative green features such as energy storage systems.

Hotel operations are particularly susceptible to being wasteful, so in fit-out plans we are seeing smart showers, LED lighting, automatic light sensors, sustainable furniture, solar heating and thermostats with occupancy sensors becoming the norm. 

However, the hotels sector arguably faces more varied and significant ESG challenges than other asset classes due to the services they provide, the labour involved, and the fact operations run 24/7 every day of the year. Typical offerings like buffet breakfasts raise questions about the reduction and management of food waste, and whether food is procured locally and sustainably in the supply chain. Certain brands have made significant shifts, such as removing single use toiletries and plastic straws, limiting the number of times bedsheets and towels are replaced, and procuring fabrics that do not require energy-intensive dry cleaning. 

Increasingly, travellers are patronising eco-friendly and socially responsible brands.  Guests can now quickly assess the environmental friendliness of a hotel by using rating systems like Tripadvisor’s GreenLeaders. 

Hotels face significant social issues as a service business, being broadly characterised as a “low wage long hours” sector with many hotel employees around the world living below the poverty line. Improving wages, training and working conditions are a particular focus. Hotels also need to attract a young workforce, for whom ESG considerations are typically a higher priority. On governance matters, hotel operators are increasingly finding that corporate clients are asking for ESG credentials before placing business with hotels. 

Planning: The Big Three...

As you may have seen, the government has been going back and forth as to whether it is going to scrap the nutrient neutrality rules, first through an amendment to the Levelling-up and Regeneration Bill (which was voted down in the House of Lords) and now through a proposed new bill (yet to be revealed).  Caroline Stares has put together a helpful summary if you'd like to remind yourself of the key concepts and main issues. 

It has also been revealed that the government is delaying the introduction of the biodiversity net gain requirement. According to the Environment Act, a new mandatory requirement that most new developments have to achieve at least 10% biodiversity net gain was due to come into effect in November of this year. However, DEFRA has confirmed that the introduction of this requirement will be postponed until January 2024 with guidance and regulations coming "by the end of November". 

Michael Gove refused Marks and Spencer's proposals to demolish and rebuild its flagship store at the Marble Arch end of Oxford Street (against the recommendation of his appointed Inspector). The decision relates to heritage harm and the importance of assessing embodied carbon when considering proposals for full demolition rather than retrofitting existing buildings. Marks and Spencer has launched a challenge over the decision so watch this space! 

A new approach to net zero?

There has been a lot of news coverage about the Prime Minister’s proposed changes to the government’s net zero policies.

These include a delay in phasing out the use of fossil fuels for off-gas-grid homes, and an exemption to the phase out of gas boilers for around 20% of households.

The government also seems to be halting on plans to raise Minimum Energy Efficiency Standards (MEES) in the domestic private rented sector.

Since April 2020, the MEES Regulations for domestic private rented property have prohibited landlords from renting out properties with an EPC rating below E.

The government has consulted on raising the minimum EPC rating, and the expectation had been that there would be changes to the MEES Regulations requiring a domestic private rented property to achieve a C rating from April 2025 to avoid being substandard. The Prime Minister has however suggested that these plans may be scrapped entirely. This raises questions about how likely owners of domestic private rented property are to carry out energy efficiency improvement works going forward.

For the time being, at least, no further mention has been made in relation to MEES for commercial property.

Q&A: Enforcement of MEES and commercial property

Q: Remind me of the risks if landlords breach the MEES Regulations?

A: There are two risks: financial and reputational.

Broadly, the enforcement authority (the local authority) can issue fines and can publish information about penalties.

The validity of the lease granted in breach is not affected.

Q: Can you explain in more detail about how the enforcement authority takes action?

A: The enforcement authority can serve a compliance notice where a landlord appears to be, or to have been at any time in the prior 12 months, in breach of  MEES Regulation 27 (i.e. the regulation prohibiting the letting of substandard property on or after 1 April 2018, or continuing to let such a property on or after 1 April 2023, without a valid exemption).

The enforcement authority also has the power, under MEES Regulation 38, to issue a penalty notice where it is satisfied that a landlord is, or has in the preceding 18 months:

• let or continued to let substandard property in breach of MEES Regulation 27

• failed to follow a compliance notice

Q: What are the fines that can be imposed?

A: The fines themselves are as follows.

• If the breach  of regulation 27 has been ongoing for less than three months, the financial penalty cannot exceed the greater of £5,000 or 10% of the rateable value of the property, subject to a cap of £50,000.

• If the breach has been ongoing for three months or more, the financial penalty cannot exceed the greater of £10,000 or 20% of the rateable value of the property, subject to a cap of £150,000.

• For failing to follow a compliance notice in breach of MEES Regulation 37(4)(a), or providing false and misleading information on the Private Rented Sector Exemptions Register in breach of regulation 36(2), the fine cannot exceed £5,000.

A landlord could be subject to multiple fines, for instance for breaching regulations 27, 37(4)(a) and 36(2). Similarly, for multi-let properties breaching the MEES Regulations, fines can add up quickly!  A breach of the MEES Regulations could therefore be very costly for a landlord.

It is also worth mentioning that any financial penalty can be recovered as a debt by the enforcement authority, which gives it an incentive to take action for breaches of the MEES Regulations.

Q: What about the reputational damage?

A: The enforcement authority can also issue a publication penalty, which effectively involves publishing certain information relating to a penalty notice on the exemptions register – which is publicly available. This includes the name of the landlord where it is a company, details of the breach and the amount of the financial penalty imposed. This is intended to act as a further discouragement for committing a breach.

Q: OK, the risks are clear. But how likely are these to occur in practice?

A: To date, there has been little enforcement in practice. This can be primarily attributed to two factors: awareness and resources.

In many instances, local authorities have very little idea that breaches are being committed, because these are not necessarily obvious. There is not, for example, an absolute requirement for a landlord to have an EPC; for instance, where the existing certificate expires and the property is vacant. So there are questions about how a breach would come to the local authority’s attention.

Local authorities are also stretched, and do not have the resources to dedicate the required time and money to properly enforcing the regulations.

However, improving enforcement is a key concern: the proposals to require landlords to submit EPCs on 1 April 2025 and 1 April 2028 is partly intended to help local authorities identify properties in breach, and those that might be when the expected minimum EPC threshold for commercial property increases to C in 2027 and B in 2030.

Investors and lenders will also not be persuaded by the remoteness of enforcement risks.

Real Estate Horizons

We have put together a new Real Estate Horizons video and a one page summary to help you navigate the fast-moving area of ESG: What does ESG mean for UK Real Estate?

Authored by Jackie Newstead, Adam Balfour, Ben Willis and Rosie Shields.