What the energy efficiency drive means for UK property rentals

Rupert Godfrey has a problem. He has decided to ignore it in the hope it will go away. “But, deep down, I know it won’t,” he says.

The landlord of four homes in south-west London, Godfrey faces a difficult decision about what to do with two of them, both flats. These are very likely to fall short of proposed government requirements for energy efficiency in rented housing unless he carries out radical — and potentially expensive — remedial work.

Even if he commits to this, he cannot be certain of success. There are limits to the improvements he can make, as one flat is on the ground floor of a larger block, and the other on its second floor. “There’s no loft you could insulate and you can’t start doing cavity wall insulation in a block of flats,” he says.

Under the proposals for rented homes in England and Wales, if he cannot bring them up to the minimum standard it will be illegal for him to let them when the existing tenancies end or renew from 2025.

Having resolved to review his options and decide next year, he fears he will be forced to cut his portfolio in half. “I will have to see whether I just sell the two flats and keep the houses.”

In a country replete with some of the world’s oldest housing stock, many buy-to-let landlords find themselves in a similar situation. Some complain that proposed measures to satisfy the green requirements are inconsistent and unclear. Others say the expense of so-called “retrofitting” will wipe out their profits from letting and make the business unviable.

The looming regulation is also creating a divide in the buy-to-let mortgage market, with lenders offering discounted deals for those with more energy-efficient properties, leaving the rest with fewer, costlier choices.

But few expect the government to change tack given its commitment to combating climate change. Some landlord-investors may decide the costs of staying within the law are prohibitive. If many owners follow suit, this risks an exodus of homes from the private rented sector, with knock-on cost pressures for tenants chasing fewer properties at higher rents and higher prices for compliant homes. FT Money looks at the potential fallout for landlords, tenants and the housing market.

Coming up to scratch

The government has set key deadlines for landlords and — eventually — all property owners. The energy efficiency of a home is ranked using a system of energy performance certificates (EPCs) that run from “A”, the most efficient, to “G”, the least. As part of its efforts to reduce UK emissions, the government wants all homes in England and Wales to reach a minimum of level “C” by 2035. In England, 42 per cent of assessed homes currently reach C or above; in Wales the figure is 37 per cent.

Landlords are under a much tougher timescale. Ministers are asking them to ensure homes for rent reach level C or higher for all new or renewed tenancies by 2025 and by 2028 for all existing tenancies. The government has yet to respond to a consultation on the matter, which closed in January 2021.

Among the options for improving a home’s energy efficiency are insulation, double glazing, draught proofing, installing a condensing boiler, fitting low-energy lightbulbs or installing renewable energy sources such as solar panels or wind turbines. But the extent of the problem is daunting. Around one-third of buildings in the private rented sector were built before 1919, making them harder to improve, compared with 20 per cent of owner-occupied homes.

In a government survey of private landlords published in May, just 15 per cent had any homes that passed the A-to-C threshold.

It is not the first time landlords have been asked to improve the energy efficiency of their homes. From April 2020, homes could only be rented out to private tenants if they achieved an E rating on the EPC scale, forcing those with homes rated F and G to improve their efficiency. However, if they spent at least £3,500 in the effort and failed to reach E they could apply for an exemption. The government now proposes to raise that threshold to £10,000, given the extra cost of lifting a home to a C rating.

In spite of these initial measures, awareness of the latest proposals is patchy among landlords. A survey at the end of 2021 by buy-to-let lender Paragon found 42 per cent were unaware of the changes, while 28 per cent said they were aware but did not understand the details.

Richard Rowntree, Paragon Bank managing director of mortgages, worries that when most landlords finally wake up to the deadline there will be a “gold rush” for tradespeople skilled in installing energy-saving household technology from 2024.

“Even if you’ve got the information, the motivation and the funding in place, the materials are going up in cost — if you can get them — and the availability of skilled tradespeople is going to become an issue as they’re going to be in high demand across the whole landlord population,” he says.

What remains unclear, he adds, is whether a landlord who spent £10,000, failed to move up a grade but won an exemption would be obliged to spend another £10,000, say, five years later, to renew it.

David Lawrenson, a landlord and author of the Letting Focus blog, says all but one of his handful of properties are rated below C and most would require at least £10,000 to get there. He sees little choice but to share some of the pain with his tenants.

“Normally I tend to [raise rents] by around the rate of inflation, which until a few months ago was 3 or 4 per cent. But I know I’ve got this big expense coming pretty soon from these properties. So I did put rents up on some of my properties by more than the rate of inflation in anticipation of the rise in EPC costs.” 

If other landlords react similarly, it will add to the growing cost burden on renters. Those with the misfortune to live in energy-inefficient homes may not only see higher utility bills but also faster rising rents — at a time when rents are in any case rising at their fastest rate in 14 years, according to property site Zoopla, which put the rise at an annual 11 per cent in the first quarter.

Landlord woes and property prices

Housing market experts warn that as the deadline for the new rules nears, it is likely to fuel demand for homes carrying A to C ratings, and put buyers off those between D and G. Rowntree of Paragon says the lender is currently seeing a modest increase in borrowers applying for mortgages on A to C rated homes, and fewer for those in lower categories. “It’s starting to shift already. It’s a change of a few percentage points, but it’s building momentum.” 

The effect has yet to show up in broader market data, housing market economists say, but will accelerate the current trend for small-portfolio landlords to sell up, handing more market share to large-scale professional landlords.

The pressure on investors has grown with tax and regulatory curbs cutting into profits or complicating the business of renting. These include a 3 percentage point surcharge on stamp duty land tax; the loss of tax relief on mortgage interest for individual landlords; and more recently the proposed loss of “no-fault” evictions that allow landlords to end a tenancy without needing to provide a reason.

Larger professional landlords typically have teams of employees with experience of maintenance and property management that can be brought to bear in upgrading a home’s energy standard, as well as deeper pockets to bear the costs of moving a tenant out while work is carried out. Individual landlords often carry the onus of management alone; in the 2021 English private landlords survey, for instance, 49 per cent of landlords said they did not use a letting agent.

Richard Donnell, research director at Zoopla, says: “What’s really being flushed out by all this regulation is the housing that’s not suitable for renting, which is effectively going back into the owner-occupier market. You can see the trend from investor landlords selling up in growing numbers. At the moment it’s not being caused by EPCs, but it’s bound to be a contributing factor.”

One big change since the proposals were first mooted has been the soaring price of gas and electricity in 2022. This may inadvertently help the government by giving landlords an incentive to improve energy efficiency and tenants to favour better-performing homes.

Lucian Cook, residential research director at Savills, says EPC ratings have not been reflected in rental values up to now. “But given that you’ve seen such a surge in energy prices, I think tenants are going to be much more aware of their energy consumption. And that could mean that rents more readily reflect the energy efficiency of the homes they’re looking for.”

A study by the Smart Energy Research Lab, a consortium of universities led by UCL, found median gas consumption in F and G rated homes was nearly twice that of A and B rated homes — or 97 kWh/day compared with 47.1 kWh/day — in January 2021.

Godfrey says he has had EPCs for his properties since 2008, when landlords were required to obtain one. No tenant ever asked to see it, his letting agent told him. But in recent months, he has found himself more interested in efficiency ratings. “I must say I’m looking to buy a house and I am looking at the EPC.” Asked if that meant spurning homes falling below the C rating, he says: “Probably not, but it might be a good way of getting some money off the price.” 

What landlords want

Landlords and housing market professionals believe the government is unlikely to delay its plans given its commitment to climate action. In its white paper on reform of the private rented sector published last month, the government insisted that emissions needed to be “largely eliminated” from housing stock by 2050 if it is to meet its net zero target. 

It added that low-quality homes with poor insulation lead to higher energy bills, piling pressure on low-income renters. “Upgrading energy efficiency to band C produces average cost savings for energy bill payers of approximately £595 per annum (upgrading from EPC band E) or £1,339 per annum (upgrading from EPC F or G),” the government said.

If the measures are inevitable, what changes do market professionals think they should incorporate? Rowntree of Paragon says the consultation delays have shortened the period available for landlords to make improvements before 2025. As a result, he believes the deadline for new tenancies and renewals is likely to be pushed back to 2026, while the 2028 deadline for all tenancies will remain in place.

As a lender, he adds that mortgage providers are wary about being asked to judge the quality of work carried out to improve a home’s energy efficiency. “We’d rather have a marketplace or a ‘kite mark’ where we say, if you’re using this supplier with that technology, that’s fine as far as we’re concerned. And the backstop would be checking that the EPC rating has improved.”

The National Residential Landlords Association would also like to see landlords able to offset the costs of energy efficiency work against tax, as they are already able to do with repair and maintenance, and a council tax exemption when properties are empty during energy improvement works.

One landlord who contacted the FT suggested the government consider doing away with the £10,000 spending minimum to qualify for an exemption, and instead replace it with a variable figure based on a percentage of the property’s value.

“Would it be reasonable to suggest, say 5 per cent of the property’s value to be contributed by the landlord for upgrading towards the potential best EPC? I can understand that if one owned a higher value property, a higher capital injection is reasonable,” says the Kent-based landlord, who asked not to be named.

The NRLA would prefer the amount that landlords should be expected to contribute to be determined by average market rents in any given area as calculated by the Valuation Office Agency. So their costs would taper from £5,000 to £10,000, depending on rental values.

If there is consensus among landlords and market professionals, it is that the new rules must bring greater clarity. But ignoring the issue is no longer an option. As Cook says, “Any landlord who thinks it’s not going to happen is mistaken. It has to happen — it’s just a case of when.”