Our views

Credit risk and energy efficiency in commercial properties

Zilla Chan, Senior Credit Analyst, Matthew Franklin, Credit Analyst and Gail Counihan, Sustainable Investment Analyst

29 January 2018

As part of the UK’s commitment under the Paris Climate Accord – the global agreement to take action against climate change – the government has released The Clean Growth Strategy, a roadmap for reducing carbon emissions across different sectors. Heating in buildings and industry creates around 32% of total UK carbon emissions. As such, the government has introduced new regulation, the ‘Minimum Energy Efficiency Standards’ (MEES), targeting the energy performance of commercial building stock. MEES will require all non-domestic landlords to have a minimum Energy Performance Certificate (EPC) rating of E for all new tenancies from April 2018 and continuing tenancies from April 2023.

RLAM are fully supportive of government initiatives that are designed to decrease energy use in properties, given their contributions to UK greenhouse gases. As bondholders, we are naturally concerned about any unexpected capital payments that may be required to sustain cash flows that we, as bondholders, are reliant on. Given the emphasis on secured bonds in RLAM’s portfolio, any potential legislation (be it energy efficiency related or otherwise) that could impact lease arrangements requires our analysis and targeted engagement with issuers.

For this reason, we wrote to all the issuers of secured commercial property bonds in our fixed income portfolios seeking further information and clarification about the steps they were taking to prepare for the new regulations. A few of the issuers did mention that this was the first time any investor had raised MEES as an issue, which we found slightly surprising given the legislation could have real consequences for landlords of commercial properties, and thus for the holders of bonds that are secured on the cash flows from those properties. We were pleased that the vast majority of issuers we corresponded with were happy to engage with RLAM and appear prepared for the upcoming legislation change.

However, a small number of issuers provided no update, had no information available or had a more sizeable proportion or their assets that did not meet the MEES requirements. Whilst we believe the spread on offer for these credits more than compensates for MEES risk, we will continue to engage with issuers to support compliance. Interestingly, we observed higher compliance across issuers with a robust environmental policy and energy-efficiency targets. This confirms our view that companies with strong policies and practices are better prepared to manage downside ESG risks, which helps protect our client’s investment.

Some MEES leaders:

Great Portland Estates
Westfield Stratford City
Land Securities Group
British Land

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.