What Impact does ESG Regulation Have on Business Rates?

Posted by Knight Frank Newcastle on 5th February 2024 -

In England, there has been a 2023 revaluation, with the next revaluations scheduled in 2026 and 2029. A careful review of the business rates assessment remains crucial to managing costs as the business rates assessment, and liability, can go up or down. The implication of ESG ambitions and the requirement for improvements to buildings, should there be an increase in the rent payable, will ultimately lead to an increase in business rates liability.

We examine how ESG policies can interact with both a landlord’s and occupier’s exposure to business rates.

The overlap of ESG and business rates - the economic perspective

Business rates, a crucial source of revenue for local services, have recently undergone a significant transformation. In March 2023, the government published the 2023 Rating List for the 2 million plus commercial properties, with the global rateable value increasing from £65.7 billion to £70.3 billion.

While sectors like retail and hospitality benefitted by receiving rateable value reductions, there were increased business rates costs for other sectors, impacting both occupiers and landlords.

Business rates remain a vital tax for the UK government, providing over £25 billion annually for local services and essential funding for local governments. Therefore, any changes in business rates directly impact commercial real estate stakeholders.

Rateable value and ESG: Where do they intersect?

The Valuation Office Agency determines the rateable value for each business property in England and Wales. It's essentially an estimate of the annual rent for a property under specific conditions – vacant, in reasonable repair, and available to let on the open market. Here's where ESG comes into play.

The Minimum Energy Efficiency Standards (MEES) implemented from April 1, 2023, prohibit landlords from letting properties with energy performance certificate (EPC) ratings of 'F' or 'G,' which are considered sub-standard. The MEES obligations are anticipated to become stricter with government proposals for requiring a mandatory EPC rating of “C” by 2027 and a “B” rating by 2030.

From a business rates perspective, this protocol is likely to result in many properties undergoing improvements. If the improved property attracts a higher rental bid, this may be reflected in a higher rates assessment. Equally, unimproved properties may see a fall in value as MEES obligations renders the property unlettable.

Exemptions may also be available to landlords undertaking improvement works. From 2022, an exemption was introduced that allowed those ratepayers who invest in renewable energy solutions such as solar PV, wind turbines, battery storage and electric vehicle charging to be able to see their rates liability reduced to exclude any added value from these systems. The exemption will be in place until 2035.

The need to future-proof offices

According to our research in 2022, 80% of regional offices occupied by leading UK-listed companies will fall short of the EPC standards required by 2030. Only 18% of available stock is rated 'A' or 'B’. In terms of business rates, the challenge for the office market is that properties below the threshold will continue carrying costs for landlords and occupiers unless it can be argued that their rateable value should be reduced.

Green assets by sector 

The UK's ageing retail property stock, compounded by the pandemic and declining rent levels, has pushed sustainability into the spotlight. In 2022, 1,300 UK retail properties were pursuing sustainability ratings, with most new constructions meeting compliance. However, older retail stock needs solutions to meet ESG standards.

Factors like EPC ratings and BREEAM credentials influence business rates in this context. Properties with superior sustainability features (particularly across the asset class of ‘prime offices’) command higher rents, resulting in higher rateable values. This is because occupiers will pay a green premium for space with the appropriate BREEAM credentials and take out longer leases.

As we approach 2030, while non-compliant properties might struggle to attract rental bids, they will still be valued for business rates across all sectors. Currently, in the 2023 Non-Domestic Rating list, properties that have not yet been improved remain assessed and valued for business rates.

Future potential

The Non-Domestic Rating Act, addresses various issues related to business rates, including Improvement Relief Schemes. These schemes aim to incentivise property improvements that support the transition to net zero and enhance employee wellbeing. Ratepayers won't face higher business rates bills for 12 months after qualifying improvements are completed before April 1, 2029.

The Act continues to support investment in green plant and machinery, outlining the heat networks rate relief for properties used for the purposes of a heat network and full relief through to March 31, 2035.

Given the evolution of the renewables market and potential impacts of the sudden lifting of these exemptions, is it likely the government will extend this deadline in the future to accommodate the growth in green technologies?

The long-term impact

As commercial investors, property owners, and occupiers contemplate the implications of the Non-Domestic Rating Bill, a crucial question arises: Does it offer a long-term benefit for capital investment to meet net-zero targets, improve EPC ratings, and attain favourable BREEAM grades?

The answer to this question will shape the commercial real estate landscape in the UK in the years to come.

The joining of ESG regulations and business rates clearly signals that sustainability and economic considerations are no longer separate entities but intertwined forces that will drive decision-making in the industry. Property stakeholders must adapt and strategise to thrive in this new era of commercial real estate.

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