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ESG And Dilapidations: Processes Are Changing, Bringing Upsides For Both Landlords And Tenants

London
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The green agenda is starting to affect all aspects of commercial real estate, and dilapidations is no exception. Where once a landlord might have asked a tenant to strip back a workplace to its bare bones when they exit, increasingly this is not the case. There is pressure on all industries to reduce waste and carbon emissions, and reuse where possible, pushed by environmental, social and corporate governance policies.

The challenge for landlords is how to reap the benefits of the new dilapidations processes instilled by ESG, rather than miss out on claims because of them.

“The whole premise of dilapidations is to repair what is there,” said Charlie Wildash, head of dilapidations at international, independent real estate consultancy Hollis. “We are starting to see a shift back towards this and away from the practise that has become common in the past of ripping everything out to start again. This is genuinely no longer acceptable. And both landlords and tenants can benefit from this shift.”

The Effect On The Dilapidations Process

Before the push to go green, the dilapidations process was fairly simple. In many cases, landlords included in a lease a requirement for a tenant to return a property to the condition it was in when it was first leased. This meant removing all soft furnishings, décor, partition walls, even flooring.

“A lot has changed in the last year or so,” Wildash said. “Increasingly, landlords are taking advice from their letting agents to inform a sensible discussion with the tenant about what needs to be removed and what could be retained.”

When this happens, tenants can see the benefit quickly. They won’t have to pay to return the space to its former state. From a landlord’s perspective, however, it can create some issues, Wildash said.

“A lease often requires a landlord to request reinstatement of the space by a certain date,” he said. “The safe option is to request wholesale reinstatement. If they miss that date, perhaps due to discussions with their agent or the next tenant, the existing tenant could refuse to do it. Notably, if a landlord says that something can be retained but this position changes post expiry, it is then up to the landlord to pay for removal, rather than the tenant. They are taking a risk.”

The long-term answer is for the lease drafting process to consider future discussions from the outset, Wildash said. Leases could contain clauses that provide more flexibility regarding notices to reinstate and an understanding that while the landlord’s best intentions are to retain what is there, if that becomes unrealistic, they will not lose the right to claim costs for removal. Overall, there needs to be a dialogue between landlord and tenant from the beginning and an understanding that these decisions can’t always be made before the lease has expired.

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The Effect On The Outcome

Along with the dilapidations process, claims are being impacted by the move toward making buildings more sustainable.

“It has been established in recent years that landlords’ work to improve energy performance certificates will affect dilapidations claims,” Wildash said. “By improving building services or installing more efficient HVAC and lighting, this will supersede a claim they could make on a tenant when a lease ends. This is obviously a negative for a landlord.”

But there are ways to turn the impact of improved embodied carbon requirements on dilapidations claims into an advantage for a landlord, Wildash said, and we are starting to see that. If landlords seek to retain or repair as much of the property as possible, rather than return the property to a bare state, they can maintain a claim against a tenant for that repair.

“For example, in recent cases, we are seeing retention of raised access floors, cladding systems, HVAC systems and so on,” he said. “Previously, these may have been replaced. But the ethos to retain and repair is seeing increased recoverability for landlords.”

Increasingly, leases oblige a tenant not to make an EPC rating any worse. Recent changes to the way EPCs are measured could cause confusion on this point, Wildash said. The change in assessment came in June 2022, by which a building heated by gas will now have a worse EPC rating, by no fault of the tenant. 

“Whilst the tenant should not be liable for this, it may make it difficult to assess the extent of impact the tenant’s changes may have had versus the impact of the regulation changes,” he said. “There is potential for dispute on this and an area that tenants should be aware of, so they do not become liable for issues outside of their own control.”

Both landlords and tenants are coming to terms with how dilapidations claims are evolving. The need for dialogue is clear, as the approach to repairing and restoring properties change.  

“When we’re consulted on dilapidations matters, all we can do is advise on how a lease is drafted and what action should be taken as a result,” Wildash said. “But this highlights the importance of lease drafting evolving to accommodate the changes to the dilapidations process at lease end, and the incorporation of a suitable green clause."

This article was produced in collaboration between Hollis and Studio B. Bisnow news staff was not involved in the production of this content.

Studio B is Bisnow’s in-house content and design studio. To learn more about how Studio B can help your team, reach out to studio@bisnow.com.