If you are a property developer or investor, you should start thinking about the measures you will need to take to comply with the upcoming introduction of heat network zoning. In this article, we examine the likely key aspects of the upcoming regulation relating to heat networks, and suggest how you can start planning for both the challenges and opportunities that they will bring.
The role of heat network zoning in getting to net zero
Heating our buildings accounts for 23% of the UK’s greenhouse gas emissions. For the UK to achieve its net zero target, this needs to be dramatically reduced. Heat networks are widely acknowledged as an effective means of reducing CO2 emissions. Therefore, the Energy Act 2023 includes a wide range of measures intended to encourage their development. The Government is currently developing secondary legislation (the Regulations), which will provide a framework to encourage the development of heat networks. To inform the preparation of this secondary legislation, the Department for Energy Security & Net Zero (DESNZ) ran the Heat Network Zoning Secondary Consultation (the Consultation), which closed on 26 February 2024).
The Government’s response to the Consultation is yet to be published, however it’s clear that the final Regulations could have a significant impact on your property investment or development business. Below, we unpack some of the likely aspects of the Regulations of which you need to be most aware.
How heat network zoning will operate
The 2023 Act provides for the designation of heat network zones. These will be areas considered appropriate for the construction and operation of one or more heat networks. The Zoning Authority will be the national body responsible for overseeing all heat network zones across England, including resolving strategic issues. It will also oversee Zone Coordinators, who (along with the Zoning Authority) will be responsible for the identification, delivery and operation of specific heat network zones at local level. The exact methodology for this will be determined by the Regulations.
DESNZ regards the lack of certainty for heat network investors concerning which buildings will connect into networks as one of the main barriers to investment in heat networks. DESNZ sees this issue as limiting investment to smaller schemes, where the necessary certainty is achieved by contractual commitments concerning individual buildings. The Consultation proposes this is addressed by requiring certain buildings within a heat network zone to connect to a heat network.
The Consultation proposes that the following will be subject to a Requirement to Connect:
(a) new buildings;
(b) existing communally heated buildings; and
(c) some existing non-domestic, non-communally heated buildings within a heat network zone.
The Consultation notes that these categories may change if the final impact assessment identifies an “undue impact on housing supply or SME developers”. This is important wording for property developers, as it indicates that the potential impact on large developers may be of less concern to DESNZ.
DESNZ proposes an enforcement regime operated by the Zone Coordinator, entailing significant financial penalties for non-compliance. These could potentially be up to £250,000, where a building is owned by an organisation with annual turnover greater than £50m. Reputational damage may also occur if enforcement action is taken against a building owner.
The precise mechanics of the enforcement regime and penalties for non-compliance won’t be known until the Regulations are finalised. However, it is reasonable to assume that they will be sufficiently painful to make choosing noncompliance an unattractive prospect for a building owner.
The Consultation is not proposing that all buildings within a heat network zone are automatically subject to a Requirement to Connect at the same time. Instead, it proposes a procedure to activate a Requirement to Connect for a given building. The Consultation also proposes different activation requirements for new and existing buildings.
What are the proposed exemptions?
DESNZ acknowledges that the specific characteristics of a given development or building may mean that connection to a heat network is not appropriate at the time required by the heat network developer.
To address this, they have proposed a scheme under which exemptions from the Requirement to Connect can be obtained.
Two types of exemptions are proposed: temporary or conditional. The Zone Coordinator will be responsible for determining whether an exemption will be granted (but how they will make this determination is not yet clear). Crucially, DESNZ states that both types of exemptions will have exit conditions, meaning that no building will be permanently exempt from the Requirement to Connect.
Temporary Exemptions
Temporary exemptions are a temporary deferral, applicable when a building owner cannot viably connect to the relevant heat network within the period required by the Zone Coordinator’s connection notice. When the deferral comes to an end, the building will be subject to the Requirement to Connect.
Conditional exemptions
Conditional exemptions will be available where a material reason makes it unviable to connect to the heat network. While these exemptions will not be time limited, they cease to apply when the material reasons for which it was granted no longer exist.
A key point is that the Regulations will compel a building to connect to a heat network but not to actually use any heat provided by the connection. Commercial terms around heat supply will need to be agreed between the building owner and the heat network developer. Whether building owners will choose to buy heat provided from the heat network (which may be more expensive than heat generated from existing - but unlikely to be low-carbon - heating systems), remains to be seen.
How the proposed Regulations will impact developers of new buildings
The Consultation defines a “new building” as “any development which receives planning permission following the designation of a heat network zone”. It proposes that a Zone Coordinator may require new buildings in a heat network zone to connect before completion of construction where a heat network connection represents the lowest cost low-carbon heating option.
The italicised words are of key importance to developers.
Firstly, by requiring connection into a heat network “before the completion of construction”, it makes it clear that you need to consider connection as early as the design stage.
Secondly, the requirement that connection takes place where a heat network connection represents the “lowest cost low-carbon heating option” means that connection will be required where there are cheaper, but non-low carbon heating options, available.
Under the proposals, new buildings in heat network zones that do not connect before completion will need to be “heat network ready”. The Consultation requested views on what “heat network ready” should mean. DESNZ indicated that it could include:
- “designing buildings containing multiple premises with communal heating systems instead of individual heating systems”;
- “installing appropriate internal measures which differ from standard building regulations for heat pumps”;
- “designing space within buildings for heat network pipes and other connection equipment”; and
- “requirements on new buildings to have appropriate levels of insulation for pipework”.
The final position within the Regulations regarding whether a building is “heat network ready” will be of particular concern to you. However, the issues this raises will be similar to those of a building that is required to connect to a heat network “on completion of construction”. The bottom line is that your building should be designed in such a way that it will be able to comply with the Requirement to Connect.
How the proposed Regulations will impact investors in existing communally heated buildings and existing non-domestic, non-communally heated buildings
Which buildings will be affected?
The Consultation states that “all buildings with existing communal heating systems will be within scope of the requirement to connect, meaning all communally heated residential and non-domestic buildings.”
It also proposes that within its scope are:
- mixed-use buildings;
- buildings which are partly communally heated; and
- other residential buildings which do not include distinct, separate dwellings (eg nursing homes).
Existing residential buildings with individual heating technologies will not fall within the scope.
Some existing non-domestic, non-communally heated buildings will also come within the scope of the Requirement to Connect. A threshold test will be used to determine this, however DESNZ acknowledged that responses to an earlier consultation regarding the threshold were “mixed”. The Consultation proposes to base it on the heat demand for a given building. Given the response to the earlier consultation, DESNZ indicated that they will consider a number of potential metrics. The final decision will be significant, given the potential number of buildings it could affect.
How will a Requirement to connect be activated?
It’s DESNZ’s expectation that building owners and heat network developers will voluntarily engage with each other, so there will be no need for the more coercive Requirement to Connect procedure.
If it is needed, then the consultation proposes that the Zone Coordinator activate a Requirement to Connect by giving notice to the owner of relevant buildings. The notice will include:
- the steps the building owner must take to enable connection;
- the window of time within which connection must occur; and
- how long the building owner has to agree the connection date with the heat network developer.
If your building is subject to a Requirement to Connect, there are a wide range of potential issues which you (as owner) need to be aware of, such as:
- practical issues (e.g. how any required works will be carried out);
- financial issues (e.g. who will bear the cost of the carrying out of works); and
- legal issues.
Regarding legal issues, we recommend that if you are a landlord, you review your existing lease arrangements as soon as possible to identify any likely issues, so you can address them prior to the Regulations coming into force. This is because, in our view, potentially significant matters could arise from existing lease structures – which the Consultation does not address. (Note that the Consultation is clear that the Requirement to Connect falls upon building owners, not occupiers.) Given that the vast majority of leases currently in place will not have taken the upcoming Requirement to Connect into account, landlords may not have sufficient reserved rights to enable compliance without the cooperation of tenants. Furthermore, service charge regimes may not enable recovery of the costs incurred in complying nor might they permit the recovery of costs for the provision of heat where a cheaper source (e.g. an existing system) is available.
There are potential benefits as well as potential burdens…
The Requirement to Connect might impose a burden on building owners. However, connection to a low-carbon heat source could offer significant benefits too – especially if occupiers are particularly concerned by their environmental impact. It will take some time for the full impact of the Regulations to manifest. However, when it does, it could provide an opportunity for building owners to decarbonise the heating systems in your buildings without incurring the significant capital costs of installing such a system. A potential benefit, then, if you have invested or plan to invest in existing buildings.
Conclusion: Preparation is key
How effective heat networks prove to be in helping the Government in its aims to decarbonise the heating of buildings remains to be seen. Regardless, if you are a property developer or investor, you need to be alive to the practical impacts of the Regulations.
We expect that it will take some time for developers, investors and their respective funders to fully appreciate the impact of the Regulations. It’s our belief that the market will adapt, as those operating in the sector become used to working within the Regulations.
It is widely accepted that achieving our Net Zero commitments is crucial, but it will come at a cost. However, although the Regulations may result in cost consequences for developers and investors alike, for an increasing number of building occupiers, connection to a low-carbon heat source will be seen as an attractive prospect – even something they expect. Why not take this opportunity to get ahead of your competition?
Read our latest report Getting to Net Zero: The potential for heat networks in our communities
The report collates the views of 80 UK-based investors and developers, as well as in-depth interviews with Equitix, Related Argent, Hemiko, SSE and Asper, to gather insights and experiences of funding and developing heat networks projects in the UK and Europe. Read more here.
This article was written by Fraser McKay, Senior Associate, Real Estate.