Greening your leases – joining forces to achieve sustainable office space
Corporations have ample motivation to pursue environmentally responsible strategies which can help to:
• Enhance their reputation with employees and customers
• Reduce operating costs
• Reduce their carbon footprint
• Benefit areas such as productivity and risk management
Companies that implement sustainability initiatives at their owned facilities often expect a similar commitment in the management of buildings where they maintain large leases. Despite the tremendous progress in many countries toward a green office marketplace over the past several years, landlords and tenants are running into roadblocks that make further progress difficult.
One of the primary challenges faced by sustainability advocates of commercial buildings is overcoming the misalignment between landlord and tenants when it comes to who pays for and who benefits from energy efficiency and other sustainability measures (also called the “split incentive” problem).
Both groups want to reduce their environmental impact; however they have different financial incentives. Some scenarios are beneficial to one party and not the other. This often results in missed opportunities for investment in energy efficiency, because the parties do not share proportionately in the cost and benefits.
The problem of split incentives is further complicated when there are several tenants in a building with different objectives. Any tenants considering a move out of the building within the next five years would not want to share in the upfront cost, knowing that they might not be around to reap the benefit. Tenants on long-term leases might be willing to pay their share, but they would not want to pay the entire cost.
While no single solution exists for every problem, strategies are emerging to manage many landlord-tenant issues.
Corporates push sustainability criteria in their location decisions
Increasingly, tenants are adding sustainability criteria to the leasing process, from location selection through to final lease negotiation. Various ’green lease‘ terms are being added to contracts to ensure that sustainability practices are instituted or maintained if a building has been designed as ‘green’.
Jones Lang LaSalle leasing brokers in the United States have reported that owners and tenants are addressing split-incentive issues in an increasing number of lease negotiations. In the past two years, owners have been attempting to negotiate terms that explicitly allow them to charge tenants for energy oriented expenditure as operating expense, up to the amount of energy savings accrued. While some tenants resist the measure initially, most large companies can see the value of lease terms that improve the sustainability of buildings they occupy - as long as they will not see their occupancy cost rise as a result.
A collaborative landlord-occupier approach
Successes like this have prompted corporate real estate directors to collaborate with one another and with large-scale owners to address these issues at a high level. One recently-formed group has brought a dozen or so large, multi-regional occupiers and property owners together. They collectively own or occupy nearly 1 billion sq ft of office space.
Jones Lang LaSalle has agreed to facilitate the formation and growth of this effort, which is based on the following guiding principles:
1. Both the landlord and the tenant will operate the building as sustainably as is commercially feasible.
2. The extent of energy savings achieved through building efficiency improvements should be available to pay for further enhancements.
3. Where feasible usage and demand for resources throughout the building should be measurable and transparent to both landlord and tenant.
US landlords find innovative solutions
A number of strategies to mitigate the split incentive dilemma have emerged in the US in recent years, including some that owners can undertake without engaging tenants.
CalCEF Innovations, a unit of the California Clean Energy Fund, discusses several public- and private-sector financing programs in its February 2010 paper, Energy Efficiency Paying the Way: New Financing Strategies Remove First-Cost Hurdles.
One private firm, Metrus Energy, provides 100% of financing for energy projects, repaid by the number of energy units saved over time (often 10 years). Another firm, Transcend Equity, offers a Managed Energy Services Agreement (MESA) where the owner pays Transcend an amount equal to its historical energy usage for five to 10 years, while Transcend pays the actual utility bill, pocketing the savings realised from the improvements.
The Metrus and Transcend programs are similar in that they allow owners to avoid upfront costs but reduce energy use. However, CalCEF agrees that both solutions face significant challenges in owner education and access to debt financing.
Of the two, Transcend addresses the split-incentive challenge more directly by allowing owners to pass on costs to tenants as operating costs under standard lease terms. Tenant operating costs do not increase, nor do they decrease in the forthcoming years as energy usage is reduced. They do however gain other benefits of occupancy in efficient buildings such as enhanced employee comfort and reduced CO2 emissions.
UK leads Green Lease adoption in Europe
In the UK, Green Leases have been in place for several years and organisations such as the Better Buildings Partnership (BBP) have helped the industry provide a framework for interested parties to use. The BBP’s Green Lease Toolkit, introduced in April 2009, contains a model Memorandum of Understanding that can form the basis for any green clauses contracting parties may want to add to their leases.
Based on non-prescriptive best practice recommendations, a partnership approach seems to provide the best basis for keeping a Green Lease agreement flexible.
It needs to allow for:
• Different property types and sizes
• Hours of operation
• Occupancy profiles
• Existing sustainability commitments
• Various other factors that make each situation different
Feedback from industry sources seems to show that uptake of the Green Lease Toolkit so far has been rather disappointing, but with a more positive market environment and the new carbon emissions regulations in force since April 2010, the incentives will now be greater.
One of the leading property companies in Europe, Hammerson plc, put in place 700 green leases with their tenants in the UK and France by the end of 2009. It intends to add BBP MoUs to their commercial leases in order to keep engaging with their retailer clients. MoUs forms the basis for a consensual approach and allows parties to agree on specific terms.
France greens leases through regulatory measures
Through its recently adopted environment bill (Grenelle Environnement), the French government wants all real estate market participants to add “green clauses” as an appendix to their commercial leases. Landlords and tenants are obliged to add this appendix to existing leases from late 2013, and to renewed leases from 2012.
While there will be a regulatory obligation for greened leases (for leased floor areas above 2000 sqm), they only need to contain minimal elements such as:
• Measuring energy consumption in common and demised building areas
• Establishing dialogue between the two parties in order to discuss energy
performance
• Any (optional) measures that could be taken to improve the energy efficient
use of the premises
To make this obligation easy to swallow, the new law does not force any kind of quantitative reduction targets upon the parties.
As in the UK and other countries, France has recently made a number of Green Lease announcements. In particular Unibail-Rodamco, Europe’s largest shopping centre owner, has started to systematically introduce sustainability clauses into their leases and has set a target to add green clauses to 60% of new leases during 2010.
Practically speaking, by signing a green lease, the tenant agrees for example not to use the full retail lighting system when the store’s shutters are drawn or when only staff and cleaning teams are present. According to Unibail-Rodamco, a 500 sq m retail store can reduce light-related energy consumption by 30% and achieve annual savings of more than €6,000 by changing to low-energy lighting.
Dutch Government ready to renew long term leases for energy efficient offices
To set an example, the Dutch Government from 2010 onwards will require all its new leases to be in buildings that have a certain energy performance level, however this level is only attained by around 20% of all existing office buildings in the Netherlands.
In order to facilitate this challenge, the Dutch Government is willing to renew contracts with a short remaining lease terms to create an incentive for necessary investments in energy efficiency measures in given buildings.
Flexibility - crucial to green lease futures
Green leases have started to emerge over the past few years as a tool to help organise and promote environmental goals as part of office lease specifications. They are a rather recent phenomenon and landlords and tenants will continue struggling with the details.
In order to increase the penetration rate of sustainability clauses and their goals in lease agreements, a number of practical solutions are appearing in markets around the World. Green Lease solutions vary from regulatory obligation to market based operating cost savings.
It is important to keep the definition of green lease terms flexible for parties to be able to accommodate variations in building performance based on:
• Hours of operation
• Tenant usage and fit-out
• Weather patterns
• Unforeseen breakdown in equipment
• Building occupancy profiles
Effective communication between all stakeholders in a building, from the owner and occupier to all service providers and contractors, will enable ongoing success in promoting and greening office space.