USE GREEN LEASES TO PUT MORE MONEY IN YOUR POCKET

A Green Lease Guide For Commercial Owners And Tenants

By now you certainly have heard of the benefits of a green lease: the energy savings; brand enhancement; and of course the increased rents. But, with all these benefits, should they be used in every case or are there pitfalls and how do you avoid them?

To begin with, let’s define the term “green lease”. In actuality, it merely a lease, or a clause in a lease, that addresses “green” issues associated with the leased property. The great thing about green leases is that they can be anything you want them to be. It can be limited to a single issue such as allocating cost/benefit of energy savings from an energy upgrade or as complex as controlling the behaviors of the tenant including the recycling practices, use of cleaners, and landscapers, etc. In other words, it is one more tool for both tenant and owner in the leasing process that can have some real benefits for both parties, if used correctly.

Benefits of Green Leasing

Let’s take a quick look at the benefits of green leasing. For purposes of this article we are only going to talk about the energy efficiency side of green leasing. That’s where the real money is for both parties. We will leave the other elements for which you can use green leasing for later discussions.

“The results show that, on average, both ENERGY STAR and LEED projects enjoy rent and occupancy premiums that not only pay for the additional green development costs but also provide attractive IRR on green investments.” Jerry Jackson, How Risky Are Sustainable Real Estate Projects?

Property managers should take note here. By improving your building’s energy efficiency, you can use that information to help persuade tenants that your building is the more efficient choice, but more importantly, that it cost them a whole lot less to lease from your energy efficient building compared to the energy hog across the street. Get the right information from leasing experts so you are able to maximize the value and capitalize on this trend.

So as you can see, there is a tremendous benefit to engaging in green leasing practices. The benefit can be one of actual dollars saved; it can be the benefit of public relations from “going green”; energy savings; or anything in between. But the key is the green lease clause that lets you allocate energy savings. You can do that as set forth above with the adjustment for rental costs, or you can do it through actual savings. The leading example of a savings payment allocation is the City of New York. In a very public effort to set an example for model green leases, New York City announced that it was requiring the use of an Energy Aligned Clause (EAC) in all its future leases. The EAC as it is called enables the City as a tenant to demand energy upgrades to its lease space while at the same time guaranteeing the building owner a payback on the investment based on the energy savings realized. The model lease was utilized very publically by the law firm WilmerHale, when it added the EAC to its 7 World Trade Center lease. The EAC is a great answer to the question posed by most owners which is, why would I pay for a capital upgrade that provides a direct benefit for the tenant but not the owner. By using an EAC, you can align the energy savings and use those energy savings to pay off the upgrade, keeping the owner happy, and then directing the remaining savings to the tenant.

Pitfalls, Downsides of Green Leases

Like anything in the commercial real estate business, if you are not aware of the pitfalls or downsides to green leasing, or you are new to the topic, you need to make sure you avoid the pitfalls. Here are some of the major downsides to green leases that you will need to implement to make sure green leasing works for you, not against you:
1) Allocation of the benefit: Building owners who choose not to do green leases are usually doing so because they don’t see the benefit. And in some of their current leasing programs there would be little benefit. For example, if the tenant is leasing under a triple net lease, what is the value to the building owner to spend $10,000, to upgrade the lighting? The tenant would reap the reward of the energy savings. If the tenant is reaping the rewards, what possible incentive would the owner have in making the capital improvements?
Solution: Implement savings alignment green leasing terms, like the EAC mentioned above. In other words, strike an agreement with the tenant to agree to pay a percentage of the energy savings back to the owner for the capital upgrade. The advantage for the tenant is that the tenant is agreeing to pay only after there is savings. The advantage for the owner is that the savings can be easily calculated. When you allocate the alignment of the energy savings, both parties reap the rewards.
2) Too onerous. Even though the example used was a single issue clause, if you make the requirements too onerous on one or more of the parties you will sink the benefit of the green lease option. Consult an expert in the field to find out how you can find the right balance to make it work without being too onerous. Additionally, if you establish a green lease that is so full of restrictions or limitations (e.g. demanding that they only use biodegradable cleaners, that they hire green landscapers (or pay CAM for you to do it), that they maintain a strict recycling policy, etc.,) it can make some tenants uncomfortable and can also lead to headaches each time they violate one of the “green provisions”. So you want to be reasonable about the provisions and be focused on the value of the program.
3) Failure to set out separate breach provisions and cures for green requirements. It is important to isolate the green elements from overall lease terms. This will enable you to properly address problems and provide you with the right tools to cure the problems. For example, data logging or energy assessments can be used to address issues of energy efficiency non-performance. Without separate specific cure provisions, the more general “termination” elements could jeopardize your lease, for the tenant and the owner.

So, as you can see, you need to think constructively about how to best implement green leases. When done correctly, they can have a tremendous value to both tenants and owners. If you are still uncertain of the value of a green lease clause in your current leasing program, it would serve you well to take the time and examine the benefits/risks. Those that understand the value, and how the game has changed, are taking advantage of this market shift and getting out ahead of the pack.

For more information, see our Energy and Green Leasing and Green Building Law practice area