|
|
Green Leasing: Addressing Sustainability in Your Lease
Lease Terms Are Going Green: Are You Ready?
Update
05.15.2009
Green leasing is an emerging field of interest to developers, landlords, tenants, board members, shareholders, lenders, and government officials. Such wide-ranging interest stems from the many financial, public relations and environmental benefits that may be realized through adoption of green leasing policies. Landlords, tenants and developers who find themselves in the following situations should consider green leasing:
-
Landlords, tenants or developers seeking ways to reduce facility energy consumption or utilize financing incentive programs;
-
Companies leasing space and seeking to comply with corporate sustainability policies;
-
Tenants contemplating near-term tenant improvements;
-
Landlords or tenants nearing lease expiration; and
-
Developers and landlords interested in maximizing rent or attracting potential tenants and users (employees or customers) that seek environmentally friendly spaces.
Green leasing practices have seen substantial growth in the commercial office space sector in recent years and are also shifting into retail markets. Retailers such as Wal-Mart, McDonald's, Subway, Target, Kohl's, Staples, Office Depot, and Best Buy have opened or are currently constructing green stores. Familiarity with green leasing concepts is quickly evolving from a luxury for environmentally conscious companies to a necessity for business and real estate professionals.
What Is a Green Lease?
A green lease is a traditional lease modified to facilitate achievement of and allocate responsibility for sustainability-related goals. Green leases utilize various incentives, standards, penalties, covenants, representations, and warranties to achieve these goals. Common areas of emphasis in green leasing include reducing energy and water consumption, using alternative on-site energy sources (e.g., solar or wind), maximizing recycling, integrating waste management practices, and creating a healthy internal environment (e.g., improvement of indoor air quality or promotion of transportation alternatives).
An effective green lease considers and defines the goals of the parties, their expectations regarding operating and monitoring the space, and the parties' willingness to assume increased costs associated with certain green leasing concepts. Other issues in a green lease that require careful consideration include defining and allocating tenant improvement and common area build-out responsibilities, rent structure and operating costs (e.g., energy and water costs), implications of lease terms on third-party certification programs, ongoing operating terms (e.g., use of hazardous materials, recycling, environmental management plans), and remedies for breach of contract.
Sharing Costs and Benefits of Sustainability
Unique challenges are presented when allocating costs incurred for sustainability purposes. If a lease unduly limits inclusion of capital expenditures in operating costs, it may discourage a landlord from purchasing capital equipment that will primarily save the tenant money. For example, a landlord under a net lease may not have an incentive to purchase high-efficiency equipment where it bears most or all of the cost of the purchase while tenants reap the reward through decreased operating costs. But, market forces could still push landlords to keep operating expenses low to compete with other buildings for tenants. Conversely, a tenant under a gross lease may not realize the benefits of lower operating costs within a green building. Determining the best lease terms to address sustainable energy and water use within the building is an important step in drafting a green lease.
Allocating costs and benefits of green development may also require examination of the base rent and, if applicable, base year operating expenses, in light of tax and other financing benefits that may be available. The party building out the green space may receive tax incentives, such as property tax exemptions, that may affect recovery of initial green development capital expenditures. These incentives may also change or disappear over time, altering the initial costs and benefits balance. These tax incentives should be factored into negotiation of the lease terms.
Multi-tenant buildings, such as shopping centers, office buildings and industrial parks, where only a few of the tenants are interested in sustainability, require special consideration. If the landlord spends money improving the energy efficiency of the common areas, should tenants who did not contribute to or support the green improvements receive the benefit of decreased building energy costs through lower operating or common area maintenance expenses? Should the landlord be able to pass on expenses incurred to improve sustainability in common areas? In single-tenant buildings, there is a strong correlation between the actions of the tenant and the expenses incurred in operating the building. In multi-tenant properties, the link is more tenuous. Absent submetering or other mechanisms that link consumption and costs, it can be difficult to align costs and benefits where some tenants are participating in sustainable initiatives and others are not.
Third-Party Certifications and Green Leasing
A growing number of businesses are seeking recognition for their green efforts through third-party certification standards such as the U.S. Green Building Council's LEED® program, Energy Star®, or Green Globes™. In some cases, lease terms can be tied to points or credits available under these programs. For example, LEED for Commercial Interiors (LEED-CI) awards points to tenants who sign leases with terms of 10 years or longer. Points are also awarded toward LEED-CI certification for tenants who lease in buildings that are LEED-certified or meet strict water conservation requirements.
Another growing area of certification is LEED for Existing Buildings (LEED-EB). LEED-EB allows a building owner to achieve certification by making certain improvements to the energy and water efficiency, waste management, and internal air quality of existing buildings. The owners of the Empire State Building in New York City recently announced plans for a major overhaul to the building that they hope will attain LEED-EB certification.
The various categories of certification offered under the LEED program provide the opportunity for one party to a lease to pursue certification even where the other party has no interest in sustainability. For example, a tenant in a commercial space can obtain LEED-CI certification by making improvements within its leased space. Similarly, a landlord may be able to obtain LEED-EB certification absent the cooperation of some tenants.
Responsibility for ongoing compliance costs is often overlooked where the landlord and tenant seek third-party certification. Who bears the cost of compliance when a standard changes? Who pays for any monitoring or study costs required to maintain or update compliance? Does the building's insurance policy provide proceeds covering the additional costs of restoring or replacing a certified building or tenant space or associated smart technology (on-site energy facilities, HVAC systems, etc.) and the additional time that may be required for restoration? These issues require careful consideration when negotiating and drafting a green lease.
What if a Party Fails to Meet Its Green Obligations?
A green lease should also define the consequences for a party's failure to live up to the defined sustainability standards. The range of remedies available is wide and open to creative approaches. Some breaches may be so significant that the non-breaching party should have the option to terminate the lease or obtain liquidated damages. For example, if a landlord or tenant constructs improvements in a manner that jeopardizes the property's LEED certification or financing qualifications, the non-breaching party may wish to exercise these remedies. Less significant breaches may warrant rent reduction or reimbursement of operating expenses. If a tenant fails to meet energy conservation targets, the lease may demand that the tenant purchase carbon offset credits.
| Practical Tips
Green leasing is a rapidly evolving area. It is important to monitor and review issues as they arise and to account for the increasing importance of green leasing and development. Plan ahead when entering into a new lease or nearing lease renewal to ensure that your lease provides the proper tools to meet sustainability demands. When considering green leasing, the following issues should be addressed.
1. Determine Your Vision of Sustainability
A clear vision of your company's sustainability goals helps to determine the policies and provisions best suited to achieve those goals. Your goals should be captured in the lease terms that define what it means for the rental space to be "green" and allocate construction, design, and operation costs and responsibilities. Many companies have incorporated sustainability principles into their corporate policies and mission statements. Information regarding green corporate policies will be provided in a future update from this series. Before investing time and money negotiating terms or drafting documents, companies should spend time reviewing existing policies and consider how such policies can be incorporated into leasing.
2. Identify Barriers to Your Sustainability Goals
The field of green leasing exists because traditional lease documents create barriers to the collaboration between landlord and tenant needed to meet sustainability goals. These barriers should be identified at an early stage. Consider your vision of sustainability in the leasing context and ask, "What is stopping us from attaining our goals?" Often, barriers to sustainability exist because the benefits offered by green leasing are not adequately reflected in a traditional lease's allocation of incentives and responsibilities.
3. Align Incentives and Responsibilities to Help Achieve Sustainability Goals
Once the barriers to sustainability in a lease have been identified, the lease must be modified to minimize or eliminate those barriers. There is no one-size-fits-all approach. A successful lease considers the sustainability goals along with the cost and risk tolerance of the parties.
4. Consider the Best Time to Implement Sustainability Goals
Some green concepts can be integrated into the building at a lower cost during construction than as a modification at a later date. These include:
-
Submetering of electrical and water consumption;
-
Incorporation of renewable sources into the power supply; and
-
Improved indoor air quality through use of products with low volatile organic compound levels.
In existing buildings, green lease concepts are generally integrated into the documents at the outset of a new lease or the commencement of a renewal term. Other events that may trigger discussion of green leasing principles include a tenant expanding, remodeling or modifying an existing space, or a landlord planning a major overhaul of common areas.
5. Negotiate Contracts for Improvements or Upgrades Carefully
Any company procuring sustainability-related improvements or upgrades should consult early and often with professionals familiar with the types of goals they hope to achieve. Contracts with a general contractor and architect should be specific in spelling out obligations to use certain materials, contractors and disposal methods. Clarify who is responsible for meeting the standards you strive for and describe the remedies available if the standards are not met.
Increased interest in green leasing has led to the development of some industry form documents. These documents can provide a useful starting point for understanding the many ways in which a lease can be a tool to promote sustainability. However, these documents are often skewed to favor one party over another and should be examined to address the unique characteristics of any transaction.
This Perkins Coie Update is the second in a series of updates designed to help you navigate the following topics: (1) green building, (2) leasing green facilities, (3) tax incentives and financing tools for renewable energy and energy efficiency efforts, (4) maximizing existing real property assets for energy production, and (5) corporate "green policies" governing facility development, advertising and management. |
1. Andrew Martin, Green Plans in Blueprints of Retailers, N.Y. Times, Nov. 7, 2008, available at http://www.nytimes.com/2008/11/08/business/08build.html?_r=2&oref=slogin.
2. Id.
3. David M. Levitt, Empire State Building Plans Environmental Upgrade, Apr. 6, 2009, http://www.bloomberg.com/apps/news?pid=20670001&sid=artf5gfuxqeg.
|
 |
|