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What Tenants Should Know About Green Leases

What Tenants Should Know About Green Leases

Green leasing seems headed toward becoming part of the mainstream real estate discussion. However, there is still widespread uncertainty about what green leasing actually is. As such, both landlords and tenants are unsure of the advantages — and disadvantages — that a green lease can afford them. This is a missed opportunity, because a green lease is an excellent vehicle for both tenants and landlords to work together to achieve and retain a green-operated building, and critically in these tight times, benefit from reduced operating costs.

Moreover, for landlords, studies show that going green can substantially increase an asset’s value, and lead to higher rents and occupancy rates.

By way of a brief primer, green leases are traditional leases that also contain provisions on green practices. These practices can cover energy efficiency, water conservation, recycling, and the use of green products, as well as indoor environmental quality. In essence, a green lease is a way for landlords and tenants to hold the other accountable for desired green outcomes.

For example, a tenant may want to ensure that specific energy efficiency practices are maintained after moving in. In some cases, a tenant may want to be certain that their building will maintain its Leadership in Energy and Environmental Design (LEED) certification. A landlord, on the other hand, may want a tenant to operate its business in a way that is consistent with a building’s green rating.

Aligning interests

Greening a building creates the potential for misalignment of costs and benefits between landlords and tenants. The right lease type and structure is therefore important. For instance, a net lease format creates a financial disincentive for a landlord while creating minimal financial incentive for a tenant.

A gross lease, on the other hand, is a superior approach because a landlord is better placed, with the control and expertise required, to undertake comprehensive green changes. The lease should also permit the landlord to pass the cost of capital improvements that reduce operating costs through to tenants on an amortized basis as part of operating expenses, and it should have a right to audit clause.

So why is talk of green leases becoming more common? The answer is two-fold. There is more interest in operating buildings in a green way. This is because it is better understood that building and operating green is also about reducing costs and therefore profitability. In fact, it is suggested that the industry is nearing a tipping point where green is the normal prudent choice, while building and operating otherwise is outdated and wasteful.

To this point, green buildings deliver many real benefits such as lower life cycle operating cost, increased building functionality and higher comfort level for occupants. There is also increasingly hard data on excellent return on investment (ROI), and growth in asset values.

A 2008 study by CoStar Group reports that green buildings outperform conventional buildings in terms of occupancy, sale price and rental rates —sometimes by significant margins. Specifically, the CoStar study found that LEED buildings command rent premiums of $11.33 per sq. ft. more than non-LEED buildings and have 4.1% higher occupancy.

Similarly, the study found that rental rates in Energy Star buildings have a $2.40 per sq. ft. premium over comparable non-Energy Star rated buildings, and as well have a 3.6% higher occupancy. In terms of increase in asset value, LEED-rated buildings commanded $171 more per sq. ft.

The other reason why green leasing is gaining ground is that it is simply a way to future proof a lease. While there are not as yet any uniform standards, green leases are nevertheless becoming increasingly popular with landlords and tenants who want to stay ahead of the game. Moreover, it is likely that in the not too distant future green leases will be commonplace so acting now will better manage risk — what every good lease should achieve for a tenant.

Green lease pitfalls

But green leases are not without risks. For a landlord, if green provisions become too onerous it may discourage potential tenants who are not as advanced in their corporate greening. For a tenant, the resultant costs of certain provisions may not be clear until well into the term of the lease. For example, there may be an obligation to use green products for repairs that come at a premium over conventional materials.

So what happens in the event of a default by either party? A good green lease will explicitly define consequences in the event of a breach. It will also clearly define which breaches constitute a default under the lease, enabling the other party to bring the full range of default remedies to bear. Some green breaches are of less significance and may only require the defaulting party to make "best efforts" to remedy the breach and prevent a reoccurrence.

Because green leasing is a process, it is necessary to start having the green conversation early on. A tip for tenants is that they should look for a broker who not only understands the questions to ask potential landlords, but also what the answers mean. That broker should also have an understanding of the various green aspects that will bring the most benefit to tenants, while also meeting their specific green objectives.

It is our experience that tenant clients are sometimes nervous when it comes to talk of green leases, which they fear are rigid, far from the norm, and expensive. To counter those concerns, it is critical to think of green as a continuum. Certain green provisions will not be suitable for all situations, particularly in the case of older buildings.

However, instead of disregarding green leasing altogether, it is important to at least explore those green outcomes that will afford good value to a tenant. In soft markets like this one, there is no better time to negotiate green provisions into a lease. This will deliver to the tenant not only immediate green outcomes but also long-term benefits, and a future-proof lease.

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