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Wins & Insights

Tenant Leasing Illustrated – Oct 2012 – It Ain’t Easy Being Green

It Ain’t Easy Being Green

Lately, it seems that everyone wants to call their product or service “green” or “organic”.

There are even “green wars”, with some people pushing the importance of organic products, while others lash out at “greenwashing” (i.e., the deceptive use of green marketing). My favorite take on this is probably the Grocery Store Wars pitting organic Cuke Skywalker and Obe Won Cannoli against the evil empire of processed food.

Maybe we should get in on the act. After all, Mintz & Gold’s legal services are pesticide free and contain no artificial flavors. And as our regular readers may have suspected, this newsletter was made with 100% recycled ideas (and humor).

And now, concerns with climate change, energy costs, carbon footprints and corporate image have even brought green to leasing.

Although the term is often bandied about, what exactly is a green lease?

A green lease obligates the landlord and tenant to use the applicable property in the most efficient or sustainable manner.

This sustainability can be achieved through, among other things, particular materials, efficient operating systems, design, location (e.g., near mass transit), term (longer terms mean less moves), landscaping and even availability of sunlight for solar energy.

There are also various organizations that have developed green rating systems for buildings, such as LEED (Leadership in Energy and Environmental Design), and to measure the efficiency of building equipment and how well it is operated, such as the DOE’s Energy Star benchmarking system.

A green lease can benefit tenants through reduced expenses, increased productivity and health of employees and zoning, tax and other financial incentives, as well as improved corporate image. Landlords also receive these benefits, as well as enhanced marketability, increased rents and potentially increased building value.

This sounds like a situation with the potential to benefit both parties, but unfortunately the negotiation often gets stalled on the allocation of expenses.

Bob Meier, an Engineer and Certified Energy Manager, explains that the reason for this is that the structure of many leases provide a “split incentive”, i.e., the party obtaining the benefit is not always the party that bears the cost.

With a net lease (and most retail leases), the tenant is typically paying all of the operating expenses other than capital items, so the landlord has little incentive to incur the costs of installing energy efficiencies.

In a gross lease, the tenant is only responsible for increases over a base amount and, in multi-tenant buildings, typically controls only a portion of the space, so it has less incentive to cooperate in reducing consumption. This is particularly true if the escalation clause is not tied to operating expenses (e.g. with a CPI escalation), but the lease allows the inclusion of some portion of capital expenditures, since the landlord would be spreading the cost to its tenants but the tenant would not benefit from any savings.

Yet even in a gross lease incentives can be reversed, for example if a tenant is obligated to pay increases in building wide operating expenses (excluding capital items), then the landlord would pay for the cost of implementing energy efficiencies and the tenant would obtain the benefit of reduced expenses.

As green buildings and leases become more prevalent, landlords will seek to realize “green benefits”, particularly in new buildings, but in conversions of older building stock as well. Recently, we have encountered gross leases in existing buildings with landlords trying to pass along to tenants “green operating expenses”, including atypical capital costs.

Remain open to the possible mutual advantages for you and your landlord with a green lease (whether in a new building or conversion), but be wary of hidden costs by focusing on the following six points that we developed with the help of Bob Meier:

  • Avoid being on the short end of a “split incentive”. Understand the flow of funds so that any energy efficiency initiatives do not arise strictly at your expense. This understanding will allow you to take advantage of the many benefits that can result from these initiatives.
  • Limit your annual cost for capital improvements. If you do agree to share in capital costs to reduce operating expenses, include the customary limitation that the annual cost of such capital improvement be amortized and not exceed the amount of actual savings.
  • Minimize the downside of green covenants. Such covenants govern tenants’ conduct (and provide the landlord with benefits in terms of various rating systems), e.g., with respect to the initial build out, future alterations, use and maintenance, operating expenses and rules and regulations, in an attempt to reduce energy consumption, minimize waste and allow for data collection.

○​  Failure to comply could lead to a tenant default so provide language indicating that tenant “will endeavor to” meet these standards as goals.

○​  Provide “safe-harbor” categories for allowed activities without the landlords’ consent.

○​  Whether a covenant or a goal, you should be afforded notice and ample opportunity to cure and only repeated violations should be deemed problematic.

○​  Make the landlord’s remedies result in a lesser penalty than a default, such as a modest liquidated damages “fine”, or landlord cure rights, or have initial failures to comply act as triggers for conversation.

○​  Specifically exclude consequential damages that could result from a loss of the landlord’s tax credits, tax abatement, loan commitment etc. and exclude green covenants from the lease indemnity.

  • Resist the use of existing lease covenants to create unintended green covenants. Landlords cannot unilaterally rewrite lease clauses to incorporate new covenants, even with the best of intentions (watch out for changes through the rules and regulations).
  • Consider imposing green covenants on the landlord. Major national tenants are starting to impose green covenants of their own on their landlords.
  • Consult with an industry expert during the lease negotiations. We always counsel our clients to obtain independent experts to advise and work with us with respect to the drafting of the technical and construction aspects of a lease. This is particularly important as you try to obtain a fair outcome regarding cutting edge technologies such as energy efficiency.

As that well known real estate attorney Kermit the Frog would say, “it ain’t easy being green“. At least if you follow some of the suggestions above, being green in terms of your lease will not turn out to be too difficult.​