In our increasingly environmentally responsible society, the “green” buzz word is pervasive – from wind, sun and other renewable energy sources, to hybrid cars and reusable grocery bags. In the commercial real estate industry, “green” entails, among other things, green buildings and green leases. In today’s “red” economy, some may argue that green real estate is just a passing fad. However, all signs indicate just the opposite – that green is the future standard in the real estate industry.
In the leasing context, a green lease could mean anything from adherence to a landlord’s recycling plan to adherence to a LEED Platinum level certification for 100% of the building. The allocation between landlord and tenant of the responsibilities, costs and benefits of compliance with green certification can be a thorny issue, sometimes resulting in a heavily negotiated and complex lease document. Factors which drive this balance are the parties’ respective green goals and bargaining strengths.
The following is a non-exhaustive list of those areas of a commercial lease which are most impacted in connection with the negotiation of a green lease.
OPERATING EXPENSES
Depending upon the type of lease, there are competing landlord and tenant incentives with respect to the sharing (or not, as applicable) of operating expenses. With a true gross lease, pursuant to which the landlord pays all operating expenses, including utilities, the tenant may not be as motivated to adhere to the green goals of the landlord – for example, enforcing among its employees adherence to landlord’s recycling rules, shutting lights off at closing or keeping heating or cooling within an efficient range, since the savings do not benefit the tenant. On the other hand, with a net lease or modified net lease, pursuant to which the tenant pays its share of operating expenses, or its share of increases in operating expenses, the tenant has an incentive to ensure that building operations and maintenance are as efficient as possible. In order to avoid part of the inequities on both sides of the energy usage problem, the tenant may want to install its own electric and water sub-meters. In the net lease context, the tenant will want the most recent or pro-forma budget up-front to understand building maintenance and operation costs, as well as the right to audit expenses and recoup overpayments.
CAPITAL EXPENSES
Traditionally, the tenant will strongly object to any inclusion of capital expenses within the definition of operating expenses, based on the rationale that such expenses are not part of the daily cost of operating the building but are more in the nature of asset costs. Increasingly however, landlords are pushing to include as operating expenses the amortization of those capital expenses that are intended to meet green objectives. The landlord’s argument is that the tenant reaps part of the benefit of such expenses through lower cost building operations. The tenant however, does not want to pay for expenses when the savings are not provable or will not be realized during the tenant’s occupancy. Therefore, the tenant may want to require proof of actual cost savings as a condition to the inclusion of such items in operating expenses. However, the short-term tenant may want to completely resist such expenses.
LEASE TERM
Some certification programs, such as LEED, give certification points to green buildings with longer lease terms, so as to reduce the impacts associated with frequent tenant turnover. From a tenant’s perspective, a longer lease term brings stronger bargaining power and ability to recoup some of the benefits of costlier capital improvements which landlord may pass through as operating expenses.
RULES AND REGULATIONS
The landlord seeking to maintain a green certification for operations and maintenance will want to incorporate an energy maintenance plan into the building rules and regulations. The various areas of concern include operating hours of each tenant (with ability to charge tenants for after-hours energy usage), recycling, construction materials disposal, furnishings, cleaning materials, office products and office appliances. The landlord may want to include use prohibitions and impose penalties for violations of its energy maintenance plan and rules. The prospective tenant will want to review any energy maintenance plan, rules and regulations and budget up-front so as to avoid any misconceptions and catch possible hidden costs.
DEFAULTS
The landlord will want to prohibit the tenant from doing anything which would adversely affect its green certification. Similarly, a tenant will want to require the landlord to enforce the building’s green rules against violators and/or have direct enforcement rights. What if green goals are not met? Issues such as quantifying damages (if any), imposing fines for violations, identifying fault, invoking cure/self-help rights and rent offset and abatement rights come into play. The defaulting party will want to avoid a punishment that outweighs the crime, e.g., lease termination. One option is to mediate and/or arbitrate such disputes.
TENANT SPACE BUILD-OUT
The landlord may require the tenant to seek a green certification for its interior. In such a case, the tenant will want to know just how “green” is “green.” It is important to identify acceptable construction materials. Adherence to landlord’s requirements may increase tenant’s build-out budget, which may or may not make sense for the tenant, depending on the tenant’s green goals, term of the lease and other financial terms.
CASUALTY RESTORATION
There may be upgrade issues where the building or space was not certified as green prior to a casualty (or certified at a lower level) and one party requires the restoration to meet green standards. This will need to be spelled out in the lease, and parties should be realistic about timeframes for restoration and green certification. Each party may want to research whether there is insurance available to cover possibly increased construction costs for green re-building. For especially older buildings which require green upgrades, either party will want to have the right to terminate under certain conditions.
ACCESS
The landlord will want to be able to monitor tenant’s compliance with its green policies to ensure that its certification is retained (for example, to verify compliance with recycling, the use of green interior build-out materials and temperature controls). This may involve the need to enter tenant’s premises more frequently than is typical. A tenant has a reasonable expectation that it not be interrupted or inconvenienced by such intrusions, and may have security and confidentiality concerns. This needs to be balanced with fair advance notice provisions, limitations on frequency of access, and landlord adherence to tenant’s security and confidentiality requirements.
INSURANCE
There may be insurance incentives to being green, and landlord will want to look into whether a green certification translates into discounted premiums. If so, the tenant will want those savings passed on to it, to the extent such costs are operating expenses under the lease.
CREDITS
In connection with the construction and/or operation of a green building, the landlord may receive income tax credits. In the landlord’s view, this is one of the many incentives to being green, and is part of the landlord’s profit, similar to a historic tax credit development. This is particularly important to the landlord in a gross lease scenario. However, in a net lease context, the tenant may argue that to the extent it is complying with landlord’s policies, it should share in some of the benefits, much like savings passed on to a tenant in connection with a real estate tax abatement.
SUMMARY
The commercial lease negotiation is a fluid process. For parties with relatively equal bargaining strength, the end product is usually the result of a series of compromises which, in the aggregate, meet each party’s goals. With the increased focus on going green, it is imperative for real estate professionals, owners, managers and tenants to understand its effects upon leasing, so they will be successful in the business of green.