Green leasing is on the rise in popularity nationally — and it won’t be long before we start seeing more green leasing in West Michigan.
A green lease addresses energy efficiency and the costs — and savings — associated with it, as well as construction and ongoing maintenance provisions and requirements. Green leases first began to appear around five years ago as tenants, particularly national retailers, began insisting that the buildings they occupy were green. Now, global companies like Walmart are demanding them.
Green leases were viewed by some skeptically at first. Prospective tenants and building owners were concerned about the increased costs associated with green building, the lack of experience in green design, and the lack of mass-produced green materials.
But as sustainable design, building practices and building materials have evolved over time, there is no longer a substantial additional cost for green buildings. In fact, the ultimate costs savings over time may make it worthwhile to invest in the construction and maintenance of green buildings.
Green buildings will typically earn a developer or owner an average of 2 percent higher rental rates over what other buildings can earn. Further, green buildings can attract tenants having a higher net worth, which improves the credit worthiness of a new or rehabbed facility, thus improving the owner’s ability to secure financing.
Tenants, too, find operational benefits from leasing green buildings. Studies have shown that employee absenteeism is lower while employee retention is higher for employers in green buildings. Additionally, productivity increases and hiring becomes easier.
Gross vs. net leases
But green leases can create some challenges, depending upon the side of the equation that you are on — and what kind of lease you have.
Generally speaking, there are two types of leases. A tenant with a gross lease pays a specific fixed dollar amount each month for the particular space, which covers everything including base rent and the tenant’s share of real estate taxes, insurance and other operating costs of the building all in one fixed monthly payment. In a net lease, on the other hand, in addition to paying the specific fixed base rent each month for its particular space, a tenant pays its share of the costs of real estate taxes, insurance premiums and other costs of operating the building based on the landlord’s actual operating expenses, which can vary from time to time significantly.
You can see the potential problems already. With a gross lease, a tenant has no economic incentive to save on energy costs since monthly costs are fixed, no matter how much energy is consumed at the building. But the landlord under a gross lease does have incentive to cut such costs, allowing the landlord to profit from the difference between the fixed amount paid by tenant each month and the savings achieved if landlord’s out-of-pocket building energy consumption costs are reduced.
Conversely, with a net lease, the tenant, who is charged directly for its share of the actual building energy consumption costs, has incredible incentive to be conservative on energy costs. But the landlord has little incentive to upgrade equipment to make that possible since the landlord simply passes all energy consumption charges straight through to its tenants for payment.
The compromise, though, can be a green lease, a more collaborative approach that creates incentives for both landlord and tenant to be more energy efficient.
Issues in green leases
Green leases the split incentives of landlord and tenant discussed above. The net result is a better, more environmentally friendly facility for both sides of the equation. In a well-drafted green lease, both sides reap rewards without either one having to bear the entire brunt of the financial burden.
Issues to consider include:
Setting allowances for utilities. This encourages a tenant to stay within certain parameters or else pay charges for extra usage above and beyond the allowance. Let’s use as an example a tenant under a gross lease with a landlord who wants to make capital improvements to the facility to increase energy efficiency. The tenant is incentivized to stay within the allowance and would therefore be benefited by the landlord upgrading building utility facilities to reduce wasteful consumption. In circumstances such as this, the tenant would likely be willing to share in the amortization of the cost of such upgrades to the building since the tenant benefits directly from the resulting energy efficiencies and reduced utility costs, while the landlord is able to improve its building at a reduced out of pocket cost.
Establishing ongoing operations requirements. If it is important to the tenant to occupy a building that is green, the tenant needs to ensure that the lease specifies that the landlord is obligated to monitor efficiencies in building equipment and energy consumption on an ongoing basis, maintain the building and grounds in accordance with green standards, etc. The tenant needs to be vigilant in requiring the landlord to live up to commitments. Landlords seeking to maintain a green building may impose requirements upon the tenant in the lease by requiring the tenant to install energy-saving devices such as light sensors and low-impact lighting, participate in building-wide recycling programs and the like.
Installing separate utility meters. These will track actual premises — not building — usage and give a better read on a tenant’s true utility consumption. This is highly recommended for energy-conscious tenants. It allows individual businesses that may share a building with less green tenants to pay only for their own careful consumption, as opposed to sharing in the cost of the entire building consumption which may be higher due to less conservative energy usage by other tenants, while allowing the tenant to monitor its own usage and look for ways to directly reduce its own consumption and cost.
Monitoring adherence to building-wide recycling programs. Large office buildings or complexes often have building-wide recycling programs. It is important for landlords to audit each tenant to ensure that there is no “leakage,” such as the business that throws away paper rather than recycling it. The landlord could charge tenants a fee for leakage. Tenants, too, may opt to audit their landlords to ensure that the materials collected are actually taken to facilities where they can be recycled.
Mandating the use of green cleaning products. Both landlords and tenants may require the other party to use green cleaning products or employ a green cleaning service in performing their respective cleaning responsibilities under the lease.
Specifying that insurance cover green reconstruction or restoration. What happens if a building is damaged or destroyed? A landlord or tenant who wants a green building should specify in the lease that adequate insurance will be carried to cover the additional costs needed to rebuild to green standards in the event of casualty.
These are just a few examples of the considerations that are taken into account by environmentally conscious and responsible parties to a green lease, and the cooperative approach taken in order to achieve their respective sustainability and business objectives.
Margaret Van Meter is senior counsel at Warner Norcross & Judd LLP. She can be reached at email@example.com.