Going Green in Commercial Leasing

Benefits of Green Leases

Both landlords and tenants benefit from green leases. Sustainability improvements made to a project ' such as energy-efficient heating, ventilation and air-conditioning, windows, lighting, and plumbing fixtures ' will lower the utility costs for tenants. At the same time, leasing in a green commercial project can reduce a company's carbon footprint and help to enhance its corporate or brand image. The Millennial generation may be more willing than other generations to pay higher costs for products manufactured by environmentally conscious companies that are dedicated to making a positive environmental impact.

One of the most important benefits of a green lease to tenants appears to be the health benefits tenants' employees gain from working in a green project. A recent study conducted on a financial institution found that its employees who worked in LEED (Leadership in Energy and Environmental Design)-certified branches were more engaged in their work and were overall more productive when compared to their counterparts who did not work in LEED-certified branches. The Business Case for Green Building, U.S. Green Building Council, February 2015, http://bit.ly/2ch3KLR. Office workers in the United States spend a great majority of their days indoors. LEED-certified projects are designed to create a healthy environment with cleaner indoor environmental quality. Improving the quality of life for employees theoretically translates to cost-savings over time, due to a mitigation of health-care costs, communicable respiratory diseases, and allergy and asthma issues; consequently, LEED-certified projects may result in an increase in employee productivity, recruitment and retention.

The aforementioned benefits to tenants have furthered demand for green projects. This increase in demand has provided landlords a competitive marketing advantage and has allowed them to charge higher rents and still stay competitive with local inefficient commercial projects. Green projects, especially those that have obtained LEED-certification, often enjoy higher occupancy rates (Id.), lower maintenance costs (Jeff Kuziemko, Do LEED Buildings Perform? Indeed They Do!, The Green Building Information Gateway, Dec. 4, 2014, http://bit.ly/2c3SL4p) and higher lease-up rates (The Business Case for Green Building, Id.).

Other benefits to landlords may come in the form of government concessions. By building sustainable commercial projects or by upgrading existing projects, landlords may be eligible to receive renewable energy credits, grants, and tax credits.

Finally, green leases are beneficial not just for landlords and tenants, but also for the environment and for the communities surrounding the commercial projects. Because of the environmental benefits of green projects, many governmental entities are starting to implement, and indeed require compliance with, green initiatives. Thus, it is important to discuss some of the provisions that should be included in a green lease and some of the concerns landlords and tenants may have in negotiations.

Drafting a Green Lease

A major barrier to the creation of green commercial leases is a lack of knowledge of green leasing practices and green lease clauses. Green lease clauses must be mutually beneficial in order to encourage both landlords and tenants to engage in environmentally friendly practices. If drafted incorrectly, one party may bear the weight of the costs while the other party reaps all of the benefits. Necessary changes to the standard commercial lease may include language in the pass-through, operational and construction provisions of a lease.

Energy Efficiency Pass-Through Clauses

Two major standard commercial lease forms, triple net leases and gross leases, do not encourage cost-saving practices. In triple net leases, there is little incentive for landlords to make energy-efficiency improvements, since they do not pay the utility bills for a tenant's space. In gross leases, there is little incentive for tenants to make efficiency improvements because they do not pay monthly utility bills. Green leases can address this problem by including efficiency investments made by a landlord as a capital cost pass-through.

Making sustainability improvements and seeking certification can be costly for landlords. Landlords will want to include the costs of commissioning, managing, reporting, maintaining and recommissioning the project to conform with the rating system of the project (i.e., LEED, Energy Star, and the Green Building Initiative's Green Globes for Continual Improvement of Existing Buildings) in the operating charges passed through to tenants. Landlords will also want to include the costs to seek certification for the project in the operating charges passed through to tenants, if the project is not certified at the time of the lease negotiations.

While tenants will benefit from certification and sustainability improvements, there are a few key protections tenants should negotiate in a green lease. A tenant should agree to reimburse its landlord for green operating expenses only to the extent those sustainability improvements produce actual savings for the tenant via greater energy efficiency. The following sample language allows a landlord to pass through “Reduction Costs” while still protecting the tenant against increased costs:

If Landlord makes an expenditure for a repair, replacement and/or improvement (capital or otherwise) to the Project by installing water or energy conservation, labor-saving devices or other repairs, replacements or improvements (“Reduction Improvements”) intended to reduce Operating Costs over time (“Reduction Costs”), the same shall be included in Operating Costs. Reduction Costs shall be amortized over the shorter of (a) the useful life of such Reduction Improvement under generally accepted accounting principles, or (b) the period of time from the date of the expenditure until the estimated date on which the savings arising from such expenditure, including in the calculation any administrative fees, rebates or other credits, are anticipated to exceed the expenditure, as determined by Landlord in its reasonable discretion.

For further protection, a tenant should consider putting a cap on such costs and adding audit rights so that it can assess the true value and fairness of any such Reduction Improvements.

Operational Clauses

Operational clauses can be tailored to meet the specific goals of a landlord and tenant. Important clauses to consider include recycling and waste provisions, temperature ranges and operating hours. If the project is already certified, a landlord will seek specific provisions in the lease detailing the tenant's obligations to help maintain certification, and counsel should discuss these specific requirements with his/her client when drafting the Lease.

If the project is not already certified, the landlord will want the flexibility to amend the rules and regulations without being required to negotiate an amendment to the lease with its tenant. Affording a landlord this flexibility in a lease can cause increased costs in a tenant's operation and otherwise restrict a tenant's normal operation. Thus, tenants should tie their responsibilities to specific, objective standards. Alternatively, if a landlord is unwilling to set objective standards in the lease, tenant's counsel should try to incorporate language that precludes the landlord from imposing any operating conditions that materially affect the tenant's business operation or materially increase the operating costs. Tenants should also seek to incorporate a “most favored nations” or non-discrimination provision that ensures that the tenant will not be held to a greater standard than other tenants.

Some examples of green operational clauses include encouraging alternative transportation for a tenant's employees (i.e., bike-to-work; carpooling), and requiring a tenant to install water sense-labeled, low-flow and low-flush fixtures in bathrooms and kitchens; use appliances that save energy and water; install occupancy sensors in rooms; install programmable thermostats; use rechargeable batteries; and use cleaning supplies that are certified or known to be environmentally friendly.

A green lease should also include a reporting clause to enable a landlord to track the project's progress. This is especially important if a landlord is seeking or maintaining LEED certification. The tenant would then be required to report its utility output if it is sub-metered. Likewise, the tenant may also want the landlord to show project energy and water usage. This clause could be drafted to mirror a gross sales reporting provision. For example, the tenant and/or landlord would be required to report utility usage a certain number of times a year and reports would be kept confidential except for certain mandatory disclosures.

An important point for landlords to keep in mind is that not all tenants may be able to comply with onerous efficiency provisions. Landlords may risk losing potential tenants because some tenants may not be environmentally savvy and may feel the green provisions in a landlord's form lease are too burdensome. Landlords should consider this risk in their leases, particularly if they are inclined to grant most favored nations status.

Environmentally Preferable Purchasing Clauses

Landlords may want to consider including an “Environmentally Preferable Purchasing Policy” clause. This clause provides standards that must be followed when purchasing material for the build-out of the tenant's premises. If the landlord is seeking or maintaining LEED certification, all construction, materials and waste disposal must be in compliance with the minimum standards of the certification. A green build-out can be very costly for tenants and landlords, and both parties will want to consider several issues when negotiating the work exhibit.

If the tenant is performing the build-out and the landlord is seeking LEED certification, the landlord should require the tenant to hire an accredited consultant to oversee the sustainability phases of the build-out. Additionally, regardless of which party is performing the build-out, the landlord should require the contractor and architect to be LEED Accredited Professionals. The landlord may also require the use of green construction practices (including waste management and the use of recycled and salvaged materials), and the use of sustainable fixtures and finishes to comply with certification.

From the tenant's perspective, the tenant should negotiate to have the specific sustainability standard that the landlord wants to achieve for the premises set forth in the work letter. The tenant should also obtain a warranty from the landlord that the landlord will obtain the agreed upon sustainability standard. If such sustainability standard is conditioned upon the project certification standard, the tenant should also negotiate for a warranty from the landlord that the landlord will maintain the certification. The tenant should have its contractor review the landlord's required construction regulations to help identify any costly and/or wasteful practices, and should consider seeking a cap on such increased expenses from the landlord.

Conclusion

Globally, green leasing practices have already begun and will continue to be more common. While counsel for both the landlord and tenant should consult closely with the clients on the specific lease provisions, the foregoing offers issues to consider.

Courtney K. Hunt ([email protected]) is an attorney at the law firm of Hirschel Savitz Parker & Hollman P.C. in Gaithersburg, MD, where she primarily represents regional and national landlords in the leasing of strip centers and mixed-use projects.