What parts of your lease matter? Aside from cost, space requirements and lease length, most building occupants aren’t paying attention to the finer details of their commercial lease. Yet, lease terms determine many aspects of building operation and energy performance, which can have a large impact on a tenant’s overall experience. By adding or modifying a few key terms in a typical commercial lease, building operations can become much more efficient—providing value to the landlord and tenant. This new kind of lease, a green lease— also referred to as an energy-aligned lease—has been gaining in uptake by leading companies since it was introduced to the market around a decade ago.
The Impact of Green Leases
The Institute for Market Transformation (IMT), Washington, D.C., understands the major impact green leasing can have on the built environment. Its report, “Measuring the Potential Impact of Green Leases in the U.S. Office Sector”, shows that a green lease can reduce utility spend by up to 51 cents per square foot in an average office building, representing a $3.3 billion savings opportunity for office buildings in the U.S. This reduction in operating costs can lead to significant added value at the time of refinancing or sale if the building is properly appraised for being energy-efficient. In fact, green clauses tend to share similar concepts with popular green rating systems, such as LEED and ENERGY STAR, and they can help expedite the process of obtaining the credits needed for these certifications.
For tenants, efficient buildings have many of the same benefits as green buildings, which are known to improve occupant comfort, reduce sick days and improve occupant productivity.
What’s the problem with existing commercial leases? While the specifics vary depending on the lease type—that is, whether a lease is full-service or some version of a net lease—most leases contain some form of the “split incentive”. The split incentive problem occurs when, because of the assignment of capital expenses and operating expenses in the lease, landlords have no motivation to improve the energy efficiency of their building while tenants bear the brunt of wasteful and poorly performing building systems (air-conditioning, heating, etc.).
For example, the financial savings of lower operating costs in a net-leased building accrue to the tenant while the landlord pays the capital costs for improvements. Because of this divide, the landlord has little incentive to make energy-efficiency improvements. Meanwhile, buildings with a full-service lease structure face the opposite problem: Although the landlord has incentive to keep energy costs down, the tenant is not penalized for wasteful energy consumption.
Green Lease Leaders
Although many companies were beginning to see the potential and need for addressing energy efficiency in the leasing process a few years ago, it wasn’t clear what defined a green lease and it was difficult to pinpoint who in the market was signing them. To set parameters and shine a spotlight on this issue, IMT and the Washington-based U.S. Department of Energy’s Better Buildings Alliance partnered to launch the Green Lease Leaders recognition program in 2014. Designed in collaboration with a cadre of commercial real-estate practitioners, serving as an industry advisory group, Green Lease Leaders awards property owners, tenants, and brokers who modernize lease language to account for energy efficiency and encourage tenant-landlord collaboration around sustainability goals.
During the past three years, 30-plus companies have been recognized, representing more than 1 billion square feet of commercial space. These companies— which include large landlords like TIAA and Forest City, as well as major tenants like Price Waterhouse Cooper and TD Bank—are proving that green leases are slowly gaining popularity in the U.S. as a tool to reach sustainability and business goals.
Those selected met the requirements of the Green Lease Leaders program by incorporating lease clauses that improve sustainability on many fronts, such as allowing for sharing of the costs of energy-saving improvements; ensuring tenants build out to green standards; increasing transparency by sharing access to energy consumption data and ENERGY STAR scores between tenants and landlords; and encouraging cooperation on environmental initiatives, like recycling.
One Green Lease Leader, Atlanta-based landlord Jamestown Properties implemented green leases across its portfolio (view a case study), using its existing lease rolls to figure out where new lease terms could have the greatest impact on energy consumption in its buildings. Among other changes, Jamestown Properties now asks that incoming tenants outperform existing building codes by 10 percent in all new build-outs.
Helping Small Businesses
Green leases are not just for large companies. Small Cleveland-based landlord NEO Realty Group has used energy audits and green lease terms as a tool to improve its existing buildings without raising rents on tenants. In one instance, NEO Realty Group reduced utility expenses by 44 percent for its tenant, the American Cancer Society, utilizing green lease terms to recoup costs during a two-year period. (Read the case study.)
Green leases can be especially impactful for small and medium building owners and small businesses. And it’s important to recognize this, because according to the Washington-based U.S. Energy Information Administration’s most recent Commercial Buildings Energy Consumption Survey, 88 percent of commercial buildings are smaller than 25,000 square feet and account for more than 25 percent of all commercial floor space in the country. With tighter margins than a larger corporation that owns or occupies a Class A building, reducing utility expenses and improving tenant retention through the low-cost implementation of a green lease can go a long way to improving the bottom line.
To help small businesses develop green leases and reduce their utility costs, IMT and the Council of Smaller Enterprises (COSE), Cleveland, recently completed a two-year initiative in the city of Cleveland called the Cleveland Energy-Aligned Leasing Program. The overarching goal of the program was to improve the small business community’s understanding of sustainability through a combination of education, energy audits, green lease resources, and financing options in a bundled program package. The effort could then be used as a blueprint for cities and local business communities across the U.S.
Throughout the initiative, IMT and COSE engaged more than 60 owners and tenants representing more than 7 million square feet of space to help them pursue energy and water-saving solutions through stronger collaboration. It culminated in Making Efficiency Work for You, a step-by-step guide to implementing green leasing for small business owners; the guide includes green leasing frequently asked questions, sample green lease clauses, tenant operations and build out guides, as well as several case studies.
Looking Forward
During the past few years, IMT has seen landlords become increasingly sophisticated in their approach to energy management and sustainability. Landlords are adapting to tenant demand to have efficient buildings through strategies like green leasing, as well as by investing in higher performance core building systems. However, another area that remains a difficult nut to crack is tenant engagement. Currently, lack of awareness and weak demand for energy-efficient spaces is preventing thousands of companies from unlocking potential savings.
Tenants use more than half the energy consumed in leased spaces across the U.S. Often this energy is wasted by inefficient operations and equipment. Achieving a 20 percent reduction in energy use in America’s commercial, retail, industrial and office buildings would save $5 billion annually, according to the Department of Energy.
To that end, IMT; the Retail Industry Leaders Association (RILA), Arlington, Va.; and the International Council of Shopping Centers (ICSC), New York, just launched the Landlord-Tenant Energy Partnership, which will work with tenants across the U.S. to spread best practices in green leasing, energy policy, and building operations together to reduce energy consumption in multi-tenant buildings.
RILA and ICSC, which represent major retail tenants and landlords, respectively, will help to continue to drive cutting-edge energy-management practices in buildings (including green leasing). The partnership has also established an advisory group of representatives from some of the largest companies with national real-estate portfolios, including CBRE, Kimco Realty Corp. and Nike.
Participants will receive expert one-to-one guidance to implement energy efficiency during site selection, lease negotiation, fit-out and operation. This will include things like metering options to resolve tenant-landlord-utility disconnects; data sharing between owners, tenants, and facility managers to drive ROI calculations and facilitate investment conversations; and financing efficiency upgrades, including innovative tools such as green bonds.
Landlords and tenants need clear and easier pathways toward making more substantial energy retrofits and improvements to their buildings. IMT is dedicated to helping provide that pathway and its representatives look forward to connecting with those in the commercial real-estate market who want to reap the benefits of energy efficiency.