Negotiate Green Lease That Creates Value for You

 The initially slow-growing movement towards environmental sustainability in past years has become a full-blown way of life for many people, chief among them business owners. In fact, some retail tenants have either staked their business model on being “green” or have improved operations by taking green measures. Some, for example, have encouraged their customers to bring their own reusable bags to stores in return for a small credit.

So in an aggressively environmentally friendly business and social climate, it behooves owners to cooperate with tenants that request green terms in their leases. But it can be confusing to negotiate your leases so that they include typical items necessary to successfully operate your commercial property, while attempting to also “green” those leases. This is especially true if you are dealing with small or first-time business owners who might not be familiar with even traditional lease terms and negotiation strategies, let alone how to work with you to transform them into green agreements.

It’s important to work with an attorney who is experienced in this area when negotiating new green leases or modifying an existing lease to include green terms. You don’t have to make up green provisions from scratch, though. You can implement sample provisions from the Corporate Realty, Design & Management Institute’s Model Green Lease, adapting them for your leases. Take the following tips into consideration so you get the most out of making green changes and avoid related pitfalls.

Understand Pros, Cons, and Due Diligence

While it can be a complicated process to “green a lease” for a tenant that requests environmentally friendly provisions, these agreements can work in your favor, too. Cost savings through energy efficiency, earning valuable credits toward LEED certification, and becoming attractive to green-centric prospective tenants are all major benefits.

There are some downsides to going green. For example, if you don’t take into account certain factors, such as the property itself and your leases with other tenants, you might be forced to overspend on green retrofitting or initial buildouts, or end up violating other tenants’ lease covenants with the changes.

That’s why before determining which green clauses to incorporate into a lease, you should conduct careful due diligence. This should include an in-depth review of your obligations under any existing leases, as well as loan agreements or covenants, conditions, and restrictions (CCRs). When examining other tenants’ leases, review the language to determine your ability to impose new green obligations or restrictions on these existing tenants. This comes into play when a new tenant or a current tenant that’s requesting green changes wants you to get other tenants on board with the changes, in an effort to green the entire building or shopping center. While you can invoke your right to “make reasonable changes to rules and regulations” during existing tenants’ lease terms, doing so works only if your changes aren’t in violation of some other portion of their leases. So make sure ahead of time that your hands aren’t already tied by obligations in other clauses.

Setting two requirements for tenants that request green provisions will give you the information you need:

Requirement #1: Tenant must specify goals. Ask the tenant to come in with goals in mind. It’s hard to grant requests when a tenant and its broker don’t know exactly what it’s looking for in the lease. You can point out to an unprepared tenant that you don’t want to change your usual lease document very much or use a lease document that you’ve been presented with unless you know what accommodations it’s asking for. Without knowing what items the tenant wants, you’ll be unable to complete your due diligence or investigate whether they are practical. Point out that you’re willing to meet the tenant half way and change your standard documents to reflect the green lease provisions suggested—but only if the suggestions are clear.

Requirement #2: Tenant must suggest substitutions. The tenant shouldn’t present you with the Model Green Lease and insist that the entire document be used as your lease. However, the way a commercial lease is structured actually lends itself to substituting provisions from the Model Green Lease that reflect the green specifications the tenant is asking for, says Alan Whitson, RPA, president of the Corporate Realty, Design & Management Institute. That’s because a green lease is structured so that the bulk of the document covers the required basic legal information, usually in boilerplate language. But the specifications as to how the lease actually will be carried out—for example, what contractors, services, and utilities will be used—are listed in exhibits at the end of the lease, Whitson notes.

So when faced with a green proposal, don’t have the knee-jerk reaction of assuming that it will create burdensome work for you. If you have an existing lease, it should be easy to pull out non-green exhibits and integrate the Model Green Lease exhibits that the tenant wants to replace them with—if the tenant knows what replacements it actually wants, says Whitson. He also suggests that owners that are negotiating a lease with a new tenant ask it for the specific sections of the Model Green Lease that it wants to apply to the new space.

Five Key Issues to Address in Provisions

Be prepared for some typical tenant concerns to come up during negotiations for green lease provisions. These points are commonly part of green lease negotiations:

1. Standards and benchmarks. A tenant could try to angle for adding a building performance clause, because a major goal of a green lease is to improve building performance. (This covers indoor air quality, lighting, and acoustics, to give tenants a better working environment.) Things that affect everyday performance usually are not in the lease document, such as ventilation rates, at what temperature the building will be kept, lighting, and other operating details such as green cleaning. But before you agree to put these in writing in a building performance clause, check with your building’s engineer and other consultants to make sure that you can actually deliver on the promises.

In addition to finding out whether the nature of your property lends itself to these parameters, you should also take into consideration other tenants. For example, a green-oriented tenant might want you to tailor the operating hours of your office building on weekdays and keep the building open on Saturdays but not run the mechanical system unless specifically requested, to eliminate costs that it would pay for, but not use. But other tenants’ leases could give them extended hours that you can’t scale back. And, in the case of a shopping center, you shouldn’t give up things like longer holiday hours of operation that draw shoppers, increasing your percentage rent. 

So think twice about agreeing to overarching specifications in the lease that would require the building to have completely inflexible defined standards and obligate you to operate the building to those standards. It’s okay to agree to proposed standards as long as you build in some flexibility for yourself—by carving out certain exceptions that you anticipate—and you can actually reach those standards.

2. Lease term. Be aware that green improvements sometimes come with incentives or certification points that are tied to a minimum term. And because they can be much more expensive than improvements made with traditional building materials or equipment, it takes more time to amortize capital expenses. So consider proposing a longer lease term, if that option works well for you.   

3. Buildouts and alterations. Many of the green aspects of a lease deal will happen during the initial buildout for a new tenant. A major green requirement that should be a sticking point for you is that tenants apply for certification under LEED, ENERGY STAR, and ASHRAE programs, and the Green Globes award. Whether you or the tenant have agreed to perform the work, your work letter should use agreed-upon and clear metrics to establish the green standards and detail who is responsible for costs.

Make sure that you also specify in your alterations clause that any future work must be approved by you and must meet the green requirements in the lease.

Practical Pointer: Be prepared for a tenant to ask for a higher tenant improvement allowance (TIA) to compensate for the greater cost of green materials and fees for certifications or consultations with green experts. Agreeing that you will each perform some of the work can help cut back on this cost. While you must use the green materials you’ve agreed to, you’ll have more power to comparison shop.   

4. Operating expenses. Your operating expense clause could be a point of contention. A dynamic that is commonly referred to as the “split incentive” has been a barrier to energy efficiency, which has, in turn, affected the cost of operating expenses and who pays for which of these expenses.

Under most net leases, energy costs are paid directly by tenants, so building owners aren’t driven to invest in efficient building systems. Conversely, in many gross leases, building owners pay energy expenses, so tenants have little incentive to save energy in their leased space. A modified gross lease can solve this problem and promote green improvements and operations. In that scenario, the tenant would pay for its proportionate share of operating expenses that are passed through to the building’s tenants, but could carve out exceptions. However, these exceptions are heavily negotiated because the requested items are very expensive. For example, a tenant will refuse to pay for your capital expenditures, such as a roof replacement. Greening your building or center adds another dimension to capital expenditures; capital expenditures to retrofit the building by replacing energy-inefficient items, like an old boiler, with a newer efficient model might be necessary to reduce the costs and inefficiency that the tenant is worried about—sparking another debate over which party should pay for it.

5. Assignment and subletting. A traditional assignment and subletting clause will require a tenant to get the owner’s consent before assigning or subleasing its space—with the caveat that the owner can’t “unreasonably” withhold its consent. But there are additional considerations in a green lease situation. You should spell out in the lease that it’s reasonable for you to withhold your consent to an assignment or sublet if the proposed assignee’s or subtenant’s anticipated use of the space or the way in which it will operate its business is “inconsistent with” the clauses in the lease that pertain to sustainability or green issues. Make sure the tenant understands that even a small deviation from green objectives in the lease can be a legitimate reason for withholding consent.

Practical Pointer: Like most leases, yours probably will include remedies for a default. In the case of a green lease, owners should be reluctant to agree that the tenant making “commercially reasonable” efforts to stick to green objectives is enough to fulfill its duties under the lease. Letting the tenant think that simply trying hard to meet green objectives equals compliance can ultimately have the unintended consequence of letting it off the hook; it could be challenging for you to prove that the tenant didn’t try its best to accomplish a green goal. Don’t leave room for a green goal to become just a goal instead of a reality.

Require Tenant to Make Green Requests from Start

Whitson also emphasizes that green requests need to be made from the start of the deal, so that owners know that green items will be expected. Be open with the broker that the tenant needs to incorporate green criteria into the Request for Proposal (RFP). Stress the possibility that if the tenant doesn’t ask for important green items up front in the RFP and the letter of intent, accommodating those requirements will get expensive at the back end.

Whitson points out that the easiest way to modify a lease for green requests is through addenda and exhibits. So it’s key to communicate to the tenant the importance of referencing those in the RFP, to avoid surprises later.

Understand Intersection of Green Terms with Technology

One of the things that should be transparent between you and the tenant is the optimization of building systems and the integration of technology in them, says Whitson, who points out that owners are sometimes shortsighted by buying items on a cost basis, rather than looking ahead to the long-term savings on other aspects of the property.

For example, different air filters are made using different types of filter technology, and you can determine their effectiveness. Minimum Efficiency Reporting Value (MERV), which was developed by the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE), is a standard that rates the overall effectiveness of air filters. (Electrostatically charged filters are cheap and effective for about a month; filters with a higher value MERV rating are very efficient—their finer filtration means fewer dust particles and other airborne contaminants can pass through the filter—and stay that way for a longer period of time, but are more expensive.) However, it’s the cost of the energy that goes through the filter, not the cost of the filter itself that is more important. “These higher-rated filters last longer, consume less energy, and give better air quality, but an owner that doesn’t understand that will likely get a filter based on only the filter’s cost today,” Whitson warns.

Likewise, integration and effective use of utilities can be a big-ticket item. Dial back air conditioning and lighting when feasible, which also saves wear and tear on equipment and reduces capital improvement expenditures.

Making your building green depends largely on how well you’re educated about the technology involved in building systems, says Whitson. He acknowledges that the underlying legal issues involved in commercial real estate leasing don’t change much, but the constantly evolving world of technology affects properties, and in turn, negotiations between owners and tenants about which advancements are important to both parties. “When technology changes, we have to accommodate for that,” he advises.

The Model Green Lease is available at http://www.squarefootage.net.

Sidebar: Realistic Green Performance Drivers Benefit Both Sides

Green lease pioneer Alan Whitson, RPA, who chaired the Model Green Lease Task Force that created the Model Green Lease in 2009, points out that good “green” intentions on the part of a tenant don’t always result in the actual green aspects in the premises that they anticipated. And green requests can prolong negotiations if they are nebulous. “It’s not enough for a tenant to simply say to a landlord, ‘I want to be green,’” Whitson warns. So make it clear to the tenant that it will have to be specific about its green objectives.

These common green tenant requests can benefit you, too, so consider granting them. But try to use them as a bargaining chip if possible. For example, ask the tenant to agree to renew its lease early if you agree to make the building’s operations more efficient and less costly by:

Using daytime and green cleaning. Using cleaning crews during the workday means that less lighting must be used at night, reducing a building’s energy consumption by 6 percent to 10 percent. Using fewer cleaning chemicals is less expensive and improves air quality.

Checking insulation. Check insulation for thermal efficiency.

Implementing recycling programs. The good news for you is that effective recycling programs have been proven to turn building operating costs into an income stream, in turn, offsetting those costs.

Upgrading lighting. Consider a lighting system with automated occupancy controls that turn lights off when a space is unoccupied, and put lighting on a timer system when applicable.

Giving annual environmental report. This report should include data concerning energy, recycling, and air quality for the building. This can also help you see the areas that need improvement.

Insider Source

Alan Whitson, RPA: President, Corporate Realty, Design & Management Institute, Newport Beach, CA; www.SquareFootage.net.