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How to Green an Existing Lease

29 September 2015 | Posted By Alex Harry 622 views No Comment

Restructuring existing leases for better energy efficiency can be a tough job. Here are some possible ways to make it easier. Executing a green lease, also known as an energy-aligned lease, is a proven strategy to increase energy efficiency and lower operating costs in commercial buildings. In fact, IMT estimates green leases have the potential to reduce energy consumption in U.S. office buildings by as much as 22 percent.  Implementing a green lease at the start of a commercial real estate negotiation puts owners and tenants on a path to better energy management; however, if either party wants to tackle energy efficiency goals mid-lease, there remain some significant challenges.

Tenants and landlords try to avoid restructuring current leases as it often requires lengthy coordination between both parties and their lawyers. Restructuring after the initial lease is in place can be costly from a legal perspective and depending on the final outcome one or both parties may be reluctant to renew future leases. These issues are compounded by the split-incentive problem, which is critical to address in any green leasing conversation, as traditional leases separate operating costs in a way that discourages landlord and tenant collaboration.

As leading experts on green leasing, IMT staff is frequently asked how to negotiate such changes mid-cycle. The following will outline some key strategies to move beyond the barriers in place.

Adjusting Rules and Regulations

Inserting green operational language into the Rules and Regulations of a lease is the first step towards an agreement that lowers utility costs. It allows the development of simple low- or no-cost solutions that both tenant and landlord can utilize without spending large amounts of cash up front. Landlords can simply insert these changes in Rules and Regulations to unilaterally modify the lease.

Operational clauses can contain energy-saving requirements such as unplugging electronic devices when not in use or upgrading to Energy Star products when economically feasible. Operational clauses can also be used to address other sustainability issues such as recycling.

Amendments

Amendments can be used to address a select alteration(s) to the lease. This strategy commonly requires legal coordination from both landlord and tenant. The approach is best used to fix split incentives inherent in a major energy upgrade and the amendment should clearly outline where both parties benefit from the improvement.

When deployed, this technique can address common energy efficiency concerns such as utility usage and capital upgrades. It’s important to note that amendments shield the remainder of the lease items from additional negotiations, as an amendment is generally a stand-alone document limited to a few pages.

One example of an energy-saving amendment is a clause to increase utility data transparency, with either one or both parties agreeing to share their energy consumption data. Transparency in utility data builds trust between landlord and tenant and lets each party see how much utilities cost. In addition it makes for easier benchmarking and encourages both parties to invest in deeper energy-saving strategies.

Another energy-saving amendment could include capital improvements in which large expenditures may be incurred on the landlord or tenant’s end for energy efficiency retrofits and upgrades. Such improvements can include chiller upgrades or full-building lighting upgrades. In this scenario, the amendment can be used to communicate the benefit, costs, rights, and obligations to the tenant and landlord and their appropriate legal parties.

To pay for capital improvements and to overcome split incentives, amendments are a great opportunity to insert pass-through clauses. A pass-through clause is lease language in which capital expenses are amortized to the tenant over the useful life of the energy improvement. By doing so, both tenant and landlord can capture the savings from the capital improvement.

Negotiation Strategies

Over the lease term and as best management practice, tenants and landlords typically discuss what each party desires in order to renew the lease at the end of the term. Use these discussion opportunities to green your existing lease with these techniques.

For landlords:

Expand Lease Term

Agree to expand the tenant’s lease so that the tenant can recoup all or a larger portion of the payback period.

Stress Financial Savings

Emphasize overall operating savings such as lower utility expenses (in the case of triple-net leases) wellness, comfort, and productivity savings to the tenant.

Be Transparent

Let the tenant know of planned improvements that are beneficial to the tenant.

For tenants:

Agree to a Longer Lease Term

By signing a longer lease, the landlord may be more inclined to renegotiate the lease if he or she is able to mitigate vacancy risk. Additionally, such suggestion helps the landlord save on transaction costs associated with replacing tenants and less waste will result from additional tenant build-outs.

Communicate Cooperatively

Stress to the landlord what you are willing to pay. Aim for a win-win resolution for both parties.

Stress Benefits to the Landlord

Emphasize what the landlord stands to gain when investing in energy efficiency. Mention lower operating costs, higher net operating incomes (NOI), a higher valued building and an improved Energy Star score.

Rebates and Tax Incentives

Research rebates and tax incentives from your local utilities. These rebates and incentives may help tenant and landlord overcome cost hurdles.

I encourage any readers who have examples of successfully implementing changes mid-lease and is willing to share their experience to send me an email at alex.harry@imt.org. And for more tips and strategies on landlord-tenant negation and specific green lease clauses, visit: greenleaselibrary.com.

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