The
article “Not Easy Leasing Green” (CIRE,
September/October 2012, p.36) told an unpopular truth. It tallied a long list
of hurdles confronting tenants and landlords who pursue Leadership in Energy
and Environmental Design certification. This situation helps explain why
California municipalities, New York City, and Canadian jurisdictions have
enacted laws mandating environmentally responsible leases.
In
fact, outside of large institutional landlords and mandated jurisdictions,
green leases are rare — and for good reason. Complex leasing provisions often
require ongoing monitoring, reporting, consulting, and benchmarking
responsibilities that typically involve engineering and computer systems
specialists, facilities and asset managers, LEED-certified examiners, cost
auditors, accounting specialists — and, of course, specialized lawyers.
Because
environmentally responsible leasing is costly, time-consuming, and unfamiliar,
many landlords and their leasing agents often dismiss it without even
investigating the possibility. Fear of the complexity and cost means the
environment suffers, since heating, cooling, and lighting commercial buildings
generates a large portion of greenhouse gases.
But
in truth, many of the heating, ventilation, air conditioning, and lighting
efficiencies that have the most impact per dollar invested can be attained with
very simple paperwork and within the typical landlord-tenant relationship.
Small, non-institutional landlords can take advantage of many profitable
environmental leasing opportunities that are easy to access.
Keep It Simple
As owners
of industrial, office, retail, and multifamily properties for more than 38
years, we have found that many environmentally responsible changes can be made
with a few simple steps that will not delay or complicate the leasing process,
nor significantly increase expenses.
The
key is to write leases empowering the landlord to make energy-saving equipment
purchase decisions unilaterally
— without having to involve the tenant and third-party environmental
professionals in the process. A lease clause permitting the landlord to decide
when and how to make building system upgrades and committing tenants to
cooperate gives unilateral power to the landlord.
For
example, this simple lease provision states that operating charges include:
the cost, amortized over its useful life, of the purchase and installation of
any device including the maintenance and repair of such device, to improve the
operating efficiency of any system in the building or reduce the cost of
insurance and thereby reduce operating expenses.
Under
this clause, the tenant pays the amortized cost without the need for an
engineering study supporting a tenant savings in excess of the amortized cost.
However, in the interest of good tenant relations, our practice has been to
exclude interest and do a simple payback period calculation.
For
big-ticket items we recommend getting an engineer’s opinion letter stating that
the savings to the tenants exceed the amortized cost. Tenants are protected by
having an engineer benchmark the existing consumption with the proviso that the
total operating costs paid by tenant will not increase when the cost of the
improvement is charged to the tenant.
Another
reimbursement method is New York City’s Energy Aligned Clause that states:
(1)
tenant shall reimburse landlord 80 percent of the yearly amortized cost of the
upgrade; and
(2)
the reimbursement period shall be lengthened to 125 percent of the actual years
used in the amortization calculation, enabling landlord to recoup 100 percent
of its outlay (80 percent of yearly amount mulitplied by 1.25, the length of
the payback period);
(3)
no interest is added in amortizing as a means of approximating the additional
benefit to landlord of having newer equipment without having had to pay all of
the replacement costs due to eventual failure of the existing equipment.
If
the landlord wishes to be more aggressive it can seek a quicker payback period
and a higher annual recovery rate than 80 percent of the projected cost
savings.
The
EAC may be more effective than a simple payback at 100 percent amortization for
capital investments that may produce savings that are difficult for the
engineer to quantify. Although the EAC lengthens the reimbursement time by 25
percent (the tenant pays back at the rate of 80 percent of the yearly amount
due), this clause is more evenhanded when there is any significant uncertainty
about the utility savings. [See “Resources” for more information.]
How Does It Work?
The
following examples illustrate how landlords can make environmentally
responsible upgrades to their buildings under different lease types.
Triple
Net Leases
. In some NNN leases, energy efficient
upgrades present disincentives to building owners because the tenant benefits
and the landlord pays. For example, why should a landlord replace eight
functioning, circa 1975 natural gas-fired boilers that are 65 percent efficient
with newer boilers that are 94 percent efficient when the tenant’s gas bill
will be reduced but the landlord will pay all of the capital cost?
But
if the landlord looks at the larger picture, the 94 percent boilers, plus the
associated engineering costs of $200,000, have an operational life of 25 years,
and an amortizable life under asset depreciation standards of 10 years. They
produce a savings in reduced natural gas consumption and maintenance of $30,000
per year. So over
the long term there is an incentive to replace the boilers.
Using
the EAC method, the tenant saves $30,000 in yearly fuel and operating costs and
pays the landlord amortization of $16,000 per year — a net gain of $14,000 per
year. The landlord recoups all of its costs in 12.5 years and owns a system
that’s still got about the same length of life remaining. Furthermore, after
the tenant vacates, the building’s inclusive costs of occupancy have gone down,
making it a more attractive rental.
CAM
Expenses Charged to Tenants
.
Numerous commercial leases require tenants to reimburse the landlord for common
area maintenance costs, which could include environmental upgrades. For example, replacing obsolete T-12
fluorescent tubes with T-8 lamps can provide 40-watt illumination with 22
watts, a savings of 45 percentof
the electrical cost with some additional savings in air conditioning since less
heat is produced.
Same
as in the triple net lease example above, the landlord can replace the old
lighting when it chooses, as long as tenants are protected by an engineering
opinion on cost recovery and the same simple payback formula.
As
in the triple net example, the tenants’ day-to-day expenses are reduced or will
not increase above what they would have otherwise paid. The landlord reaps the
long-term benefits of newer equipment — delayed bulb changes and ballasts
replacements and reduced air conditioning use.
Gross
Leases.
In gross leases without pass-through
cost increases, the landlord pays all of the utilities, so it’s beneficial to
replace equipment whenever there is a net savings of utilities over the
amortized replacement costs. However, to calculate return on investment, the
landlord must determine the current usage standards. For example, experts can
install measuring devices over long periods of time to determine illumination
needs during times of day and seasons, measure the workday air balances and air
quality (volatile organics and CO2levels), air tempering, and shading needs from
beginning to end of the work days and under various outside climate conditions.
But
tenants may object to electrical engineers or HVAC technicians probing their
ceilings during working hours. In fact, some tenants may object even to work
done on weekends or evenings because it disrupts their business hours or is
considered a security risk.
To
solve this issue, leases should have a broad cooperation clause allowing
reasonable access to landlord’s representatives and experts at any time during
the term to analyze and upgrade and not just to repair systems. While all
financial returns accrue to the landlord, tenants have reduced risk of
equipment failure and enjoy modern advances in lighting or HVAC. Also, the
carbon footprint, water consumption, or sewage burden is reduced.
Modified
Gross Leases.
With tenants paying increases in
operating charges over a base year, it is always in the landlord’s interest to
make capital improvements when reduced operating charges will exceed the
investment.
For
example, replacing working metal window blinds with insulating double-layered
cloth blinds reduces natural gas used for heating and electricity used for
cooling. The new shades have a 20-year life and cost $70,000. The mechanical
engineer provides a detailed opinion that yearly costs for natural gas for
heating and electricity for air conditioning will decline by about $6,000.
If
savings from reduced heating and air-conditioning use are difficult to estimate
with precision, use the EAC method here and do a payback schedule over the
shortest time that would result in not charging more than 80 percent of the
yearly savings.
With
an amortized cost of $4,800 per year with a $6,000 utilities savings, a
tenant’s portion of the passed-through increases are actually reduced by its
share of the $1,200 annual savings. In those spaces where tenants are still
below the base-year expense level or in vacant spaces, the landlord would
reduce its expenses based upon the total building savings of $6,000 per year.
When the Lease Is Silent
Without
permissive lease language, a landlord must obtain the tenant’s approval. Our
practice has shown that this is best done through an assumptive close.
When
sending the annual pass-through statement, attach a spreadsheet showing
detailed operating costs in comparison to those of the base year and
list the amortized amounts of capital
investments that reduce those expenses. These expenses are footnoted for each
item. The property manager also calls the tenants and explains the rationale
and what they gain.
In
multitenant buildings, a few holdout tenants should not scuttle your
improvements since the reduced financial savings combined with the intangible
benefits of newer equipment and higher tenant satisfaction from better HVAC or
lighting could still justify upgrading.
For
small, private investors competing against deep-pocket institutions, it’s hard
to find attractive new properties at the right price. However, money invested
in upgrading equipment in your existing buildings will often yield higher
returns than new projects. An environmentally responsible property is more
competitive and more attractive to tenants both new and old. And, it’s just the
right thing to do.
Miles Schlosberg, based in
Anchorage, Alaska, is involved in commercial real estate development,
construction, and investment in Alaska, Florida, and Washington state. Contact
him at m.s.schlosberg@comcast.net. Carl
D. Kuhn, CCIM, is a broker with Jack White
Commercial in Anchorage. Contact him at cdk@gci.net. The authors thank Gordon
Timmerman; John T. Moore; Brian Player, PE; Mark Miller; and Brian Schmid, PE,
for their assistance.
