Legal Briefs

Greening Up

Economic forces are moving buildings toward sustainable leases.

In February, San Francisco Mayor Edwin Lee signed into law the San Francisco Existing Commercial Buildings Energy Performance Ordinance, requiring commercial building owners to file annual energy benchmark reports and to conduct more-extensive energy audits every five years. New York passed a similar law that requires all private buildings larger than 50,000 square feet to periodically measure and report energy usage. In addition, Washington, D.C., Austin, Texas, Seattle, and Washington State have enacted sustainability mandates. And, in December 2010, the Energy Independence and Security Act of 2007 took effect, requiring federal agencies to lease space only in buildings that carry the U.S. Environmental Protection Agency’s Energy Star label.

As energy efficiency plays a larger role in the commercial real estate industry, green leases must contractually mandate tenant cooperation, since failure to comply with such auditing requirements can lead to a breach of leases, tax abatement agreements, and loan covenants in addition to the loss of green certification. The magnitude of such failures can’t be overstated: For example, the developer of Destiny USA, a retail project in Syracuse, N.Y., is in danger of losing more than $120 million in tax exemptions for failing to include promised alternative energy innovations in the redevelopment.

In many U.S. cities, planning departments are leading the way by requiring all new construction to meet sustainable or green standards, as evidenced by the fact that some are adopting the International Green Construction Code.

Market forces as well as government mandates point to a future where all new construction contains sustainable elements. These technologies include using high-efficiency interior lighting and day-lighting by increasing window size and number, improving the sound-attenuation and air quality of interior spaces, using reclaimed water for landscaping irrigation, installing water-efficient plumbing fixtures, using recycled or renewable materials in building construction and tenant improvements, and using low-toxicity cleaning materials.

Return on Investment

In surveying brokers throughout the country, feedback consistently shows that tenants generally will not agree to pay a base rent premium in the near term for leasing space in green buildings. And, the anticipated reduction in operating expenses does not justify landlords’ expenditures to retrofit buildings to meet green standards.

Instead, developers construct green buildings and landlords make retrofit investments to achieve an expected increase in building value upon sale. With federal entities and more private businesses demanding green space, the green building values continue to rise — even without higher rents — because sellers can demonstrate increased occupancy and market demand for energy-efficient space.

In fact, green building values continued to climb during the depths of the recession in 2009, according to McGraw-Hill construction reports. From 2005 to 2009, green building value increased from $10 billion to $49 billion and is estimated to increase to $150 billion by 2013. In addition, CB Richard Ellis reports that green buildings comprised 35 percent of new construction last year.

Lease Intelligence

Architects and designers often lead green building initiatives, incorporating their sustainable designs into corporate properties. While large, publicly traded companies have been first to implement sustainable practices, they are also the most interested in occupying sustainable buildings to gain improved employee productivity and positive public relations, according to CBRE data.

As green leasing trends trickle down to smaller properties and tenants, the challenge will be for brokers to learn how green leases protect both parties by requiring compliance, not only with energy and water audit laws, but also with more broad-based state and local green building construction mandates.

Green leases have key elements not typically seen in other leases. For example, green leases require a landlord’s detailed review of the space, including interviewing occupants and checking a property’s thermal comfort and other systems to ensure they are being used correctly and maintained properly to maximize efficiency. Green leases also help to ensure that tenant actions remain consistent with landlord intentions to meet state and local green rating compliance obligations.

Commercial real estate professionals have access to numerous green leasing resources. The Building Owners and Managers Association International’s most recent Guide to Writing a Commercial Real Estate Lease, Including Green Lease Language provides suggestions for brokers to incorporate sustainable operations and management practices into their deals. In addition, the Real Property Association of Canada’s National Standard Green Office Lease for Single-Building Projects is available free online. The RealPAC lease has a lengthy addendum, whereas the BOMA lease has the provisions integrated throughout the lease.

Lastly, www.squarefootage.net provides a model green lease that was created by a task force of attorneys, real estate brokers, corporate tenants, landlords, and green-building consultants. It covers indoor air quality, energy use, carbon credits, water consumption, recycling, green cleaning specifications, insurance, commissioning, operating costs, tenant improvements, and building regulations.

Richard C. Mallory is a partner in the real estate group at Allen Matkins Leck Gamble Mallory & Natsis LLP in San Francisco. Contact him at rmallory@allenmatkins.com.

Richard C. Mallory

Green CCIM Resources As a free benefit, CCIM members can log in and listen to three “Green Building Economics” Webinars that cover industry trends, energy-efficiency case studies, and the CCIM professional’s role in sustainability. Access the Webinars at www.ccim.com/education/ward-center.

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