Module 6: Green Building

• Overview
• Rating Systems
• Green Leasing
• Program Planning
• Practices
• Running Your Program
• Resources

Green Leasing

The term “green leasing” is a relatively new term without a real definition as few people have ever negotiated a green lease. A “green” lease is more than just language to stipulate product requirements and practices. A truly green lease requires rethinking the basic tenets of today’s office lease.

The Net Lease^[13]

An office building’s real value is determined by computing a present value using estimated Net Operating Income (NOI) over subsequent years. Since the discount rates are a function of the financial market, the landlord has to increase NOI to increase the value of the building. Increasing income is not always possible due to competition and market conditions, so decreasing the operating costs becomes the landlord’s best option.

Due to constantly rising and unpredictable costs of utilities in buildings, and the fact that the tenant controls the use of these resources, landlords began shifting from the all-inclusive “Gross” lease to the “Net” lease. A Net lease allows landlords to protect investments from inflation, and avoid risks the landlord cannot control – like rising energy costs. Landlords also incorporate rent escalation clauses into their gross lease documents using the consumer price index (CPI) adjustment, or scheduled rent increases. The idea is to insulate the landlord from inflation and provide an automatic adjustment that is independent of influence from both the landlord and the tenant, but based on an acceptable and transparent methodology. However, such increases may not be sufficient to cover increases in operating costs as utility costs, property taxes and the costs of complying with government mandates are heavily influenced by local trends, which may not be in line with national averages.

While the advantage of the Net Lease is that it transfers the risk of rising operating and utility costs to the tenant, the downside is that the landlord gets none of the benefits from reducing operating costs, and this has no impact on the building’s NOI. In some cities the gross lease is the norm, in others it’s the net lease. Some cities have transitioned over the years from the gross lease to the net lease. According to CoStar, a national real estate information company, tenants in 58 percent of the nation’s office buildings do not have energy costs included in their base rent. Proponents of the net lease say this creates a more transparent lease arrangement, and creates an incentive for tenants to use less energy.

However, according to the Building Owners and Managers Association’s 2005 Experience Exchange Report (BOMA EER), the energy costs for the average office building is approximately $1.59 per square foot a year, which is 16 percent of the total operating costs. However, energy only represents 0.6 percent of an office tenant’s cost of doing business. If the average tenant with a net lease reduced their energy usage by 40 percent (The average for U.S. Environmental Protection Agency (EPA) ENERGY STAR buildings) the savings would be less than $1.00 a day per employee. It is apparent that a business will choose a layoff over replacing lights to cut expenses, as workers are 80 percent of the cost of doing business.

For the owner of an office building with gross leases, however, reducing energy costs in the average office building by 40 percent would save $0.64 per square foot. If these savings were capitalized at 7.75 percent this would increase the building’s value by $8.26 per square foot. Net leases create an unnecessary hurdle for green buildings. Landlords that have embraced green buildings often find they are paying a premium of one to five dollars per square foot to build a superior building. To compensate for the added investment, they have boosted their asking base rent. On the surface this seems logical. Yet, this logic breaks down because tenants and their real estate brokers know that under a net lease the landlord has little incentive to aggressively control a building’s operating costs. Therefore, when a landlord tells prospective tenants, “My building’s operating costs will be lower than other buildings in the market,” tenants don’t buy it.

An office lease is often a tenant’s largest single contractual obligation. A tenant’s No. 1 objective is getting the best possible space at lowest total occupancy costs. However, a net lease removes the dollars representing the operating costs from the table. This shifts the tenant’s negotiating efforts solely to negotiating base rent. The tenant is now in a situation of seeking the lowest total occupancy costs, but is limited to bargaining on 45 to 60 percent of that cost. To aggravate matters, the tenant must prudently assume the operating costs will be at the high end of the range. The landlord enters the negotiations knowing that a prospective tenant with a savvy real estate broker will have other buildings on their short list. At this point, it’s all about the dollars and making the deal. Experience has taught landlords that 80 percent of something is better than 100 percent of nothing. The result is that the base rental rate gets disproportionately reduced to make the deal, thus lowering the landlord’s return on investment. This does not make a good case for investing in green buildings.

Greening the Gross Lease Format

Advances in technology and improved O&M practices make it easier than ever before for landlords to manage operating costs and reduce energy use. Simultaneously, operating costs have become a smaller percentage of an office tenant’s cost of doing business. The net lease fails to take these facts into account, and punishes operational excellence, environmental performance and energy efficiency. To create the green lease we must return to the gross lease format. The gross lease, with the appropriate language, transfers the fiscal responsibility for controlling operating costs back to landlords, who are far more qualified and willing to do so than the tenants. It creates a financial incentive for landlords to effectively design, build and manage high-performance and green buildings without sacrificing comfort or service while maximizing the landlord’s return on investment.^[13]

TEN ESSENTIAL ELEMENTS FOR A GREEN LEASE

A green lease encourages landlords to compete for tenants by designing, building and managing green buildings without sacrificing comfort or service while maximizing the landlord’s return on investment. It ensures that tenants receive the full use of space in a high-performance building over the lease term at a competitive price. To meet this dual objective, a green lease must have these 10 essential elements:

1. Gross lease format with appropriate escalation clause and expense stop clause to reward landlord for operating a high-performance building.

2. Appropriate operational procedures and building control/management systems for charging tenants for after hours/excess energy usage, supported by appropriate lease language.

3. A comprehensive and equitable definition of building operating costs in the lease to protect the interest of both the landlord and tenant.

4. As part of the definition of building operating costs, the lease should contain language that allows the landlord to amortize the cost of projects that will reduce operating costs and treat those amortization costs as operating costs, as long as they do not exceed savings.

5. Right to Audit – This lease clause protects the tenant from overcharges and defines the audit process to protect the landlord from frivolous audits.

6. Hazardous Materials – A clause that defines what it is and states that neither the landlord nor any tenant violates laws or regulations regarding hazardous materials.

7. Green Cleaning Specifications – This lease exhibit should define the materials, procedures and protocols for cleaning the building in a sustainable manner.

8. Building Rules and Regulations – This lease exhibit stipulates a building-wide recycling program.

9. Tenant Construction Agreement – This lease exhibit defines sustainable product requirements and construction practices.

10. Tenant Manual & Development Guidelines – A guide to explain the building’s sustainable features and benefits, procedures and operating parameters, that should provide insights into how to maximize the building’s features to create a sustainable workplace.