Owners and occupiers both have strong incentives to incorporate sustainability into their real estate strategies. Unfortunately, traditional lease structures tend to create an imbalance between which party bears the cost of sustainability investments and which party receives the benefits.
Green leasing aims to address this imbalance by modifying the lease structure to adequately incentivize investments in sustainability. It usually does this through specific terms (such as “pass-through” or “percentage share” clauses) that ensure whichever party bears the cost of these investments receives enough of the benefit to justify it from a business perspective.
According to a study by the Institute for Market Transformation, “green leases have the potential to reduce energy consumption in office buildings by 11 to 22 percent, yielding reductions in utility expenditures in U.S. commercial buildings up to $0.51 per square foot. Green leases have the potential to provide the leased U.S. office market $1.7 billion to $3.3 billion in annual cost savings.”
While the benefits of green leasing may be clear, the implementation and follow through often isn’t. This article unpacks what green leasing looks like and how Tango recommends occupants and owners should implement these agreements.
What is a green lease?
A green lease, also known as an “energy-aligned lease,” “energy-efficient lease,” or “high-performance lease” is an agreement with modified terms and clauses that align both parties’ financial incentives and sustainability goals. These modifications are designed to result in mutually beneficial investments in the real estate’s energy efficiency, climate resilience, air quality, waste management, water consumption, and overall sustainability.
Since sustainability priorities vary widely from one company to another, so do the specific green lease agreements they create. However, Green Lease Leaders, a partnership between the Institute for Market Transformation and the US Department of Energy, has established green leasing standards and certifies compliant lessees and lessors as “green lease leaders.”
How green leasing differs from traditional lease structures
In a traditional full-service gross lease, the lessor pays utilities. They may be incentivized to make capital improvements to increase efficiency, but the lessee has no built-in incentive to keep consumption down (such as penalties for overconsumption), making it harder for lessors to benefit from their investment.
In a traditional net lease, the lessee pays utilities, so the lessor has no built-in incentive to make capital improvements.
Modified gross leases can shift this balance, but still, one party typically invests while the other reaps the benefits, or the benefits accrue too slowly to make the initial investment worthwhile.
A variety of green lease clauses can be added on to either of these lease structures to specifically address sustainable capital improvements:
- Pass-through clauses allow the lessor to recoup their costs through the savings generated by more efficient equipment.
- Amortization clauses require the lessee to repay the lessor over the asset’s useful life.
- Sustainability standards in the lease can require lessees to configure and design their space according to sustainable specifications, such as lowering lighting load limits, reducing plug limits, or using ENERGY STAR appliances. Lessors can also still require lessees to follow standards like LEED for Commercial Interiors or ENERGY STAR without forcing them to pay for certification.
Alternatively, a green lease can also use an entirely different structure rather than simply modifying a traditional one. Performance-based lease structures create a framework for equitably aligning the costs and benefits of sustainability investments to help both parties comply with regulations. This model sets building performance standards and distributes responsibilities between lessor and lessee to ensure those standards are met, establishes transparency between both parties, and monitors performance over time.
How to implement green leasing
Incorporating green leasing into your real estate strategy is straightforward in principle, but it can be challenging if it isn’t adopted across the location lifecycle. Lessors and lessees alike need to ensure they have the mechanisms in place to prioritize green locations, optimize location performance, and follow through with the commitments of green lease terms.
Include ESG criteria in site selection questionnaires
As you compare sites to renew, relocate, or acquire, ESG performance metrics and building certifications should be included in your site selection criteria. This keeps green leasing a focal point of your location strategy, rather than relegating it to the negotiation process. If you start with more efficient, sustainable facilities, it’s easier to make green commitments part of the conversation. Modern site selection software like Tango Predictive Analytics can incorporate sustainability criteria to help you analyze and compare options at scale and keep all of the relevant data in one place.
To prioritize sustainable locations effectively, sustainability specialists should also be part of the discussion to ensure both parties are set up to achieve sustainability goals and comply with applicable regulations. Tenants and landlords should include a sustainability point of contact to make it easy for relevant specialists to interact as needed throughout the process.
Optimize facility management and track utility performance
For green leasing to work, landlords need visibility into utility data, even when the tenant is the party responsible for paying utility providers. This needs to be established with data-sharing agreements in the lease terms and may require submetering to track an individual tenant’s electricity, gas, and water usage.
One of the major challenges to green leasing, however, is that even with access to all this data, lessors and lessees alike lack the ability to use it to monitor performance. Utility providers don’t collaborate to standardize their billing formats for you, and the more distributed your portfolio is, the more providers you have. This makes auditing and analyzing utility data tedious, complicated, and expensive. Tango Energy & Sustainability by WatchWire simplifies this process by automatically deciphering energy bill data and standardizing the data across your portfolio. It even audits this data for common errors like duplicate data or gaps in billing periods.
Amortize capital expenses to overcome split incentives
Ensuring that both parties have an adequate means of cost recovery for investments like retrofits, renewable energy procurement, and renovations and fit outs is essential. Amortization in a green lease should establish a clear schedule for recovering costs based on how much the improvement reduces building operating costs or the benefits gained from energy efficiency tax credits and incentives. The lease should create a framework that provides enough incentive for both parties to make investments that benefit each other.
In some cases, this system effectively turns these capital improvements into additional leases, which will need to be accounted for separately, like embedded leases. So, if you’re going to have green leases in your portfolio, it helps to have an adaptable lease accounting solution like Tango Lease, which can keep these amortized investments associated with the right leases, automatically calculate their amortization schedules, and enter the relevant information in the General Ledger.
Align stakeholders with long-term sustainability objectives
In a green lease, the terms should create guardrails to ensure tenants comply with a landlord’s sustainability practices—including working with approved third-party sustainability professionals—and streamline approvals for tenant improvements that satisfy sustainability specifications. These provisions help stakeholders keep sustainability objectives in mind as they make decisions about maintenance, fit outs, building commissioning, and waste management.
Mitigate capital and compliance risks
Sustainability in real estate isn’t just about improving efficiency and reducing waste. Green leases also need to account for the climate risks the real estate is vulnerable to, with clauses regarding how the landlord and tenant will improve the building’s resilience against these risks. These improvements don’t necessarily increase efficiency, but they do protect both parties’ real estate investment.
With how rapidly and drastically sustainability regulations can change, green leases should also address how both parties will navigate requirements from laws, energy codes, and building performance standards that take effect after the start of the lease. These are future compliance risks that impact both tenant and landlord, so it’s important that the terms adequately incentivize steps necessary for compliance.
Modernize your portfolio with green leasing
Green leases yield numerous benefits to tenants and landlords alike. By properly aligning financial incentives and cost burdens, they reduce operating costs, decrease climate and compliance risks, improve occupant wellbeing and productivity, and more.
But to get these benefits, lessors and lessees need to incorporate specific terms and clauses in their lease agreements. In a Tango Connect session on green leasing, Tango Sustainability Manager Prerana Tirodkar shares examples of specific language green leases should include to follow our recommended approach. You can access the presentation here.
Get the slides or request a demo of Tango to see how our tools support your green lease strategy.