Green: The Color of Commercial Leasing

July 9, 2009

With the American Recovery and Reinvestment Act (ARRA) stimulus dollars available, and good commercial tenants aware of the number and quality of their options, the color of leasing for savvy landlords is green.

“Green” (sustainable) development is a generic term that typically means using renewable energy, materials, systems and resources in the design and use of real property. Tenants negotiating new leases want green. In addition, as landlords retrofit existing buildings, new green legislation, requirements or goals can affect existing tenants. Building green can impact revenue and operating costs, increase rents and reduce expenses, produce zoning, tax and other valuable financial benefits, and impact resale and mortgage values.

But the cost of going green cannot be so overwhelmingly laid on one party in real estate documentation that there is a disincentive to pursue it. Without appropriate provisions in a triple net lease for example, the landlord must pay for capital improvements to go green, but the tenants – who pay the utility bills – reap the benefits of these energy-saving measures.

Apart from the physical changes in the building itself, how does a landlord document that a building has become green? As landlords develop new properties or upgrade older buildings, green covenants, conditions and provisions can be built into most commercial leases. Today, if major tenants require a landlord to incorporate green in a building, the landlord will most likely seriously consider those requests, especially if there is a financial benefit. A major tenant may seek income or property tax benefits, or may simply have adopted green policies for all its leased space in its role as a corporate citizen. But is that enough in an economy where every dollar must be wisely spent?

The law of green buildings is generally found in local government policies, expanded through legislative process, tax programs, and zoning codes, and in leases and loan documents. From a case law perspective, this is largely unchartered territory. The implementation of green goals or requirements is instead significantly governed by the contract the parties negotiate.

Some commercial leases now reference green ratings through one or more rating methods conducted by private rating companies. Leadership in Energy and Environmental Design (LEED) was developed by the U.S. Green Buildings Council and sets performance goals in six categories. Projects earn points in those categories to obtain certification at four levels: Certified, Silver, Gold and Platinum.

Green Globes, an alternative but lesser-known rating system, was brought to the United States from Canada in 2005 by the Green Building Initiative (GBI). Through Energy Star, the U.S. Environmental Protection Agency promotes energy-efficient equipment, appliances and devices for consumer and commercial products, new homes and commercial buildings. BOMA International has suggested sustainable building operations and management practices that make sense from business and environmental perspectives. But which party pays for the green rating under one of these methods – landlord or tenant – can become an issue, and the allocation of the costs for going green can arise in many scenarios.

For example, a landlord’s decision to impose new green rules on existing tenants due to the requirements of a new tenant impacts design decisions, contractor selection, costs of materials, furnishings, fixtures and equipment, and means and methods of construction for the existing tenants. The text of the existing tenants’ alterations clauses in the individual leases determines the landlord’s ability to impose the new green goals. If a landlord imposes new green goals for alterations without appropriate lease provisions, existing tenants may contend that the landlord is unreasonable and that they should not subsidize the landlord’s costs of bringing in the new lessee. How does a landlord impose conformity in practice to new green building standards? Through a well-drafted lease, of course.

Most existing commercial leases contain rules and regulations, and require compliance by all tenants. They also state whether the landlord can change the rules and regulations without tenant consent. Leases for smaller tenants typically require the tenant to accept changes in rules and regulations adopted by the landlord from time to time. Larger tenants may have negotiated language in their leases limiting the landlord’s right to change rules and regulations, or limiting rule changes to those that are reasonable. If the change benefits all tenants, the issue may then be whether the change will require existing tenants or the landlord to incur new costs, and how those costs might be passed on to tenants. Adequately drafted green provisions can help.

Alternatively, a landlord may be able to impose new green programs without changing rules and regulations, but rather by simply passing the costs through the operating expense clauses. If a landlord wishes to modify cleaning products for public areas, or institutes a more costly green trash removal procedure, the landlord can often pass on the extra costs through typical lease pass-through provisions. New capital expenditures are another issue. Solar panels or a green roof, for example, will cause existing tenants to claim it is a capital expense. The lease must be crafted to anticipate a pass-through for green capital expenses.

Being in a green building can also impact tenants negatively in leases. A tenant will have to comply and cause its employees to comply with “green rules” or be in default of its lease. Not all green objectives are the landlord’s cost alone. For example, a tenant will have to bear the cost of carpool incentives, transit use, or space layout. Sublease and assignment clauses are also affected.

The subleasor/assignor will seek to pass green covenants along to its subtenant or assignee and disengage itself from liability for them with the landlord. However, the subtenant or assignee may be unwilling to accept costs of a green covenant that exceed those of a standard lease. For example, if a lease requires the prime tenant to periodically obtain reports regarding various LEED objectives, a subtenant (especially one taking less than the entire space) or an assignee may insist that the prime tenant keep this responsibility or pay the subtenant’s/assignee’s costs of complying.

Both landlords and tenants must consider how new green provisions will impact their traditional leasing arrangements. Jumping on the green bandwagon without explanation of the implications of green leasing and an appropriately drafted lease should be avoided, and guidance should be sought from a green leasing counsel.