More on green lease clauses: Out with the bad, in with the good

 

Today’s post shares details about that “bad” green lease featured last Friday. Also I’m sharing a few green lease tips from BEPN that talk about ways green lease language can help support value creation in environmentally certified buildings.

The “bad” green clause’s web of risk

Several folks pointed out that LEED-EBOM certification can be achieved without any cooperation from the tenants. Unfortunately, our “uniquely negotiated” lease contained other typical provisions, which, when combined with the green clause in question, made the green business case uncertain, in the eyes of the buyer.

The lease in question was that of a major tenant - and major tenants are often able to negotiate special terms many other areas of the lease, with a deep focus on the expenses that can be passed through via common area maintenance and capital expenditures.

The major tenant lease was no different.  Lease language required the Landlord to obtain the major tenant’s permission in advance of passing through any expenditures, which were outside of a stipulated list. On top of that, the pro rata formula for calculating the tenant’s share of base building common area included an alternative common area square footage.  The formula denominator was a negotiated larger number, so the major tenant would pay less than its full share of common area expenses.

All of the above moves are typical, and limit the major tenant’s exposure to unforeseen or undesirable cost increases over the lease term.  In exchange for this, the Landlord gets a great tenant on a long term, which greatly enhances the building’s image and value.

The limiting of expenses (which is typical) plus the questionable “green” clause, created a situation for the investors where, a) much of the CAM and capital expenditure repayments were “locked in” by the prior owner over a very long time, limiting the new landlord’s flexibility, and  b) if any type of CAM or cap-ex charges were related to “green features” over the major tenant’s lease term, they couldn’t recoup those charges from the major or any other tenant either.

These investors’ business plan is to hold assets for a long term and realize an explicit increase to NOI from operating them as certified green buildings. So they were very focused on lease language not limiting their ability to execute that strategy. Losing part of the CAM recovery via the negotiations might be typical, but being further prevented from recovering costs from any tenant for any sustainable features over a long term put the lease contract into their “risky” column.

BEPN: “Green leases essential for achieving landlord’s environmental goals”

Check out this article from BEPN titled “Green Leases are Coming” (subscription might be required). It lays out a few issues that green leases address, all aimed to make sure that tenants and landlords are aligned with the environmental goals set for a project.

Essentially, the article talks about the kinds of lease provisions that can be negotiated with tenants so that it is easier for the landlord to achieve environmental objectives for a building.

The only part of the article that I would question is the assertion that most leases in the United States are triple net. During my tenure on the San Francisco Mayor’s Task Force, we talked about this point at great length. Large owners and property managers on the task force indicated that most office buildings are leased with gross leases. Of course, retail and industrial properties are nearly always triple net leased.

In any event, the main point here is to make sure you do not exhaust yourself trying to develop or retrofit green, then negotiate the “same old same old” in your leases. If you do, you are passing up a great opportunity to maintain and enhance the value of your environmentally certified building.