Climate Corps: How to Harvest Savings by Greening Leases

EDF Climate Corps

Climate Corps: How to Harvest Savings by Greening Leases

[Editor's note: This blog is part of a series from the 2009 Climate Corps fellows. The program, from partners Environmental Defense Fund (EDF) and Net Impact, pairs MBA students with companies to identify energy efficiency opportunities and develop actionable strategies that help host companies reduce costs, energy use and greenhouse gas emissions.]

A few weeks ago I wrote about a growing trend among real estate owners to create more energy efficient facilities. In a similar way, an increasing number of tenants are looking for ways to drive down operating costs where possible. For example, here at Biltmore Farms, we have a specific tenant in Biltmore Park that holds environmental stewardship as a core company value. As a property manager, what can we do to help and encourage tenants to exercise that shared principle?

Green leasing is becoming more popular in real estate these days as building owners and tenants find themselves codependent when it comes to reducing consumption.

Leasing Strategies

The property owner seeking more efficient buildings will need to be creative in crafting leasing agreements. For the tenant, aside from the obvious physical attributes of an available space, the two most important cost factors are: a) the monthly rent per square foot, which is determined by the class rating of the space and the local competition for that class and b) the estimated monthly operating expense charge.

The once common gross lease, where each tenant pays only one lump sum to the landlord that will be used to cover both rent and operating expenses has gone by the wayside. Today, the net lease is more common, with rent and operating expenses as separate payments. Under a net lease scenario, the landlord pays the operating expenses, then passes the costs on to all tenants in a building, perhaps on a pro rata basis. These expenses are usually charged monthly on an estimated basis, with a credit or charge for the difference from the actual cost at the end of the year.

So, with tenants paying for energy, how can landlords become more vested in the effort for greater efficiency? The best incentive, aside from the ability to advertise more competitive operating costs, is a financial one. Under an expense stop arrangement, if an operator can make the building more efficient than the baseline estimation and rate set forth in the lease, the landlord retains the difference. This could be the simplest and most practical strategy for building managers to take the necessary steps to reduce how much electricity, gas and water are consumed in the building.

However, barring unusual circumstances, energy reduction upwards of 25 percent in many newer buildings is going to require considerable involvement from tenants. After all, it's usually the tenant that upfits the vanilla envelope with appliances, office equipment and lighting of choice, and it's the tenant that determines usage. It's important to recognize that the presence of energy-hungry devices and the inclusion of elaborate controls aren't the only determining factors for a building's performance.

The biggest hurdle to realizing energy savings is human behavior. As an engineer recently told me, "Even the most primitive building with a control system comprised of only thermostats and light switches can be operated very efficiently by people that are trained properly."

If the tables turned and landlords were the only party to see benefits from efficiency, it's unlikely that tenants would make much of a reduction effort. One solution is for landlords to incentivize lessees to meet target reductions, through the sharing of costs and benefits. For example, who should be responsible for fronting the cost of an occupancy sensor that turns off lights and HVAC supply in a tenant area? The tenant will achieve a lower energy bill, but the landlord achieves a facility with greater value and functionality. The landlord should be able to apply some of the tenant's prospective savings toward the investment. There's no better time for a landlord and tenant to work together on efficiency than when planning the space upfit, and this should be accounted for in the leasing contract.

It's also important that building managers be able to accurately measure consumption so a tenant can measure and track usage patterns. It's easy, and relatively inexpensive, to install sub-meters -- or smart meters -- for individual spaces during building construction, but if that equipment didn't make it into the building, it could be installed as a retrofit. Equipping finished spaces with sub-meters can be cost-prohibitive, but there are some reasonable options today, especially with wireless technology.

A Group Effort

Energy efficiency in a commercial building can be best achieved when building managers and tenants are aligned in the effort. These parties can work together to make the needed investments and behavior changes, and they can share the rewards. Occupancy sensors, tighter building envelopes, energy management controls, frequent HVAC commissioning, low-power light fixtures and daylight harvesting are examples of strategic expenses that most tenants on a short-term lease can't easily implement. With the involvement of the building owner, these measures can help to make operating expense rates more appealing for the lessee, while maximizing the value of their building on an income-producing basis. Additional benefits for the owner include reduced vacancy, increased flexibility in economic slumps, and greater tenant satisfaction.

If you'd like more details on writing a greener leasing arrangement, check out BOMA's most recent Guide to Writing a Commercial Real Estate Lease.

Hunt Briggs, a 2009 Climate Corps fellow and a Net Impact member, is pursuing a Master's of Business Administration degree at the University of Michigan Erb Institute for Global Sustainable Enterprise.

Image courtesy of Biltmore Park.