What’s Wrong With Green Leases (And What’s Right)

If you’re remotely involved in sustainability, decarbonization or ESG in commercial real estate, you’ve likely heard of green leases.

For those unfamiliar, a lease is “greened” when additional clauses aimed at improving collaboration between tenants and landlords around energy use, efficiency and reporting.

Most of the time, green leases are part of a larger sustainability/ESG strategy and therefore can be glossed over without fully understanding what they do (and where they fall short).

The truth is that, while an effective tool in the landlord's decarbonization arsenal, they should not be viewed as a panacea…

Data Sharing

Green leases were originally designed to solve for the split incentive problem. From Green Lease Leaders:

With the sudden deluge of ESG reporting requirements from investors, tenants, and regulators, green leases have also been called upon to solve the data sharing challenge.

That is, especially in triple net leased properties, landlords have struggled to get access to tenant-controlled utilities for reporting purposes.

In response, green lease clauses for data sharing often state that tenants must share their utility data.

In theory, it works. Reality is another story.

The thing is, once a landlord has a data sharing clause in place (which obviously can take many years as tenants renew or move-in), that doesn’t mean getting the data is easy.

Here’s a common scenario:

1. Property manager or ESG lead sends an email to tenants requesting data
2. No response
3. Another email is sent
4. The tenant responds with a spreadsheet provided by their accounting department
5. It is explained that the data must be auditable by a third party, and they need copies of the actual bills
6. No response
7. Another email is sent
8. The tenant sends scanned PDFs, some of which are unreadable
9. A consultant is hired to manually transcribe the data into various reporting frameworks
10. While they’re doing that, it comes to light that some tenants missed some months; other sent the wrong year
11. Another email is sent
12. No response
13. Follow up email
14. No response
15. Given no other choice, the matter is escalated, and the lease language is used to compel the tenant to act

For all the emphasis on tenant experience, this is the antithesis of what should be happening.

A better solution to capture this data is shadow metering. Check out How Triple Net Owners Are Handling Carbon Accounting and More Than ESG Reporting: Metering for Tenant Engagement to learn more.

Cost Recovery

So, if green leases aren’t a great solution for data sharing, do they fulfill their original purpose?

On that question, it’s a resounding yes.

Cost recovery may be a stickier negotiating point, but when in place, it has been shown to break down many of the barriers to implementing energy efficiency.

In fact, Green Lease Leaders has found that utility consumption is up to 22% lower in buildings with cost recovery in place.

That’s because it aligns incentives for landlords to invest in energy efficiency improvements by giving them an avenue to recoup their investment.

And unlike data sharing, there is already a framework to do this (common area maintenance charges). It doesn’t require any extra work from the tenants (just their cash).

These days, Fortune 500 tenants are asking for these clauses in their leases. They want the buildings they lease from to be efficient just as much as landlords do.

Usually, the projects will be around LED lighting, HVAC upgrades and improvements to the building’s envelope.

But it can also cover the same metering infrastructure that gets around the data sharing challenge mentioned above.

While on this topic, another area worth exploring is the Inflation Reduction Act-enhanced 179D tax deduction for energy efficiency improvements. The changes bring the maximum incentive from $1.88/sq ft to $5.36/sq ft.

Overtime HVAC Charges

In gross lease properties, green leases can also be used to ensure that the true cost of operating the property is reflected in utility bill backs to tenants.

Overtime HVAC costs in particular are often a hidden cost center.

In many properties, the rate charged for overtime HVAC is calculated once and then not updated for years, despite significant increase in costs to landlords.

In one property Enertiv works with, the landlord was charging $30 / hour for overtime HVAC.

However, once the true cost of operations was calculated however, including peak demand charges, it turned out the appropriate amount was $120 / hour.

That $90 / hour difference, multiplied by 18 hours per week is a $84,240 subsidy over the course of the year.

Correcting for this either helps the landlord recover their full costs, or encourages the tenant to reduce their consumption.

Conclusion

Green leases are simply not an effective way to meet modern ESG reporting requirements, especially in triple net leased properties.

That does not mean they should not be implemented for every new lease that is signed.

Green leases are an important mechanism to finance efficiency projects and the industry’s transition to net zero. There are also important considerations for ongoing cost recovery in gross lease assets.

For more information, here are Green Lease Language Examples from the Institute for Market Transformation and the Landlord-Tenant Energy Partnership.