Green leases

The recent announcement by Legal & General Property (LGP), which has £10.3bn of property assets under management, that it has amended its standard lease format to include ‘green’ clauses, is a game changer for the commercial property industry. Notifying its full panel of lawyers, LGP has issued a memorandum of green lease principles that must be considered in the drafting of all standard leases going forward, including clauses relating to the use of environmental contractors and upholding Energy Performance Certificates (EPCs).

Bill Hughes, MD of LGP, said, “The decision to implement green lease clauses further demonstrates LGP’s ongoing efforts to reduce the environmental and social footprint across its portfolio, working from the grass roots up to implement change.

“As one of the UK’s largest property fund managers, we recognise our responsibility to minimise the environmental impacts of our assets, and believe that by working closely with our occupiers, we can take these changes to the next level. The move to incorporate green lease clauses represents just one element of LGP’s wider sustainability strategy which we look forward to continuing to develop going forward.”

IMPLEMENTING CHANGE

With a sustainability strategy centred on maximising the efficiency and sustainability of its portfolio, LGP recognises the fundamental importance of working with tenants to take these changes to the next level. Additional conditions set out in the lease include the implementation of a recycling strategy, and the agreement by both parties to meet regularly to discuss such issues as energy consumption and the use of grey water.

The lease also sets out amendments to tenants’ handbooks, to include incorporating information regarding energy and environmental management in relation to the estate, including EPC ratings and recommendations. Furthermore, leases may include energy reduction targets, monitoring data and other green initiatives in relation to the estate.

LGP considers it of the upmost importance that tenants understand the benefits of green policies, especially where they reduce energy costs and therefore the running costs for their premises. Its decision to adopt green leases follows a number of comprehensive initiatives undertaken by the Company to engage with occupiers, including the ‘Office, Retail and Leisure Occupiers’ Guides to Sustainability’. The Guides seek to equip tenants with a thorough understanding of the environmental impact of property and the necessary toolkit to implement change.

Additionally, the company has broken new ground by being the first investment management firm to provide an intensive, six-month training course on sustainable property investment.  Participation has been made compulsory for all property fund managers within the business and rolled out to the rest of the industry through its partners and agents.

Katherine Laurenson, Senior Solicitor at Legal & General Property, said, “The memorandum sent to our full panel of lawyers seeks to provide full, clear guidelines as to the issues that we consider key, so that they can effectively liaise with our tenants’ representatives to find a lease structure that accommodates both parties’ needs and responds to the fundamentals of the building.

“We work from a principle that encouragement and flexibility is the most effective way to deal with green issues in leases, rather than enforcement provisions with penalties for tenants who fail to comply. If tenants can see that these procedures enhance their Corporate Social Responsibility (CSR) profile, reduce their energy costs and are less harmful to the planet, it is more likely that they will implement them.”

The emphasis on ‘green’

Green leases have gained increasing prominence in the last few years, driven by policy and legislation, such as The Energy Performance of Buildings Directive (EPBD). The EPBD led to the requirement for Energy Performance Certificates (EPCs). These certificates are based on the energy efficiency of a building and are required by law when buildings are sold, let or renovated. EPCs give the equivalent of a ‘fridge rating’ for buildings to indicate their energy efficiency and level of carbon emissions.

Other key drivers for the adoption of green leases include risk mitigation against rising energy, water and landfill taxed. Increasingly, acting to protect one’s company’s reputational risk, and maximising the CSR opportunities of a robust environmental and sustainability management policy are compelling business reasons for engagement with the agenda and a buy into the notion of green leases for landlords and tenants.

At a time of global austerity and constricted resources, however, the additional burden and cost of adapting and implementing the requirements of a green lease can appear onerous, especially on the tenant. To assist parties to meet the challenge the Better Buildings Partnership (BBP) has produced a toolkit for green leases to enable owners and occupiers of commercial buildings to work together to reduce the environmental impact of their buildings.

Green strategies

The guidelines are intended to be nonprescriptive, helping owners and occupiers to agree carbon, energy, waste and water reduction strategies which best fit with the circumstances of individual properties. The toolkit is intended to assist any owner or occupier to positively engage in developing practical ways to effect significant change, with the hope to accelerate the process of making existing commercial properties more sustainable. The toolkit can be downloaded at http://tinyurl.com/d5f2ct4

The toolkit includes the following: Non-prescriptive best practice recommendations by which, through a partnership approach, owners and occupiers can agree appropriate arrangements to best fit with the circumstances of individual properties.

A model Memorandum of Understanding which can be used in full or in part and which parties can enter into at any stage of a lease.

Model Form Green Lease Clauses that the BBP believes should be included in new and renewal leases as a minimum as best practice. The extent to which these clauses are used will depend on the parties’ ambitions and what is appropriate for individual circumstances.

The green leases message it seems is getting through – and being acted upon. Mat Lown, partner at Tuffin Ferraby Taylor (TFT), “In a recent survey, 81 per cent of investors and landlords feel that they will need the full co-operation of their tenants before implementing any form of green lease, with every tenant agreeing that they would need to work together with their landlord. In a similar vein, over half of both parties believe that the costs of implementing sustainability measures should be shared between those who own the building and those who occupy it.”

There is less consensus, however, as to the commercial consequences of increasing a property’s sustainability credentials. The TFT survey founds there is an even split between those who believe that a more sustainable building will result in a higher property value to those who expect no rise.

Only 11 per cent of commercial property owners believe that they would be able to gain any extra income from a more sustainable building, however, 39 per cent expect there to be a reduced tax burden.

Over 50% of landlords and tenants believe the cost of sustainability measures should be shared between them.’

Lown said, “There is also a fear that a tenant’s green requirements will result in increased costs to the landlord under repair and refurbishment contracts. Financial implications are fuelling anxiety from tenants towards green leases, with the vast majority worried that they will bear the brunt of the bigger financial responsibilities that going green would create.

However, an area where they do not expect to see any financial implications is rental costs, with only 21 per cent thinking that they will see rents increase.”

RESIDENTIAL LEASES

In the residential sector the argument is much less defined and developed. The primary sticking point is the landlord currently has little incentive to pay for the installation of energy efficiencies when he himself won’t benefit from the savings i.e. the tenant pays the utility bills and as yet there is no perceived increase rental yield for higher energy efficient homes. Furthermore, Assured Shorthold Tenancy agreements don’t incentivise the landlord to invest in his tenant unlike commercial green leases where the nature of longer-term leases provides investor and tenant ROI.

Legislation to compel private landlords to improve their inventory’s energy performance is currently limited. In England and Wales, from 1 October 2008, social and private landlords are required to provide a landlords’ Energy Performance Certificate (EPC) for all rental properties with a new tenancy. The EPC must be made available free of charge to prospective tenants before any contract is entered into. There is a fine for non-compliance. EPC’s are not required for any property that was occupied before 1 October 2008 and which continues to be occupied after that date by the same tenant.

The game changing piece of legislation impacting private landlords is the Energy Act 2011, which has a provision that states from 2018 a property with an EPC rating lower than ‘E’ will not be legally allowed to be rented. The Government estimates that over 680,000 rented properties are currently ‘F’ and ‘G’ rated and so will be affected.

Landlords will have the opportunity to improve the energy efficiency of their properties at no upfront cost via the new Green Deal initiative. The Green Deal is listed to be introduced in October 2012. A loan against the property, which would be repaid through a levy added to utility bills, will be the market mechanism.

In a recent poll, The National Landlords Association found that a quarter of landlords would definitely take advantage of the Green Deal while a further 38 per cent would consider it. Some 21 per cent of landlords surveyed said they were unsure about the deal while 17 per cent said it had no appeal.

David Salusbury, NLA Chairman, said, “The scheme guarantees tenants lower utility bills while providing them with warmer homes and landlords will benefit from long-term improvements to their properties. It’s pleasing to see that two thirds of landlords are considering using the Green Deal to improve their properties when grants become available next year, but the actual cost of these improvements will be a key factor.”

GREEN LEASES – THE LEGAL BRIEF

Michael Fahy, head of commercial property at Steeles Law, outlined what green clauses might typically appear in a lease, the perceived problems, solutions and benefits.

Clauses

1. Repair: The tenant should use materials from sustainable resources so far as practicable.
2. Service charge: The landlord will be entitled to have regard to the cost of environmental good practice.
3. Tenant fit-out: The tenant will be required to use materials from sustainable resources that are approved by the landlord.
4. Sharing of information: The tenant may be required to share information with the landlord on its plans for improving energy efficiency. This can be organised in a variety of ways, for instance through a formalised Committee (comprising the landlord and tenant) or simply informally informing the landlord of details of any changes implemented by the tenant for reducing energy use.

Perceived problems

1. Cost: the additional costs involved in reducing the carbon footprint derive from a range of possible improvements in buildings, operations and management. Environmentally friendly obligations can be imposed on a tenant relating to, for instance, waste disposal, recycling and use of specific types of cleaning products that comply with environmental policies. For the landlord, the costs involve the initial expense of setting up an environmentally efficient system and the loss of a potential tenant who may be deterred to enter a lease due to the costs (in the form of increased rent and service charge) passed on from the landlord to achieve energy efficiency.
2. Uncertainty. This can arise in two ways. The covenants imposed on the tenant may be too vague (eg ‘to cooperate with the landlord to improve energy efficiency’) and so there is uncertainty regarding whether a breach has occurred. Secondly, the potential costs to the tenant of certain green clauses may be unclear in the initial stages of the term.
3. Time: The landlord producing and the tenant complying with energy efficient policies will take up time and resources that could be used elsewhere in the business.

Solutions and benefits

1. Ultimate increased profitability for both landlords and tenants: Initial costs of setting up environmentally friendly practices should be outweighed by future significant reductions in costs from, for instance, lower electricity bills and reduced service charges from more efficient buildings.
2. Improved reputation: Beneficial to companies to strengthen their corporate social responsibility image.
3. Looking to the future: Green leases will undoubtedly become increasingly common with certain obligations, probably becoming mandatory, required by future legislation designed to achieve the government aim of reducing greenhouse gas emissions by 80% by 2050. There is already some sign of this with the introduction of the Carbon Reduction Commitment in April 2010.

Gordon Miller is Co-founder and Sustainability & Communications Director of Sustain Worldwide (www.sustainworldwide.com).

Is the future very green?

So where does that leave the notion of green leases? In the private rented sector, they are a country mile away, and they shall remain that distance apart whilst ever a green lease is dependent on a degree of compromise, collaboration and agreement. Certain green clauses may begin to creep in, however. For example, if fines for noncompliance of recycling directives are introduced, as is mooted periodically, a clause compelling the tenant to recycle or pay the consequences (fine) would be inserted as a ‘green’ clause.

In the commercial sector? Green leases are moving towards the norm, driven by legislation (CRC requirements) and managing reputational risk and associated CSR profile. The question is no  longer if they will be adopted but to what degree, how they will be implemented and what legal standing they carry.

Mat Lown of TFT, said, “So far there appears to be three gradients of green leases: dark, light and a memorandum of understanding. All three establish practices for both parties in taking measures to improve a building’s effect on the environments. Both dark and light green leases are legally binding documents that replace the standard lease.

“A dark green lease includes specific obligations and targets, whereas a light green lease includes more general obligations without setting specific targets. The third option is the inclusion to a standard lease of a supplementary non-legally binding memorandum of understanding.

Tenants get lower bills and warmer homes, landlords benefit in the longer term. David Salusbury, NLA

“It is the two moderate versions that appear to have the most backing. In our poll, 43 per cent of landlords said they would consider signing a light green lease and a further 37 per cent noted a memorandum of understanding to be most appealing. It is also clear that, while there is an acceptance that increased sustainability and green leases are inevitable, both landlords and tenants feel that there needs to be stronger support from the sector as a whole, as well as from the Government.

The writing is on the wall: green leases are the future. When a behemoth like Legal & General Property amends its standard lease to include green clauses, the future has all but been decided. For mere mortals – landlords and tenants alike – the question remains do you wait to be dragged via legislation into adopting the new order, or do you jump willingly and therefore maximise the CSR, marketing and improved reputational benefits of being seen as an early adopter.