Although the concept of a “green lease” has been around for more than a decade, a lot of people who work in the commercial property industry have a limited understanding of what this actually means. In this note we explain the terminology and consider why leases may need to become greener over the next five years, including a review of the forthcoming minimum energy performance standards.
What is a green lease?
A “green lease” is a catch-all term for any documents, clauses or arrangements entered into between a landlord and tenant with the aim of minimising adverse environmental impacts. The provisions may cover just energy efficiency or may extend to other environmental concerns (for example metering, water and waste management, recycling, use of sustainable materials and green transport).
The provisions may be legally binding – for example clauses in the lease or an obligation to comply with tenant regulations – or may simply require that the parties take a cooperative approach, documented in a memorandum of understanding (MoU). Where binding obligations are entered into these are known as “dark green” provisions, while the non-binding obligations are “light green”.
The Better Buildings Partnership (BBP) has created a green lease toolkit which provides guidance and recommendations on green leases. It includes a set of best practice recommendations, a model form MoU and model form green lease clauses, suitable for both new and renewal leases. The green lease toolkit can be downloaded here: http://www.betterbuildingspartnership.co.uk/working-groups/green-leases/green-lease-toolkit/
What benefits can green leases bring?
For a new building, which has been constructed to ensure that it is sustainable and environmentally friendly, green lease provisions will be aimed at ensuring the building’s green credentials are not reduced. For older buildings the green lease provisions are more likely to focus on the improvements that can be made.
However, before considering the advantages that a landlord and tenant may gain from green lease provisions it is helpful to look at some of the reasons why they are not being adopted at the moment:
- Market norms: Most landlords, tenants and their advisors are unwilling to try anything new. While it continues to be unusual to have green provisions in a lease, it is easier to just strike them out when they do show up, than actually think about why they’re in there.
- Lack of understanding: When green provisions appear in their draft lease, tenants fear that landlords are just trying to find a way to pass on costs to them. While this may sometimes be the case, many green lease provisions actually work to the tenant’s advantage: the landlords who adopt them generally want to take a more collaborative approach and are keen to establish a joint strategy. There is a lack of understanding of the benefits that the provisions may bring.
- Payment of costs: There is no established basis on which the costs of any improvements are paid. The landlord doesn’t want to pay out for improvements which will reduce the tenant’s electricity or water bill unless he can expect to achieve a higher rent or increased freehold value to compensate for this. However, a commercial tenant on a five year lease doesn’t want to take on liability for carrying out works when he won’t hold his interest for long enough to recover his expenditure through reduced bills. However, green lease provisions need not be expensive: the parties could agree to only zero or low cost provisions such as education and changing of behaviours.
So what are some of the advantages to green leases?
Rather than increasing costs, improving the energy efficiency or other green credentials of a building can actually bring a cost saving to the occupiers. If less energy is being consumed (because low energy technology is being used or occupiers are encouraged to switch off lights and computers), or the building generates some of its own energy, the bills will be lower. The same is true of reductions in water usage and waste disposal (trade recycling is usually significantly cheaper than landfill, so just separating out rubbish can lead to savings). These savings can be documented either by way of binding lease obligations or in an MoU.
Many organisations have Corporate Social Responsibility (CSR) policies. These may stem from a desire to “do the right thing”, because of reputational reasons or to align their values with those of their employees. CSR policies often contain commitments to reduce environmental impact. Entering into green lease provisions, whether as landlord or tenant, is a good way to demonstrate that CSR policies are more than just a piece of paper.
In addition, companies are increasingly required to report on environmental issues. Directors of quoted companies must already include information about environmental matters in annual business reviews where this is relevant for an understanding of the company’s business; it is likely that this will be extended in the future. There is currently voluntary reporting on Greenhouse Gas (GHG) emissions and there are anticipated regulations which will impose a duty on all quoted companies to include this in their directors’ reports. Being able to make reference to green lease provisions will help demonstrate what the company is doing in respect of environmental matters and to reduce emissions.
The Carbon Reduction Commitment (CRC) scheme was introduced in 2010. Most landlords have been unable to pass the costs of compliance with CRC on to their tenants. Working with tenants to reduce their energy consumption will reduce the landlord’s CRC liabilities.
Energy Performance Certificates (EPCs) are required for the majority of commercial properties when they are let. While the rating in the EPC doesn’t currently seem to have much of an impact on the letting value of a property, this is may well change with the introduction of minimum energy performance standards – see the separate section below for more information on the implications of this. Green lease provisions could include a mutual commitment to improve the rating of the building and should as a minimum prevent either party from doing anything that would invalidate the EPC or negatively affect the rating.
Minimum energy performance requirements set by the Building Regulations are already fairly stringent. Green lease provision can be used to ensure that these standards are maintained, for example by requiring that building management systems are used correctly and the tenant’s fit out works do not affect the building’s standard.
A greener building accompanied by a green lease may help to protect both landlords and tenants against future commercial and physical risks:
- It may become more difficult to secure a constant energy supply in the future. Coupled with increasingly volatile energy prices it makes good commercial sense for buildings to be built or converted to incorporate their own energy supply (eg solar panels).
- Landfill space is running out meaning that landfill costs are going up. Recycling is already cheaper and the difference is likely to become more significant in the future. Green lease provisions requiring recycling will keep costs down.
- There may be water shortages: installing water efficient appliances and grey water recycling will reduce this risk.
- The number of cars on the road is continuing to increase. Providing green transport options such as car share schemes, bike hire/funding and secure bike parking will help keep businesses running smoothly.
- Climate change is leading to more extreme weather events: constructing or renovating to cope with this (eg flood defences) will reduce the risk of expensive damage to the property.
What are the minimum energy performance standards?
Minimum energy performance standards (MEPS) are due to be introduced no later than April 2018, under the Energy Act 2011. Where MEPS apply, a landlord may not let a property that falls below the required rating (likely to be an E); there will be a fine for letting out a commercial property in breach of this requirement. However, there is not yet clarity over how these provisions will apply, in particular:
- We don’t yet know what types of property will be affected by MEPS or what exemptions may apply, so we cannot advise on whether any particularly building will be caught.
- The phrase “may not let” may be restricted to the grant of a completely new lease or it may also catch renewals and reversionary leases, even where the landlord is under an obligation to grant them (for example under the 1954 Act). There is even a possibility – though this seems unlikely – that “may not let” will be defined as “may not continue to let” which will cause significant issues.
- It is not yet clear what work the landlord is obliged to carry out before it can let a property which has failed to meet the MEPS. It may only be works that can be wholly paid for by a Green Deal Plan, in which case if funding is unavailable it may be possible for the building to be let despite having an F or a G rating.
Despite this lack of clarity, landlords and tenant should start thinking now about the implications of the MEPS, particularly for properties that are currently below the required standard. Landlords will want to ensure that their properties meet the MEPS as soon as the requirements take effect, so that they can continue to let; they will not want to have a lengthy void period while the property is brought up to standard. However, tenants won’t want to agree to provisions which oblige them to carry out the works, permit the landlord to recover the costs of the works through the service charge, or allow the landlord extensive access rights to carry out the works during the term (though a tenant may want wider rights to make alterations or improvements, so that it can bring the property up to the necessary standard if it wishes to sublet).
It is unlikely that any of the standard provisions in an existing commercial lease would oblige the tenant to carry out the necessary improvements: the Energy Act does not impose an obligation to do any works, so the statutory compliance obligation won’t apply, and normal repair clauses do not require a tenant to carry out improvement works. However, for multi-let properties the service charge provisions may allow a landlord to recover improvement costs from the tenants – this will depend on the wording of the particular provisions.
While there’s no right answer as to how MEPS should be dealt with, both parties should at least be considering this when a lease is entered into: many of the issues dealt with by green lease provisions will have an impact on a property’s rating, and could be used as a tool to help improve or maintain the property’s current rating.
Is the future looking greener?
While take up of green leases is still very slow, there are significant landlords and tenants at the upper end of the market who are using them. Notable landlords who have successfully introduced green lease provisions include Hermes, Land Securities, British Land, PRUPIM, Grosvenor and Legal & General; and tenant-led policies are also appearing with Marks & Spencer entering in MoUs with all BBP members in respect of existing stores and requesting green clauses in all of their new leases
However, green lease clauses are still viewed by many in the industry as a burden rather than a benefit. Neither EPCs nor the CRC has acted as the driver that was expected and green leases will only become the norm once property owners, occupiers or agents start to look on them as a positive: they can be about saving money rather than spending money but they do require cooperation between landlords and tenants.
With the introduction of MEPS in less than four years, landlords should be reviewing their leases now – using the BBP toolkit as a starting point – to see what they can do to improve or maintain the efficiency of their buildings. Tenants with a CSR environmental policy should ensure that their property managers are aware of this and that they act on their paper commitments. Above all, landlords and tenants should start talking about green lease issues: property related legislation in this area is only going to increase, so we should make sure that we are ready for a greener future.