Most real estate experts agree: The biggest and longest-standing hindrance to creating green tenant space and truly green and energy efficient speculative office buildings is the idea that Amory Lovins (noted energy expert and founder of the Rocky Mountain Institute) began talking about more than 20 years ago - the so-called "split incentive."
The split incentive problem is the idea that, depending on the type of lease, either tenants or landlords (but not necessarily both) will reap the rewards of efficiency upgrades. If tenants sign a net lease, then the landlord has no incentive to help them upgrade their space or create efficiencies because the tenant sees all the benefit. If the landlord uses a gross lease structure, then the tenant has no incentive for being efficient in its own space (with efficient lighting or by minimizing plug loads, for example) because the landlord capitalizes on the tenant's efficiency.
Increasingly, however, the argument is being made that there is a way for both the tenant and landlord to see benefit from efficiency, and that way is actually the gross lease with green and energy efficiency clauses. As the argument goes, a gross lease DOES have inherent benefit to the tenant because the more efficient a space, the less a landlord can charge in rent. Other than location, cost is the No. 1 priority for a tenant, so the building will be more attractive because it'll be cheaper. Additionally, landlords are still making more profit because, even though they may be getting less in rent, their operating expenses are lower and they're leasing up their building quicker and with longer-term, better-credit-worthy tenants.
"There isn't a lease out there that isn't better for a tenant in an energy-efficient building," said a developer during an interview as I was researching an article in the December 2008 issue of Building Operating Management. This was also a point made by the presenter in a seminar I went to last week about a soon-to-be-released model green lease. More specifically, the presenter argued that the net lease structure is what disincentivizes landlords and developers from building energy efficient buildings. So more widespread adoption of the gross lease structure and the landlord being able to include green clauses in the standard lease is what will ultimately turn the market toward energy efficient and green speculative and multitenant office buildings.
The problem is that, according to CoStar, 58 percent of leases in the U.S. are net leases and landlords may not have the option to suggest the gross lease if net leases are the standard in the city in which they're leasing space. That seems to be the case here in Chicago, and as the green lease presenter joked, "So the problem we have here in Chicago is that we have to fix stupid." He argued that it will just take one landlord with, um, cajones, to start the market transformation.
Opinions about this topic seemed to be varied...and passionate. What's yours? What do you think is the most logical way to transition the standard landlord/tenant lease to one that is both green and energy efficient, but also beneficial financially for both? Please comment below.
I would suggest that if a landlord can be shown to benefit from upgrades in efficiency then a net lease is no deterrent to making those upgrades. If it can be demonstrated that the operating expenses paid by the tenant are less than at equivalent properties then the landlord can get a higher net base rent. Depending on the time to pay back the cost of upgrades with the incremental increase in rent, besides the eventual greater cash flow the value of the real estate is increased (and maybe significantly so) by virtue of higher income, which capitalizes to higher value.
The challenge is that there is little easily accessed specific proof of saving that I have found for various levels of LEED certification for example. There is not even much hard information on the cost saving relative to the cost of obtaining certification. Where there is good data on efficiency gained and reasonably short payback periods, as with upgrading lighting, I have found that building owners are willing to perform upgrades, as would tenants with enough lease term left to realize the benefit.
When discussing rent, rent basis and value equations it is critical to have verifiable data and standards to reference. Otherwise neither landlords nor tenants will be willing to take a potentially expensive risk on upgrades. Better quantifiable data, more widely and clearly distributed, is the best route to show the benefits of efficiency, if there are any economic benefits. The market for space, including rental rates and lease terms, will adjust to benefit more efficient property with the availability of the facts proving the benefits. When there are tables in BOMA and facilities publications that compare building operating expenses based on easily obtained systems, efficiency and standard modifications and show the benefits of increased efficiency then those modifications will be made.
It is fairly early in the morning here in the wilds of upstate New York. Maybe I am still dreaming. Isn't there a resistance to spending money to become "green" by both the tenant/landlord and the occupant/owner?
Nearly every conference, symposium, and general conversation on investing in a green initiative begs, in some manner, for tax payer money channeled through the government.
At times I have the impression that if there was free food available many would want a subsidy for the gas to go get it. hmmmmm.
We have some really good developers out there. They understand that investment in capital expenses outweigh the operating cost tax benefits at the end of the year. They build good buildings; many don't.
We have engineers who design infrastructure for new and existing buildings with life cycle cost analysis in mind. They get beat out by "Option 2", the lower capital cost. Some think the better design is a waste for time because the concept failed before.
It would be nice to have a clear path to follow. "Green", with all its publicity, is still an emerging philosophy. There is a grasping for definition. The concept is out there at arms length and distant to many. As this topic says, we need to analyze it in each of our own buildings, not generalize. We need to open our own wallets to the concept and make it our own program. If we make it our own, if we champion it in our own buildings, the relationship of tenant, landlord, owner, or occupant will green.
Bernie
Their is no question that the focus around the country is on reducing expenses due to decreased revenue/profit. This is true in the business world as well as in the individuals own financial situation. So, it is a short step for tenants looking to save money to find locations that operate more cheaply (Read: more Energy Efficient). They can power this vehicle called "Energy Efficiency" by demanding real cost savings for space they lease and the landlords can steer it in the proper direction by doing what is necessary to provide a lower cost option. The quickest and most obvious way to lower tenant costs is to first use low/no cost options to lower lighting and HVAC utility expenses such as turning them off more regularly when not needed and purchasing more energy efficient items for these utilities than the ones already purchased for normal replacement and maintenance.(Flourescent, L.E.D. lighting and ballast, high efficiency motors for equipment and other energy efficient options) This concept of energy efficiency can be driven further by landlords doing larger upgrades and improvements by keeping their focus always on reducing the utility expenses in the building These are things the tenant sees a cost savings from without a reduction in services and amenities. The Landlord wins by attracting tenants in a highly competitive market. The advantage being, LOWER COST. The current economic conditions around our country present the ideal opportunity for tenants and landlords alike to utilize this new vehicle called: Energy Efficiency. It is an obvious choice that focuses on better decisions by the landlord and better decisions by the tenants. The outcome is a much more stable relationship that is beneficial to both.
You have hit one of the nails on the head. Every time I talk to a landlord with seperate tenants they have answered the problem with the 1970's solution. "Split the heating and let the tenant pay for it. What do I care?"
Now we have greenhouse gases. Will the government make them analyse that they are using more fuel with many heating plants in the buildings. Many of these plumbing dreams (for the contractors) will have to be rearranged to minimize the building efficiency objective.
The best way is to have the landlord minimize his energy use and then he is more competetive in the rental marketplace.