Green Lease model creation for single-user office building

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1 Green Lease model creation for single-user office building Karoliina Rajakallio Director, green building and sustainability consulting Pöyry Finland Ltd. Finland Miia Anttila Leading specialist Real Estate Consulting Pöyry Finland Ltd. Finland Summary Green Lease is a leasing agreement concept that seeks to remove disincentives in to improve the environmental performance of a building and encourages sustainable practices by both the landlord and the tenant. It ensures that the costs and benefits of good environmental performance fall to the agreement parties in fair way. The existing Green Lease models from the USA, Canada and Australia are studied in context of Finnish leasing practices and a green lease agreement is developed for a single user office building. Keywords: Green lease, energy consumption, agreement, environmental performance 4. Introduction 4.1 Background, drivers Based on technical calculations and existing best available technologies, designing and constructing an extremely energy efficient facilities is already possible. However, many of these very energy efficient buildings that are taken into use exceed their estimated energy consumption. In older buildings, the payback time of energy refurbishments with even moderate investment costs is tens of years. Investors are also struggling with tenants, who rarely are willing to pay significant premium in rents for a green building. On the other hand, several green developments are competing in the real estate market, meaning that it is necessary for investors to find ways to differentiate themselves in the property market. In traditional gross and net lease agreements the costs and benefits of good environmental performance often fall to the different parties of the lease agreement, making investments to improve environmental performance of a building often economically unattractive. For example owner s investment to energy efficient lighting fixtures benefits the tenant responsible for the electricity bill. There is a need to improve the tenant-landlord relationship to get the best out of a green building through joint efforts, to make sure that the buildings operate at the optimal level. There is a need for a mechanism that forces both parties to drive and maintain the building, so that it can meet its green objectives. For an environmentally conscious tenant, there is a need to ensure that his facilities are kept up with the environmental development and that the tenant may minimise his environmental impact in his operations. Popular green labels, such as LEED and BREEAM also promote better tenant-investor relationship, especially in cases of certifying existing buildings. Green Lease is a leasing agreement concept that has been created in order to tackle the problems

2 presented above. First, it ensures that the costs and benefits of good environmental performance fall to the agreement parties in fair way. It helps to tackle problems related to human behaviour and technical investments for environment with cost premium. It may be a strict agreement concept enabling sanctions and rewards for environmental behaviour and correct use of the building or an agreement on co-operation processes and joint objectives. 4.2 Previous applications Green lease has most widely been applied in Anglo-American countries, and only recently there have been public statements about the adoption of the concept also in Scandinavia. There have however been efforts to improve tenant-landlord co-operation in environmental management, such as WWF s Green Office. The most significant difference between green lease and other co-operation programmes, is that green lease is a contractual document and as such a legally binding document with resolution mechanisms. Also there is typically monetary reward-sanction approach involved. These aspects hypothetically make green lease more efficient tool to steer the environmental performance of the building than voluntary approaches. Different rental agreement concepts to support environmental efficiency have been developed in different parts of the World. The contents of these concepts vary significantly. At their loosest form, green lease concept has consisted of merely pro-environmental phrases, whereas the strictest green lease models contain detailed legal clauses of tenant and landlord contractual liabilities. The existing Green Lease models are mostly following the Anglo-American leasing practices with net to triple net rents. The American Building Owner s and Manager s Association BOMA, Commonwealth of Australia Department of the Environment and Water Resources and Real Property Association of Canada (RealPAC) are among the developers of early green lease models. Finnish divided rent practice, where investment and maintenance costs are divided between tenant and the landlord with fixed and variable cost elements, Green Lease models have not yet been applied. 4.3 Objectives and scope Objective The study was carried out to create a new ecological lease agreement model to support the landlord and the tenant to operate and occupy a single-user office building including research facilities in a more sustainable way. In the study a divided rent model is taken as the starting point. After experiences from this pilot case, the model is planned to be amended to a lease model applicable in other buildings with single tenants. Results of this study benefit the real estate investors, who can increase the attractiveness of their facilities in the rental market and also extend their environmental work to cover better the usage of the buildings. Also the result of this study can be applied by environmental-conscious tenants as a tool to incorporate landlord to support tenant s environmental work Limitations The study is limited to single-user office building. A typical Finnish divided rent leasing practice is taken as the starting point for the lease model development. 4.4 Methodology / Application of green lease model The study was conducted by first researching international literature discussing green leasing issues and then further developed as a single-case case study regarding the leasing process of an office building in pre-planning phase for the Finnish Environment Institute. Since there are only few

3 scientific articles on the topic of green lease, most of the theoretical studies are based on conference publications and studies by real estate industry associations. 5. Existing green lease models Environmental objectives covered by a green lease agreement The environmental criteria that green lease agreement typically adopts / tries to manage, are related to energy and water conservation, reduction of pollutants, waste minimisation, avoidance of hazardous materials, healthy indoor air and user satisfaction. These criteria is in line with the established most important environmental impacts of built environment, defined by the academia. They are also implemented as a basis of the most popular green building classification and labelling systems, such as LEED, BREEAM, CASBEE, and Finnish PROMISE Scope of a Green Lease Agreement In green lease, above mentioned topics and related construction and maintenance processes are typically not steered as a whole. The agreed clauses cover specific factors affecting those operations, so that they can be monitored and measured at appropriated detail level (example!!). Also the green lease agreements target environmental impacts that can be affected during the usephase of the building s life cycle and thus steered through a lease agreement. For example topics related to the location and structural solutions are typically not covered by a green lease agreement Green lease mechanisms There are certain approaches and mechanisms that can be found in an effective green lease agreement. These mechanisms have been identified for example by S. Michael Brooks in his SB08 conference publication. They can also be found in studied green lease guides by BOMA (Guide to Writing a Commercial Real Estate Lease, Including Green Lease Language), RealPAC (National Standard Green Office Lease for Single-Building Projects) Corporate Realty, Design & Management Institute (model green lease, Investa Property Group (Green Lease Guide for commercial office tenants). The most applicable model for this study was found to be the Green lease Schedules by Commonwealth of Australia Department of the Environment and Water Resources [1] [2] [3]. According to Brooks and analysed models, there seem to be at least two approaches to a green lease: 1. A paternalistic approach where the obligations for reduced consumption and environmentally responsible behaviour are mandated by either the tenant or the landlord within the lease; and 2. A co-operative model, where mutual objectives are set out in the lease for both parties to achieve, leading to responsibilities and liabilities for both parties. Identified mechanisms include: 6. Joint targets and reference values - Joint targets and reference values for energy, water and waste recycling are set either as absolute values (e.g. as amount of MWh consumer per year) or using target percentages (e.g. as reduction of current annual consumption). Also other targets should be set as unambiguous as possible, using mutually accepted reference values and standards. 7. Dispute Resolution Mechanism - Dispute Resolution Mechanisms apply in the event of a disagreement between the landlord and tenant as to why a particular target or objective prescribed by the lease

4 is not achieved. 8. Environmental management plan - Environmental management plan describes how the environmental targets set for the building are to be achieved, list of actions, schedule and organisation. 9. Technical specifications - This refers to a vast list of principles about the operations in the buildings such as use of materials and chemicals, green cleaning, procurement principles, quality criteria for gardening, water usage, repairs and refurbishments, tenant guidance, office appliances etc. 10. Valuation methodologies to be used - An important aspect to be incorporated into a green lease agreement is principles of investment calculations based of the life-cycle of the investments. Agreed principles enable both parties to estimate the economic impacts of investment decisions in a common way. 5.2 Finnish leasing practices in single tenant buildings Traditionally the Finnish lease type has been gross rent excluding electrical and cleaning. From the green lease point of view the gross rent is problematic since the tenant has no information of the cost allocation. An advantage is that the tenant usually has his own electricity contract and therefore gets the consumption and cost figures from the energy company. However, tenant is not aware of the consumption of the property electricity and his possibilities to influence, for example, the ventilation and cooling. Net lease type of rents are becoming more common especially in single tenant buildings. The benefit is that the tenant is aware of all the consumption and cost figures. From the green lease point of view the main problem is investments. If the landlord cannot amortize the investments that improve energy efficiency or environmental friendliness, and it mostly benefits the tenant, it may slow down the improvements. A quite commonly used rent type is divided rent. As shown in the graph below the rent is divided in the absolute net rent, fixed maintenance rent and variable maintenance rent. The absolute net rent includes the base rent, taxes and insurance. The maintenance rent is divided in two: the variable and fixed maintenance rents. It is agreed on case by case which costs are included in which; frequently the decision is based on the division between common/shared space and leased space. From the green lease point of view the divided rent gives the contract parties a good platform to fix the rent so that it has its best steering influence. For example the mobile rent includes the electricity for lighting, ventilation, cooling and sockets. The risk is that the rent mechanism is set to be too complicated and/or it does not coincide with the metering and reporting. Regardless of the rent type the key factors are accurate and carefully chosen metering, reporting and billing mechanism.

5 Variable Maintenance Rent Maitenance rent Fixed Maintenance Rent Total Rent Fixed rent Absolute Net Rent Figure 1. Divided rent 6. Results 6.1 Synergy Building Senate Properties is leading a project called Ecologically efficient office building Synergy building. The new building being designed as the head office of The Finnish Environment Institute (SYKE) contains office premises for approximately 625 persons as well as laboratory facilities. The programme area of the building is m 2 which consists of office space (80 %) and laboratories (20 %). The following environmental classification levels have been set as project targets: Breeam Europe 2009 Office: Outstanding, Leed New Construction 2009: Platinum and Hanke-PromisE: A- Class. Therefore it was natural also to link the environmental aspects to the lease contract. At the time of writing this paper a Final Draft version of the green lease agreement is being outlined. The main highlights of the case study are presented on the following lines. In this case a divided rent lease agreement was chosen. It is currently still under discussion whether the variable maintenance rent would include the costs of heating, electricity, water and waste. A co-operational model (as described in ch ) was chosen as the preferred approach Joint targets and reference values Since the building is new the main focus is on future targets and values. Energy calculations have been made and are being used as baseline for heat, electricity and water. It has been agreed on that the real baseline will be set after 2 years usage of the building and joint targets for the consumption be set based on it. It has been agreed that the Finnish indoor air quality standard S-2 is being used for reference for indoor temperatures. Normal office hours and other hours have been agreed on and the building automation system is adjusted based on them. Therefore it should never happen that, for example, the cooling system is on by night. S-2 allows a certain number of tolerance days when the room temperature does not need to meet the target temperature. The tolerance days cover the hottest and coldest days in Finland. The tenant agrees that this is acceptable and that energy efficiency is the guideline during these extreme days. For the waste management it has been agreed that at least 70% of the waste will be sorted and recycled. The property owner is obligated to arrange the needed waste containers and the tenant is obligated to instruct his employees to sort the waste accordingly Dispute resolution When talking about green values, green targets and green operations the bargaining process includes co-operation and negotiation. In this case the use of sanctions for not meeting the environmental targets was seen as peculiar, as the tenant is responsible for the costs of electricity, heating, water and waste. These costs can thus be seen both the carrot and the stick: less consumption means less (or no higher) cost.

6 6.1.3 Environmental management plan The cornerstones of the management plan are regular cooperation between the tenant and the landlord, accurate and detailed metering of energy and water consumption and reporting, daily maintenance of the building and the tenant s environmental management system. Three co-operative meetings between the tenant and the landlord are focused on Green Lease issues annually. New targets are set each autumn. The yearly consumption and costs are reviewed in winter and the possible compensations in costs are carried out in spring. Detailed agendas of these meetings are described in the Green Lease Year clock. The landlord is obligated to arrange sufficient metering in the buildings. The measured variables are for example electricity for cooling, ventilation, and lighting during office hours. The landlord is also obligated to organize proper reporting. The reported parameters are for example electricity total kwh/m 2, kwh/work place, kwh/ man-year. The landlord is obligated to arrange green daily maintenance. The main guidelines can be found from green building classification and labelling systems. An example is outdoor maintenance: guidelines are found for ice and snow removal, cleaning of façades, the equipment and chemicals used etc. The tenant is obligated to have his own environmental management system which includes for example green cleaning and employee guidance for cooling and lighting systems, waste sorting and the usage of office equipment Technical specifications The most significant issues are related to energy. The heating system of the property is district heating. There will also be local energy production with renewable energy sources at the same plot. Here renewable energy source is defined as sun, wind and biomass. Power that is produced with renewable energy sources will be used, when possible, in the building. Power that is considered as renewable energy source is sun, wind, biomass and electricity produced by dam-free hydroelectric power plants. Parties involved commit to follow the governmental decision principle to promote sustainable choices in public purchases. During years at least 30 % and from year 2015 at least 60% of the building s power purchased is produced by renewable energy sources Valuation methodologies to be used Investments to improve energy efficiency or environmental friendliness can be performed during the rental period in the real estate. The reasons for the investments can be environmental issues, technical development or problems related to the technical implementation or aging in the real estate. Investments to improve energy efficiency and environmental friendliness are set, evaluated, and implemented, separately and in collaboration, by the landlord and the tenant. Investment principles to improve energy efficiency: - Savings are primarily distributed so that the investor can first amortize the investment in a reasonable time and then savings are distributed equally between the parties - The investments amortizing practises are agreed separately for each investment: the amortizing, for the tenant, can be executed either as single instalment, as several instalments or though the flat rent that is determined in the lease. - If the landlord cannot amortize the investments that improve energy efficiency or environmental friendliness, and it mostly benefits the tenant, then the tenant is accountable for the investment costs.

7 6.1.6 Conclusion In general it can be said that the environmental classifications give a good practical background to the green lease work. Key elements of a green lease agreement were identified to include better co-operation between the parties, righteous operating cost division and setting out ambitious consumption targets, for example, for electricity use. The main challenges in bringing green lease agreements into practice are committing the parties to green procedures and the substantiation of consumption saving results. 6.2 Rakli initiative RAKLI (Association of Finnish Building owners and developers) has launched The Eco-efficient contracting practises development initiative together with the field s leading companies. The initiative introduces a task list, that is valuable in letting processes and -contacts, which consist of the essential green contractual elements. The initiative forms a description of responsible letting and portrays ways to implement the contractual elements in different situations. The goal is to develop contractual practices in the field to be more customer-oriented and environmentally friendly. The initiative creates, with win-win-principle, elements for a functional and transparent approach in letting and real estate services. The initiative provides tools to improve the letting process, service process and the investment process, and to improve the related contracts to be more customer-oriented, risk-free, costeffective and environmentally friendlier. The company receives benchmarking to the fields leading international practices and ways to implement goals, agreements and practices according to various classifications and reporting (e.g. GRI, LEED, BREEAM, Promise, and Green Office) that are commonly defined by the industry. The goal is to provide: Green Lease A good way to rent a compact document in Finnish and English Green Check List Task list a compact document in Finnish and English, including impacts on Investment- and real estate service processes (and process steps) Green Lease The renting risk matrix The RAKLI initiative started in November The initiative was well welcomed. The participation companies (21 in total) were easy to find and the discussion has been active in all work shops. The work shops are held December 2010 May The final seminar will be in June The final results of the RAKLI initiative can be included to the final Full Paper. 7. Discussion and conclusions The green lease as a concept is an excellent tool to improve tenant-landlord co-operation and discussion generally about environmental issues in a building. Often the understanding of the most significant environmental targets vary between the landlord and the tenant. The negotiation procedure of making a green lease agreement forces the parties to value different environmental aspects and find common targets that the both parties can agree and commit to. In the Synergy building, the tenant was highly aware of environmental issues, however there were still possibilities to improve their understanding of the environmentally conscious building maintenance and operational steering procedures. Due to several cost items typical for the divided rent model, the green lease easily gets very detailed involving several sub meters to accurately divide energy and water costs. Consequently there is a risk that management of the agreement becomes overly resource consuming and overshadows the benefits of the agreement. Thus it is important to maintain the big picture, i.e. jointly agreed environmental objectives, in the agreement negotiations and to emphasise the cooperational aspect of the agreement. This means that detailed cost and benefit divisions are jointly agreed case by case based on total benefits to both parties.

8 When applying green lease to Finnish divided rent model to the tenant s actual monetary savings remain relatively small compared to the full rental costs. Also, to gain full effect, the tenant s role to operate the building is relatively large. As a consequence, the tenant should still be motivated to improve his environmental performance for other reasons than significant monetary rewards. For the landlord, the payback time of most of environmental investments is alone too long to be considered economically beneficial. However, the most significant benefits of green lease greatly overshadow direct monetary savings. Improved dialogue with tenants and possibility to provide added value trough green lease could be considered as the most important business aspects of green leases. References [1] Green Lease Guide, Investa Property Group, Investa Properties Limited, Trough [2] Roussac ym. (2008) Changing the culture of commercial buildings in Australia: the role of green leases. World Conference SB08. 6 s. ISBN [3] Whitson, A. (2006) Green Lease: Creating an Incentive to Effectively Design, Build and Manage High-performance and Sustainable Buildings through a Green Lease. Environmental Design & Construction, Jul 2006, Vol. 9 Issues 6. p ISSN