In South Africa, the Green Building Movement steadily gathers momentum, with 5 Buildings Certified and more in the process of undergoing certification. A critical discussion that is to arise, as witnessed in international markets, is the operation of these certified assets and the peculiarities from such designation. Green Leasing plays an important role in the distribution of rights and responsibilities between landlord and tenant in an, ideally, equitable manner that the maximum value can be extracted from a Green Star Certified Building. With the introduction of a Green Star SA Commercial Interiors rating tool in the tenant market in South Africa, the focus is definitely set to shift towards the errors of commission and omission of current leases and the role that Green Leases can play in ameliorating such transition.
What is a Green Lease? It is a conventional lease that takes into account issues of sustainability as an added focus to the traditional leasing discussion of location, space, amenities, cost apportionment, duration , rental rate and escalation for renewal. The additional areas of focus relate in so much as to:
1. Ratio of Energy Cost Saving Sharing between tenant and landlord
2. Obligations for the landlord to pursue Green Building Rating at a future date
3. Specifications for minimum Green Star SA Commercial Interior Standards
4. Adherence to Environmental Benchmarks (Water, Waste, Electricity)
5. Determination of penalties and incentives for over or under performance relative to Environmental Benchmarks
6. Split in Tenant and Landlord Capex Contribution towards green measures
7. Access to Tenant Space for Building Fine Tuning and Commissioning of Systems
8. Common Area Charges and the role of incentives and rebates
9. Clauses for reasonable efforts by landlord and tenant to retain Green Building Certification during duration of the lease.
The driving force behind Green Leasing internationally has been the issue of the Split Incentive Problem. This is where a tenant on a Triple Net Lease pays for utility costs, thus the landlord is not incentivised to invest in energy efficiency measures as such benefits flow through to the tenant in the form of lower operating costs which do not compensate for the return to accrue from the investment. Thus a clause is required in leases which stipulate the ratio of which energy savings are shared in particular for capex targeted at Energy Efficiency as well as to provide the tenant with the option of co-investing in such long term expenditure. Alternatively another creative method for the landlord to recover costs is to negotiate an extension of lease terms on the same rental rate with reduced operating costs.
A building may be marketed to a tenant on the basis that it is in the process of securing a Green Star Office or Retail certification. In the case of an existing building this may be due to an overall planned refurbishment that is set to disrupt a tenant’s tradability. In order to ensure that a reward is attained from the resulting business disruption, it is important that a tenant include in the lease a commitment from the landlord for Green Star Certification with penalties for non-attainment. This together with the prospect of a lower rental escalation on the renewal of the lease.
As the market for green space expands and tenants become conscious of the options for environmentally friendly space, given two equal offerings, one certified and the other not, the choice becomes increasingly simplified. It would represent a significant opportunity cost for a tenant to be contractually tied to a landlord that does not enforce the original promise of Green Star Certification for the entirety of its Gross Letable Area (as controlled by itself in common area as well as the space of other tenants). Disposal of tenant fit out material and the choice of materials that is included in the tenant refurbishment becomes an important discussion towards the overall sustainability of the building. Equally the choice of operating hours and choice of equipment (electrical, heating, water usage) that is used in the tenant space all contribute towards the sustainability credentials of a building.
Likewise, from the perspective of the landlord, it is important to ensure that the Green Core and Shell of the building which they provide to tenants, and certified to high standards, is not contaminated in the long term by inferior unsustainable practices from a tenant. A 5 Green Star and above building will require the attraction of tenants that pursue Green Star SA Commercial Interiors to high standards. Tenant fit-out remains a significant unquantified environmental impact in the South African Commercial Property industry, with tons of waste produced and often disposed in less than environmentally friendly ways. To mitigate from such risks it is evident the need to stipulate minimum Green Star SA Commercial Interior specifications. This clause does not need to apply to currently certified Green Star SA buildings. It could apply to all high performance buildings and especially those with long term aspirations to seek a certification as budgeted in future building renovation capex.
In a prior article Published in the Sustainable Energy Journal (Andre: 2011) it was demonstrated to the property asset management industry the value of adopting environmental benchmarking practices. The introduction of Green Leasing will further enhance the added benefit of these benchmarks in the process of impartial enforcement. Benchmarking reduces subjectivity and enables a quantitative basis for determining appropriate compensation (for over or under) performance of industry agreed benchmarks. If a building is specified to deliver for example 200 Kwh/m2 of electricity consumption, benchmarks enable tenant and landlord to determine performance relative to it (of say 230 kwh/m2). Subsequently the analysis shifts to the sources of over or under performance being either landlord induced (adherence to maintenance schedules, development of building management manual for tenants, building fine tuning of systems) or tenant (non adherence to building users guide requirements, installation of inefficient and non-sustainable equipment, etc).
An example of an established benchmarking system is that of the Global Real Estate Sustainability Benchmark (GRESB), a non-profit organisation in the Netherlands that has 21000 buildings in its database. GRESB is a, industry-led organization committed to assessing the sustainability performance of real estate portfolios (public, private and direct) around the globe. The dynamic benchmark is used by institutional investors to engage with their investments with the aim to improve the sustainability performance of their investment portfolio, and the global property sector at large. On its website it states that “GRESB’s mission is to enhance the disclosure of sustainability reporting and ultimately to enable its members to achieve strong sustainability performance. By uncovering the sustainability best practices in the industry, GRESB shows the way forward for the real estate sector. Benchmarking current sustainability performance can help generate and strengthen the market forces needed for the necessary change”. With GRESB’s membership including significant commercial property funds such as a RRREF, Legal and General, Hermes Real Estate and Axxa Real Estate as well as members in regions with local benchmarks (e.g. Australian Super) it becomes increasingly relevant to South Africa as it seeks to develop a local benchmark with funds such as Growthpoint, Redefine and New Europe Property Investment (NEPI) with international operations.
A motivating factor for the introduction of green leases and its significant role as a stimulus to the Green Building Market in South Africa is the split incentive dilemma. In other words, the challenge created by triple net leases, in which benefits from landlord investments towards building improvements, including those for energy and water efficiency, flow directly to the tenant. This is where it is necessary to contract the amount of savings that is shared between tenant and landlord, using industry benchmarks (rather than solely equipment specifications) to determine the extent of the saving upon which the sharing is to take place. For example, let’s suppose that there is an A Grade Office building in Durban CDB that has undergone significant refurbishment. The benchmark for a building in this category and geography is found to be 250 kwh/m2. During the lease negotiation it was determined, by the third party outsourced property management company, that due to its operational efficiency, it can guarantee a performance of 230 Kwh per m2 (equivalent of national average). At the end of the financial year the electricity meter readings reveal that the actual amount consumed is in fact of 260 Kwh / m2. The landlord, represented by the property management company, has not delivered on its performance and the excess of 30 Kwh/m2 is under contention. Multiplied by the GLA and then by the weighted average consumption price, the total Rand value of inefficiency is exposed. At the beginning of the lease negotiation it is determined the ratio that this to be shared, based on a certain pre agreed list of interventions (specified in the Building Users Guide) not followed adequately by either tenant or landlord. If in this instance, of an outsourced property management firm, is employed, dependant on the manner in which it the external party is compensated, will determine if it can reasonably act as an impartial referee to the discussion. A schedule of ratios is determined for the errors of omission by either tenant or landlord (50:50, 60:40, etc). Within this discussion of split incentive is the contentious definition of common area and determining the appropriate allocation of costs between both parties.
Green Leases open up the possibility as well for the inclusion of capital co-investment or leasing strategies for the deployment of onsite renewable energy solutions such as roof top solar panels. This effectively representing a levy surcharge that the landlord accrues in order to settle the interest payment of the capital expenditure (if fully acquired) or to pay the utility provider the additional charge for green power. In many instances the landlord leases the rooftop space to the solar photovoltaic operator and the rental amount sufficiently compensates for the cost of leasing the equipment, its maintenance and cost of power (depending on scale). If there is a shortage in leasing cash flow between landlord and energy provider, the landlord can pass the difference via a Green Lease to the tenant.
Similar to clauses that take into account tenant business disruption arising from significant building refurbishment, it is important to not ignore the role of contracting preferential times for building fine tuning of systems in tenant spaces, by the independent commissioning agent as appointed by the landlord. These visitations by the landlord, although disruptive to the business of the tenant, are required specially if building systems are provided as part of the core & shell of the building and thus falling within the responsibility of the landlord in ensuring adequate ventilation, heating and cooling levels.
Potentially contentious is the negotiation of common area charges between tenant and landlord. More specifically as it relates to sustainability the rationing of costs incurred by the landlord for Green Star SA Certification, Recycling facilities, alternative transportation (in particular hybrid vehicle sharing in office complex) and building improvements of the common area. If these interventions result in positive cash flows accruing to the landlord, for example from carbon credits or from additional municipal and or national rebates these need to be netted from the costs that are passed onto the tenant. Carbon credits can originate from small scale CDM projects for methodologies such as Solar Water Heating, Energy Efficiency (in particular variable speed drives of Chillers) and alternative energy generation. These small scale methodologies would be applicable to portfolio wide interventions and not at a single building level with the relevance being in national tenant lease negotiations. An unexplored impact is that of the introduction of a Carbon Tax in South Africa in 2013-2014 fiscal period and the implications upon landlords. It would appear prudent on the part of the tenant to ensure that such tax is not passed through via the lease (as an additional electricity surcharge).
An often overlooked dilemma is the issue of the maintenance of Green Building Certification. Although not debated in the South African context it seems inevitable that such discussion will arise in the future, as logic would dictate, that a building cannot be merely certified once and retain such status indefinitely. It would be the equivalent of expecting a 5 Star Hotel to operate at such standards indefinitely or not be subjected to higher future revised standards. The risk thus retains for the tenant of the being tied to a lease agreement in which a Green Building Certification is placed under contention or is set to lapse within the specified lease period. In such event adequate compensation would be required for the time that the tenant operates in a downgraded “conventional” building in spite lease terms (rental, duration, etc.) having been negotiated on the basis of Green Certification.
International examples of Green Leasing Practice abound. In France, Axxa Real Estate has implemented Green Leasing in 43% of office space in France. The Better Buildings Partnership in the UK, released the Transactional Agents Sustainability Guide with a checklist of items for brokers and managing agents to investigate in the sale/purchase of a commercial property. The BBP is a collaboration of London’s leading commercial property owners and allied organisations, supported by the Mayor of London and the Greater London Authority with the aim of developing solutions towards improving the sustainability of London’s existing buildings. Growthpoint Properties, South Africa’s largest listed property fund on the JSE, has announced its intention to launch green leasing and environmental benchmarking practices in its portfolio. The trend is flourishing internationally and emerging locally, and it will be interesting to see how, in a complex South African Leasing environment impacted by the Consumer Protection Act, Green Leases will unfold with the progressive current and projected growth in Green Building Certified Commercial Property Assets.
André Ferreira is the South African Representative of the Global Real Estate Sustainability Benchmark (GRESB). GRESB is an industry-led organization committed to assessing the sustainability performance of real estate portfolios (public, private and direct) around the globe. A Green Star SA Accredited Professional (with the Green Building Council of South Africa) and Bachelor of Business Science (Economics) graduate from the University of KwaZulu-Natal.
André (2011), “Benchmarking – An Analysis of Office & Retail Properties’ Electricity Consumption”, Sustainable Energy Journal
Green Lease Guide For Commercial Office Tenants (2012) – Investa Property Group
Transactional Agents Sustainability Toolkit (2012) – Better Buildings Partnership
Global Real Estate Sustainability Benchmark (www.gresb.com)
Embracing Our Green Journey – Growthpoint Properties (2012)
Axxa Real Estate Sustainable Development Report 2011-12