Green leases – do you know what you’re getting?
A big challenge for our industry is determining the green performance of future developments, based on pre-commitment lease agreements. How are green standards for these developments agreed, and what are the cost implications? RODNEY TIMM investigates.
The desired green performance of a new building will probably be manifest in some form of green agreement to lease and lease schedule between developers and tenants. But what is the commerce and issues of these forms of leases? And what remedies are available to the tenant if the building’s promised green performance is not delivered?
Generally, the industry has come to grips with different green rating tools, which now revolve around the two primary Australian rating tools – NABERS and Green Star. Simplistically, the key distinguishing features between these two rating tools is that NABERS is based on actual performance of buildings and to-date has focused on energy and water; Green Star is all about the attributes of the building covering a more holistic range of environmental outcomes.
NABERS ratings are based on consumption benchmarks of the building tested over a prescribed period of occupancy. By contrast, Green Star ratings are based on certification at various stages during design or after completion of the development and subsequent life-cycle of the building. The process considers a broad range the building attributes and requires extensive documentation and evidence. The final ratings are not known – even if every design decision is focused on achieving these ratings – and the final ‘as built’ outcome can only be measured after completion. With both rating tools, therefore, the final outcome is not known until the building is complete and certifications delivered.
The commercial arrangements to support green outcomes in pre-commitment lease agreements can be complex. Developer guarantees sound good but are subject to final certification by others. With the NABERS rating tool, if the target is not achieved, the outcome may be able to be delivered via retrofitting – a potentially expensive and disruptive process. With Green Star rating, retrospective actions are more problematic. If target points are missed during construction – from whatever causes, including, as examples: not using recycled material targets as planned; innovative ideas not accepted; or defective documentation – then the rating may not be achieved and not much can be done. Developers may as a result believe guarantees are too risky to make commercial sense – dependent on the tenant’s legal remedy rights.
A trend has emerged to structure joint commitments by the developer and tenant to achieve specific green performance, but this changes the dynamics of the outcome. With the tenant in the design process and being able to provide input, the tenant is now a collaborator in the process and there is a fundamental transfer of the risk. If the building does not achieve the target rating, then both parties are responsible and remedies, if any, are complex.
Best endeavour undertakings by the developer may be the way to go, if available. Even though more onerous than reasonable endeavours, from the tenant’s perspective, is this acceptable? What happens if best endeavours are not good enough and the target rating is not achieved? No doubt the tenant may feel aggrieved and one of the key accommodation objectives will not be achieved.
The nature of the remedies that the tenant may have should be included in the pre-commitment lease agreement and are fundamental to the commercial outcome. If the agreement is structured to give the tenant the right to cancel their lease commitment, this is still unlikely to meet the objectives of either party. The developer is suddenly without a tenant and the tenant probably does not have alternative accommodation options with the required rating. And even more complex is the timing and logistics – certification is usually only received after the tenant has moved into the new building.
An alternative remedy is linked to rental reductions. But for the tenant committed to environmental outcomes with corporate statements about reducing their ‘carbon footprints’, is this acceptable? And by how much should the rent be reduced – a notional, market or penal quantum? This remedy does not achieve the desired outcome for the tenant who may now be locked into a ten/twelve year lease agreement in a building not meeting their environmental benchmarks.
Probably the most equitable remedy is structured around the enforcement of rating commitments – no matter what the cost – through retro-actions. But this can only be done with NABERS rating tools. As such this remedy has complications but can provide assurance to the tenant about their required green statement.
GREEN LEASE ECONOMICS
From an owner’s perspective there is a push for premium rentals for premium buildings with green credentials to provide the required return on development costs. However, as green initiatives become the norm and entrenched as part of commercial building quality grades, it will be difficult to argue that these initiatives should justify premiums above a normal ‘market’ rental. In the tension of negotiating, the tenant’s argument will focus on the belief that future-proofed green developments will be able to command much firmer (lower) required investment yields, hence pushing up property end-values. This is particularly true if the new premium green building has its income underpinned by a strong tenant covenant and thus justifies the development cost premiums. However, tenants should note that in green leases there is usually a reciprocal commitment on the tenant to deliver a green-rated fitout – no matter what it costs.
In the final analysis high-profile tenants will be seeking green leases to make a commitment statement to lowering their carbon footprint in new accommodation. In this market astute developers will be keen to obtain a competitive edge and attract quality tenants by creating buildings with reduced carbon footprints. Ultimately the transaction is all about the willingness of the parties to understand each others’ objectives and to reflect these in equitable terms. It is likely that the commerce of green leases covering rentals, remedies, lower operating costs and enhanced building life-cycles will mature over the next few years as these become the norm.