Last year, a joint group which included the Real Estate Board of New York, US Green Building Council, the Natural Resources Defense Council, the Environmental Defense Fund, and HR&A Advisors endorsed a Model Energy Aligned Lease Provision, which purports to remove the “split incentive” problem which can exist with respect to commercial “gross” leases. In a nutshell, the split incentive problem occurs in the gross lease context, where all utility costs are typically passed through to tenants on a square footage ratio, so the landlord is not motivated to retrofit their buildings with energy and other resource-saving improvements for which they will never recover the cost. For background on the split incentive issue, see my prior post, “The Net Lease and the Split Incentive”.
The model provision is actually a document insert into the standard gross lease, whereby the tenant and landlord agree to amortize the cost of the retrofit improvements based upon an engineer-certified estimate of cost savings. The concept is that the tenant would not pay more in pass-through retrofit costs than the amount of the cost savings.
This model provision may be helpful in at least some gross leases, but it has important drawbacks. First, it really can’t become a useful tool unless all leases in the building have the same provision. In a typical commercial building with a gross lease, the utility pass-through provisions are all exactly the same, so that the pass-through applies uniformly to each tenant. It would serve no purpose to have a mix of standard leases and others with the model provision.
Second, the model provision does not incentivize tenants to undertake their own resource-saving measures. In order to motivate tenants to undertake additional actions, the pass through of expenses should be based upon the tenant’s energy, water and other resource usage relative to other tenants in the building. This is entirely possible to do with current technology (see my prior post, “Will Tech End The Split Incentive?”).
While the commercial leasing world may not be able to incentivize landlords and tenants overnight, landlords can begin the process by incorporating alternate (i.e., not yet effective) provisions such as the model provision into new leases and lease renewals, beginning immediately. The provision might contain a clause to the effect that this alternate provision is not effective unless and until all leases within the building contain substantially the same provision, plus notice given by the landlord that the alternate provision is now effective. Leasing agents, attorneys and other real estate professionals must take the lead and suggest these provisions to landlords and tenants to get the ball rolling now.
