Challenges

Solving the financial puzzle – green leasing economic challenges
Solving the financial puzzle – green leasing economic challenges

There are several significant barriers to green leasing:

ECONOMIC CHALLENGES

First Costs
The initial capital outlay required to implement energy efficiency measures continues to be a significant barrier for both public and private organizations.  Depending on the availability of capital at reasonable terms, investors with a long-term perspective can choose to make investments and expect to earn the anticipated returns over time.  However, investors that typically hold assets for relatively short terms may not expect to recover such incremental investments and are thus reluctant to make these types of investments.  Public agencies are most disadvantaged, since many are still operating under municipal budgetary constraints that do not recognize life cycle costs and benefits.  The first cost challenge has deepened for both public and private entities, exacerbated by the nation’s economic challenges and the global credit crisis.

“Split Incentives”
Split incentives arise when the flow of investments and benefits are not properly rationed among the parties to a transaction.  In leasing, there are two primary types of split incentives:

  • Gross Leases – Tenants pay a single lease amount that includes a pro rata share of building ownership costs (utilities and other operating costs, taxes and insurance). A tenant has little economic incentive to invest in energy efficiency if an allocated share of the energy savings will accrue to other tenants.

  • Net Leases – One or more expense categories are assigned directly to the tenant (e.g., the costs of utilities, taxes and/or insurance).  If the tenant is paying the utility bills, energy efficiency investments will decrease the tenant’s operating costs.  The landlord thus has no economic incentive to invest in energy efficiency.

LEASING CHALLENGES

Lack of Standardization
Each lease negotiation is a unique transaction.

  • Time and Complexity. A typical real estate manager or leasing agent may manage dozens of leases at any one time with a wide range of lease structures under strict time constraints.  Since each lease structure results in a different balance of benefits and burdens between the landlord and tenant, the issues of cost responsibilities need to be resolved separately for each lease.

  • What is “green”? While certification programs such as LEED® have helped to standardize terms and specifications, (a) LEED® is not yet the universal standard, and (b) too few market participants understand it.

Limitations of Existing Standards
LEED® takes a very broad perspective to green but does not emphasize energy, a high priority for California, while ENERGY STAR focuses primarily on energy efficiency.  LEED® and ENERGY STAR are most powerful in combination.

Limited Inventory of Qualified Properties
Less than 10% of California’s office buildings are LEED® certified or ENERGY STAR rated.

Benefits

The total discounted cost of owning, operating, maintaining, and disposing of a building or other type of long-lived asset.

  • Green Building Toolkits

  • Green Building Features

  • Green Leasing Report

  • Green Building Toolkits

    The California Sustainability Alliance has developed several toolkits and other resources that aid local governments in planning and implementing sustainable initiatives. These include:

    • Green Leases Toolkit
    • Energy Efficient Financing Calculator
    • Class B Office Improvement Toolkit

  • Green Leasing Report

    In May 2009, the Alliance released the results of a study examining the current state of green commercial buildings in California and challenges and opportunities for the accelerated adoption of green leasing in California’s existing office space.


    Titled Greening California’s Leased Office Space: Challenges and Opportunities, the report provides information to policymakers and market participants about the pivotal role green leasing plays in achieving the resource efficiency, environmental, and societal benefits of green buildings. The report outlines the constraints on green leasing and recommends changes that need to be made to policies, programs, and practices in order to establish green leasing as standard practice in California.

    Challenges

    90% of California’s commercial office space is leased, and the greening of this space is constrained by several challenges, notably:

    • Real estate owners not economically motivated to invest in building retrofits as the financial benefits flow to tenants;
    • Tenants may be less inclined to adopt conservation measures as financial benefits can accrue to other tenants and/or the building owner;
    • Imbalanced benefit distribution or ‘split incentives’ on core and shell retrofits, between the building owner and tenant. These retrofits (usually the responsibility of the owner) often have long financial payback periods. These costs, if they cannot be passed to tenants, discourage the building owner from making such capital investments; and
    • The ever-growing range of standards, concepts and protocols requires negotiating a unique balance of benefits and burdens for each leased property, which consequently adds time and complexity to the lease transaction.


    Opportunities

    Green leasing can be a key strategy for greening existing office space. In order to boost the market adoption of green leasing, the report concludes that owners and tenants who are motivated to find mutual benefits can collaborate to significantly improve the resource and environmental performance of California’s existing building stock.

    The Alliance, in consultation with its Green Building Advisory Committee, recommends a broad range of strategies for accelerating green leasing in California – from establishing consistent statewide standards and definitions of “green”, to documenting and publicizing the costs and benefits of green buildings (also known as the green building value proposition), implementing building labeling, and modifying state and local policies, ordinances and utility programs to recognize the different needs and interests of landlords and tenants under various types of lease structures.

    Green buildings are a growing segment of California’s overall building stock. In late 2008, LEED® and ENERGY STAR rated buildings accounted for 10% of California’s total office space. 6 months later, they comprised 13% of the state’s total office space – a 30% increase. They feature prominently in class A buildings (35% of all class A buildings in California), but implementation in lower grade properties is more limited (class B and C, at 3.6% and 0.2% respectively).

    To download the full report, click here.

    Image source: Thomas Properties Group

    Office space maximizing natural daylighting
    Office space maximizing natural daylighting