Solving the financial puzzle – green leasing economic challenges
There are several significant barriers to green leasing:
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 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.
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.