Green buildings seem to be on everyone’s agenda and this is increasingly manifested in some form of green lease between owners and tenants. But what is the commerce and issues of these leases? For completed buildings with proven performance outcomes, this is not too problematic. But it is not so easy for pre-commitment lease agreements for developments still to be completed. How are green standards for these developments agreed, and what are the cost implications? What remedies are available to the tenant if the building’s promised green performance is not delivered?
Currently the industry is trying to get to grips with the different green rating tools and the commercial impacts of outcomes. Discussion generally revolves 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, while Green Star is all about the attributes of the building covering a more holistic range of environmental outcomes. With developments the final ratings are not known – even if every design decision focuses on achieving these ratings – and the final outcome can only be measured after completion.
NABERS ratings are based on consumption benchmarks of the building tested over a prescribed period of occupancy. Green Star ratings are based on certification at various stages over the lifecycle of the building during design or after completion. The process considers a broad range of the building attributes and requires extensive documentation and evidence. However, not all properties are eligible for this rating tool. For example, a location within 100m of a wetland area is not eligible no matter what initiatives are implemented. With both rating tools, the final outcomes are not known until the building is completed and after certification.
The commercial arrangements to support green outcomes in precommitment 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 retro-fitting – 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 not using re-cycled material targets as planned, innovative ideas not accepted, or defective documentation – the rating may not be achieved and not much can be done. So developers may believe guarantees are too risky to make commercial sense, but this is all dependent on the tenant’s legal remedy rights.
With a trend to structure joint commitments by developer and tenant to achieve specific green performance, the dynamics of the outcomes change. Being involved in the design process and being able to provide input, the tenant is now a collaborator and there is a fundamental transfer of the risk. If the building does not achieve the target rating both parties are responsible and remedies become more complex.
Best endeavours undertakings by the developer may be the way to go. Although 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 will not be happy and one of their key accommodation objectives may not be achieved. This will be particularly irritating if an alternative accommodation option that was passed over previously is shown to deliver the target rating.
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.
There are agreements that give the tenant the right to cancel its lease commitment. But this remedy is unlikely to meet the objectives of either party. The developer is suddenly without a tenant and, for the tenant, what alternative premises with the required rating exist? And even more complex is the timing and logistics – certification is 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 12-year lease agreement in a building not meeting its environmental benchmarks.
Probably the most equitable remedy is structured around the enforcement of rating commitments – no matter what the cost – through retro-actions. This remedy has complications but may ensure the tenant can make its green statement. However, tenants should note that in green leases there is usually a reciprocal commitment on the tenant to deliver a green-rated fit-out – no matter what it costs.
Green lease economics
As more developers and users commit to green leases, the economics of developing green-rated commercial buildings is becoming more evident. Discussions tend to revolve around the significant cost premiums green initiatives add to development feasibility. Certainly during the pioneering period, as developers experimented with various innovative technologies, this was true. But as the building industry has become more familiar with rating tools and technologies have evolved, the cost premiums are trending downwards.
The other side of the discussion has been the argument of lower building operating costs. In general, this principle may be true – certainly in energy and water saving initiatives – but other initiatives such as black water treatment plants are not cheap to run and require a minimum through-put to justify the capital costs. Alternative energy-generating technologies seldom provide an acceptable pay-back period compared to cheap Australian brown-coal energy tariffs. And until an effective carbon-tax regime is introduced, this is likely to prevail.
From an owner’s perspective there is a push for premium rentals for the perceived premium buildings, and 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 market rentals.
The tenant’s argument will focus on the belief that futureproofed green developments will be able to command much firmer (lower) required investment yields, hence pushing up property endvalues – particularly if underpinned by a strong tenant covenant – and justifying the development cost premiums.
In the final analysis, tenants seeking green leases want to make a statement of commitment to lowering their carbon footprint in new accommodation. Astute developers are keen to obtain a competitive edge and attract quality tenants by creating buildings with reduced carbon footprints. These are parallel but complementary objectives, but ultimately the transaction is all about the willingness of the parties to understand each other’s objectives and to reflect these in equitable terms and commerce in green lease agreements.