Buildings are the United States’ single-biggest energy consumer, and commercial buildings generate much of this demand, spanning roughly 87 billion square feet across 5.6 million buildings.
Energy efficiency should be a no-brainer in commercial real estate, but competing interests between landlord and tenant often discourage commercial efficiency upgrades – a major roadblock to cutting power sector emissions and utility bills, considering 40% of all US office space is leased.
But according to the Institute for Market Transformation (IMT), “Green Leases” could clear this hurdle by aligning the financial and sustainability interests of landlord-tenant leases, unlocking up to $3.3 billion in annual energy cost savings.
Getting Past The Split Incentive Problem
Energy efficiency is one of the most appealing clean energy technologies, promising lower power bills and reduced emissions. But efficiency upgrades require capital investment up front for a payback over time, a formula favoring whoever captures the return on investment through reduced costs.
This equation usually doesn’t work in a landlord-tenant relationship, because of what’s known as the “split incentive problem” in commercial office settings: Landlords don’t pocket the full cost savings of cutting power demand, tenants don’t want to pay for improvements on building they don’t own, and neither party is fully incentivized to pay for major efficiency upgrades.
Green leases avoid this roadblock by linking incentives through financially beneficial clauses for both sides of the commercial leasing relationship. Landlords can cut overall operational costs and increase net income through higher occupancy and increased interest from socially conscious companies, while tenants cut demand up to 22%, paying up to .51 cents in power less per square foot.
“There’s great potential for green leases to catalyze energy efficiency measures and for owners to transition their entire real estate portfolios to green leases,” said Andrew Feierman, IMT Commercial Real Estate Engagement Program Associate. ”Saving 50 cents per square foot quickly becomes a substantial sum when executed across a set of buildings.”
Green Clauses Create Green Leases
So how exactly do green leases work? IMT outlines a series of clauses for landlords and tenants to consider:
- Savings pass-through: Landlords can recover more of the capital costs required for major efficiency upgrades and reduce project payback periods by passing operational savings from lower power bills through from tenants to their operations, up to the point where the original expenditure is repaid, at which point tenants retain all savings.
- Energy efficient tenant buildout: When tenants occupy a building, they often design (and pay for) modifications to their leased space. But landlords can reduce power demand and overall costs by requiring tenants to meet basic efficiency and sustainability standards like installing LED lights, Energy Star appliances, occupancy sensors, or reducing plug load through simple applications like smart power strips.
- Submetering: Energy costs are often aggregated across a building and paid proportionally, which reduces tenant awareness of power consumption. But by adding submeters for each tenant, landlords can benchmark utility costs and encourage energy efficiency by billing individual tenants for their actual energy consumption.
- Building commissioning: Most buildings undergo periodic recommissioning to update operational systems, but by mandating regular evaluation and improvement with defined energy efficiency provisions, tenants avoid inefficient building operation and landlords avoid delays in the upgrade process.
Green Leases Taking Off Among US Real Estate Leaders
Most building owners and tenants want to see proven success before adopting new business practices, but green leases aren’t just theoretical, they’re already in practice among forward-thinking commercial real estate leaders. 14 companies with a collective 400 million square feet of commercial space have been recognized by IMT and the US Department of Energy’s Better Buildings Alliance as Green Lease Leaders.
With defined market leaders moving quickly into green leases, the US commercial building stock seems primed to realize much more of its energy efficiency and emissions reduction potential – not to mention a stronger bottom line. “Billions of dollars in energy costs can be saved every year when America’s landlords and tenants are on the same page and working toward a mutual sustainability goal,” said Cliff Majersik, IMT Executive Director.