Green leases don't need to cost the earth
Commercial property leases incorporating environmentally responsible provisions are swiftly becoming a market standard. Energy efficiency measures, waste management and energy performance data sharing all feature in the latest generation of retail and leisure leases. Adding ten pages of ‘green provisions’ to already lengthy lease agreements has often prompted a sigh of resignation from those who need to read these documents. Post-Covid, will this apathy be replaced with a fresh resolve and will the 2020s be the decade in which occupiers, asset managers and investors embrace the virtues of ‘Green Leases’?
Targeted at improvements in the environmental performance of a property, green lease provisions can often leave tenants exposed to additional costs and increased expenditure either directly or through the service charge regime.
From the tenant’s perspective getting a handle on potential exposure to additional costs can be difficult, and so the default position is to seek to limit financial liability if possible.
But if ‘green’ equals ‘cost’ can the sector afford to ignore sustainability? Buildings have a huge environmental footprint. Around 30% of total greenhouse gas emissions in the UK come from the operation of buildings.
While there has been a real focus on new developments and much fanfare generated about flagship new build projects built with excellent environmental credentials, the vast majority of leased commercial property in Scotland is older and does not meet current standards.
Reducing the environmental impact of these buildings will be critical in taking effective action against climate change in the coming decades.
Why do leases need to go green?
The Scottish Government’s target is to become carbon neutral by 2045 at the latest. For that to happen, major improvements will need to be made to the environmental performance of older properties - and that will come with a significant price tag.
In the retail sector operators are becoming more conscious of the impact their businesses have on the environment and sustainability issues. With the rise of the ethical consumer in the post Covid world retailers will have no choice but to ensure all elements of their business pass the sustainability test.
In recent years this has been a key driver in the prevalence of green lease provisions, and worldwide more companies are actively choosing to enter into green leases where sustainability/environmental efficiency is specifically covered off.
Green leases are a sector-driven initiative, setting out parameters in the lease for landlords and tenants to work together to improve the sustainability/environmental performance of both the use and management of the property; reduce waste and emissions; and to ensure maintenance and any works are carried out with consideration to the environmental impact these would cause.
When both parties are invested and committed to these goals these can be very effective at increasing the environmental performance of the building. Co-operation allows initiatives to succeed, but relies heavily on shared objectives between landlord and tenant to get going in the first place.
As more businesses make commitments to reduce their environmental impact, this is likely to drive the change in commercial practice even further.
Change is also likely to be driven through legislative requirements, which will force parties to give thought to environmental provisions.
Regulation of green leases
Currently, the environmental performance of existing buildings is evaluated in an energy performance certificate (EPC) and recommendations report, the production of which is a legal requirement on the seller or landlord at the point of sale or lease of the property.
In 2016, more onerous obligations were introduced for buildings with a conditioned floor space of 1,000msq or more, with an additional obligation to provide an action plan alongside the EPC. The action plan sets out a timescale within which the recommendations in the report should be carried out.
In practice though, the owner may choose to defer the implementation of the recommendations, effectively reducing obligations to ongoing monitoring of the environmental performance of the building. Currently, this can go on indefinitely.
In England, landlords are already subject to minimum energy efficiency standards enforceable when a property is leased or an existing lease is renewed, ensuring a basic efficiency standard at the outset of the lease. This is not yet the case in Scotland, but for the government to meet the ambitious carbon targets set out it seems necessary that more onerous requirements will be imposed.
It’s impossible to guess what these might be, but obligations to meet minimum standards and carry out recommended improvements seem likely. We can expect that any requirement to action is likely to be imposed on the owner of the property.
In terms of the commercial property market, especially for retail and leisure, the question will be to what extent these additional obligations can be passed down to tenants under occupational leases?
How retail and leisure property could be impacted
The balance of liabilities between landlords and tenants have been established in commercial leasing practice over many decades, but environmental performance and environmental improvements are a relatively new concern and the market has not yet set a satisfactory standard for the split of these costs.
Going into a lease, the tenant may have to accept they will be liable for additional costs relating to environmental improvements for the building. Conversely, it is not impossible to imagine that rents would be affected where the environmental performance of the building was inadequate.
If obligations become more onerous then it will be impossible for both parties to limit or ignore their liabilities. Responsibility will need to be shared between landlords and tenants to ensure that there is an increase in the environmental performance of buildings in Scotland.
Ultimately, for effective action on climate change and ambitious carbon neutrality targets to be met, green provisions and environmental considerations need to become so embedded in the real estate sector that they are an accepted market standard for every commercial property.
At that point, every lease will be a green lease.
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