It’s been a while since we talked about green leasing here at GRELJ. That’s not because it’s an issue we’re no longer interested in – far from it – but frankly there has not been all that much new to report on the front, notwithstanding the ongoing market rebound.
Recently, though, New York City announced that the law firm WilmerHale signed a lease at LEED Gold-certified 7 World Trade Center. Deals at the first commercial office building in the country to earn LEED certification are always worth noting, but WilmerHale’s lease is of particular import because it is the first to incorporate form green lease language developed by the Mayor’s Office of Long-Term Planning and Sustainability. By our own (admittedly informal and unofficial) count, New York now joins Portland (Oregon), Winnipeg, and various municipalities in Australia where green lease arrangements between private sector players have been publicly disclosed.
The lease, which WilmerHale signed with 7 World Trade Center landlord Silverstein Properties, aims to address the much-discussed split incentive, which remains prevalent in most commercial office leases in New York City. As you may know, the “split incentive” refers to the scenario where a landlord pays for building capital improvements but does not benefit from any reductions in operating expenses that are created because its tenants pay for operating expenses pursuant to the terms of the lease. In addition, although many leases do allow landlords to pass the costs of capital improvements through to tenants, the time frame for recouping those costs – typically over the working lifetime of the improvement, which can extend for decades – creates a practical impediment to owners actually making any energy-efficient capital improvements to their buildings in the first place.
The new New York City lease language, whose development was spearheaded by the NRDC’s Green Lease Forum, was derived from two fundamental concepts. First, to give them an incentive to make such investments in the first place, the language guarantees landlords that they will recover the costs of any energy-efficient capital improvements from their tenants over the projected payback period for the improvement – not over the useful lifetime of the improvement.
Second, the language aims to assure tenants that those improvements will actually result in cost savings that – even when split with the landlord – will still result in a net benefit to the tenant. Accordingly, once improvements are made, tenants will not only realize actual savings, but will pay the landlord 80 percent of the projected savings as assessed by an independent, NYSERDA-approved engineer (creating a buffer in case savings are not as projected) as part of building operating costs. After the payback period compensates the landlord for the investment, the tenant will continue to enjoy the benefits of the energy savings.
Here’s the most pertinent section of the model clause, which sets forth the landlord’s ability to include capital improvements within the lease’s definition of building operating expenses:
Commencing with the first Comparison Year following the year in which such Capital Improvement is completed and placed in service, and continuing for the duration of the Adjusted Payback Period (as hereinafter defined), Landlord may include in Operating Expenses a portion of the aggregate costs of such Capital Improvement equivalent to eighty percent (80%) of the Projected Annual Savings, so that the aggregate costs of such Capital Improvement will be fully amortized over one hundred twenty-five percent (125%) of the simple payback period (such period of time, the “Adjusted Payback Period”). By way of example: If the aggregate costs of such Capital Improvement are $2,000,000, the Projected Annual Savings are $500,000 and the simple payback period for such Capital Improvement is forty-eight (48) months, then Landlord may include $400,000 of the aggregate costs of such Capital Improvement (i.e., an amount equivalent to 80% of the Projected Annual Savings) in Operating Expenses for five consecutive Comparison Years (i.e. sixty (60) months or 125% of the simple payback period).
According to Mayor Bloomberg, the lease “breaks new ground in the field of energy conservation – and we expect it will be a pioneering model for commercial leases. This is part of our broad campaign to increase the energy efficiency of large buildings all across the city. When it is fully realized, this ‘Greener, Greater Buildings Plan’ – the first of its kind in our nation – will be the equivalent of making a city the size of Oakland, California completely carbon neutral.”
More interestingly, all of New York City’s commercial office space leases are negotiated by the Department of Citywide Administrative Services, and DCAS has agreed to add the green lease language to all of its new lease negotiations. The language has also been endorsed by REBNY.
WilmerHale’s lease is particularly important to note because much of what has been written and discussed about green leasing generally over the past few years has been almost entirely theoretical. For a number of reasons, it has been difficult to identify, and subsequently analyze, green lease language which the real estate industry has implemented. While it remains to be seen what types of capital improvements (if any), whose costs Silverstein Properties will seek to pass through to WilmerHale or any other 7 World Trade Center tenants (the building was completed in 2006), the Mayor’s Green Leasing Language should demonstrate to the rest of the New York City real estate industry – and landlords and tenants in other markets – that green leasing principles can be applied in the most high profile of Class A settings.
It is also worth noting that the basic concepts behind the language echo those that underpin the Model Green Lease (which is drafted as a full-service gross lease with an escalation clause and base year expense stop clause). As part of its definition of building operating costs, the MGL allows the landlord to reasonably amortize the cost of projects that will reduce operating costs and treat that amortization cost as an operating cost, so long as that amortization cost does not exceed savings to the tenant. The tenant’s obligation in the MGL is to “pay its pro rata share of any increase in Building Operating Costs over the Base Year.” The actual language in the MGL includes within the definition of “Building Operating Costs” the
[c]osts of any capital improvement made to the Building that reduces Building Operating Costs, the costs of such improvements shall be amortized over the minimum period acceptable for federal income tax purposes, and only the yearly-amortized portion thereof shall be treated as a Building Operating Cost. In no event shall this charge for yearly amortization be more than the actual reduction in the Building Operating Costs.
WilmerHale will be relocating from 399 Park Avenue to 210,000 square feet on the 41st through 45th floors of 7 World Trade Center, which is now 90 percent leased thanks to the deal.
A copy of the Mayor’s Green Leasing Language is available here for download.