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At LEED Gold 7 WTC, Law Firm Signs New York City’s First Green Lease

7 World Trade Center - Mayor's Model Green Lease Language

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.

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10 Responses to At LEED Gold 7 WTC, Law Firm Signs New York City’s First Green Lease

  1. Alan Whitson May 4, 2011 at 3:36 am #

    Stephen, as usual a well written piece. I would like to add that the update for the Model Green Lease will incorporate some similar language with a couple of twists representing the latest thinking from some of best lawyers on the west coast. Remember I’m in California, so we’re always pushing the envelope.

    Also I must admit to being “too clever by half” when I inserted the line “the costs of such improvements shall be amortized over the minimum period acceptable for federal income tax purposes” into the MGL.

    My intent was to encourage the use of “tangible personal property” which is typically depreciated over a 3,5,7 or sometimes 15-year schedule. Rather than the typical 39-years. As for “useful life” that concept doesn’t survie first contact with “Made in China” and low cost bidder.

    We must commend the Mayor for pushing a major landlord ito including such language into his lease form. While it may not have any practical application for the short term with this lease. It is a signal to the marketplace that change must happen.

    What I haven’t seen anywhere in the discussion of this deal — is WilmarHale’s new digs bigger or smaller than their existing space?

  2. Paul D'Arelli May 4, 2011 at 11:28 am #

    Thanks Del Percio, as usual, for the info. I think the innovative approach with the Energy Aligned Lease Language is a good step forward for trying to manage the “split incentive.” However, when I read the press release and noodled on the language, it struck me that success of the approach still depends on the building performing substantially as modeled since there is no actual performance verification. While the 80% pass thru provides some hedge, it appears that a Tenant with a short-term lease could find itself on the short end of the stick if actual energy savings falls significantly short of expectations. Not that such ever happens in the real world….

    Taking the example in the Model Energy Aligned Lease Language itself in section 1(b)(i), assume that the $2,000,000 in Landlord’s capital improvements is “projected” to result in $500,000 in energy savings, which can then be passed through to Tenant at $400,000 per year for 5 years at the 80% rate. Let’s then assume the base energy cost without the capital improvements was $1,500,000 a year (e.g., the improvements are “projected” to result in a 33% energy reduction – a notable outcome).

    What happens if energy consumption is only actually reduced by 10% for whatever reason?

    Tenant’s Outlay:

    Energy cost ($1,500,000 x 90%) $1,350,000
    Capital Ex pass thru $400,000
    Total Annual for 5 years $1,750,000

    Total Annual year 6 + $1,350,000

    Now I am just a lawyer and not a finance guy so someone please correct me if I am wrong, but query whether this is a good outcome for a Tenant with a 5-10 year lease who would have otherwise paid $1,500,000 a year without the capital improvements being made. If I am not wrong, then the point is that with the Energy Aligned Lease approach, much still depends on actual building performance aligning fairly closely with projected or modeled performance (or having a very long-term lease over which to recoup the shortfall). From what I understand, in the industry the alignment between models and actual performance is no sure thing…

    Perhaps the Model Energy Aligned Lease Language should be backstopped somehow by a provision that allows reconciliation if actual energy use is significantly greater than that projected? The plaNYC document “Model Energy Aligned Lease: Detailing language to help solve the split incentive problem” provides that “Moreover, using projected savings avoids having to monitor actual savings, which can be prohibitively expensive.” Again, as merely an attorney, I would let others opine on whether it would in fact be “prohibitively expensive” to monitor actual energy savings…

    In sum, kudos for the forward thinking by the folks in NY in developing this model language. However, as noted in my soon to be released guide “Negotiating Leases in the Era of Green Building: Managing Risk and Merging Expectations in Pursuit of the Deal”, as with all model language, careful evaluation should be conducted to fully understand the implications to you or your party in interest before dropping the Model Energy Aligned Language into a lease.

  3. Steve Teitelbaum May 9, 2011 at 10:57 am #

    Stephen, thanks for covering green leasing. I’m happy but unhappy to see your comment that most green lease discussions to date seem to focus more on the theoretical than the real. Happy because it confirms my own experience; unhappy because it means we haven’t made much progress. Maybe this new REBNY clause will change things. (If this is truly the first green lease in NYC, three years after CoStar proclaimed 2008 to be The Year of the Green Lease, we really do have a serious problem with implementation.)

    A couple of observations on the article:

    (1) I have been told that the clause actually used in the WilmerHale lease is “more pro-tenant” than the model clause the Mayor and REBNY are touting. Which wouldn’t surprise me, because the REBNY clause is fairly pro-landlord, which, I suppose, is why REBNY is willing to promote it. The latter may be a good thing in that it might inspire landlords to use the clause and make capital improvements. That was a large part of the goal of the NRDC Energy Efficiency Task Force in 2008-2009, which is the direct progenitor of this REBNY clause. (You may recall that Sean Neill, who was on the panel, and Constance Damon, who ran the panel, on which you and I participated in NYC a year or two ago ran that NRDC Task Force, and they were apparently part of the team that drew up the REBNY clause.)

    (2) I disagree with your statement that “the basic concepts behind the [REBNY] language echo those that underpin the Model Green Lease.” The REBNY clause is significantly different than the concept of the Model Green Lease (and the BOMA Green Lease Guide and most other leases I’ve seen that address the cost of energy-saving capital expenses) because the REBNY clause is predicated on projected savings, as predicted by a landlord-selected consultant, does not require that the actual savings be in line with the projected savings or that there be any actual savings at all (and therefore does not cap the pass-through to the tenant at actual savings) or that there be any follow up at all to determine if there are savings, and uses a significantly different amortization schedule. That is the conceptual breakthrough of the REBNY clause, in my opinion.

    BTW, I hope that you are aware that BOMA recently reissued the 2008 BOMA Green Lease Guide in a much improved version. The “green” provisions are significantly better written and have significantly better analysis provided as a result of three years of maturity. (Even the standard lease provisions have been upgraded to address some issues that others have pointed out to me, and the commentary there too has been enhanced.) The book has also been retitled as the BOMA “Commercial Lease Guide: Guide to Sustainable and Energy Efficient Leasing for High-Performance Buildings.” (That mouthful is why I still call it the BOMA Green Lease Guide.)

    Keep up the good work. I enjoy your postings.

  4. Ujjval Vyas, Ph.D., J.D. May 11, 2011 at 1:08 pm #

    Stephen,

    Thanks for your continued clarity and objectivity in this arena.

    I am very interested in knowing how a clause that is not based on actual performance is an improvement over the current leasing language. The NRDC’s desire to create language that cannot lead to a verification of the economic advantages of the leasing again indicates, to me at least, a continuation of the core problems in this area. Smoke and mirrors to make people feel good about themselves or as a marketing adventure or as political treacle is rather unsatisfying. But maybe this is exactly why it is structured in this way. If no performance of the energy efficiency attributes is required than the whole thing makes no economic sense for either owner or tenant.

  5. Brian D. Anderson May 17, 2011 at 10:06 am #

    Thanks to Ujjval and Paul for your splendid insights. Relying on projections is an open door to fraudsters and yet more green mendacity. Forgive me if they’re included elsewhere in this revolutionary leasing provision, but I didn’t see any provisions governing who has the authority (under what process) to project, determine and dispute “Projected Annual Savings”?

    Also, it seems that using actual energy performance has its challenges. For example, how do you analyze year to year data to actually determine whether there was a savings (resulting directly from a particular capital investment) since weather, occupant use, occupancy type, aging/failures in other equipment, operational changes, etc. can affect performance from year to year? As Paul said, I too am just a lawyer, but it seems to me that looking at actual energy performance would require some artful analysis in order to ferret out the savings resulting from a single variable.

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