Since its debut in March, the Urban Green Council’s Paul Reale has been presenting to the local green building and real estate industries on the benefits to landlords and tenants who implement the Energy Aligned Lease Clause, which we’ve written about here at GRELJ previously. After over two dozen presentations to organizations across New York City’s commercial real estate industry, Mr. Reale and UGC are continuing their outreach efforts with an FAQ document outlining some of the most frequently asked questions about the clause, many of which are of interest from a variety of perspectives.
According to the FAQ, WilmerHale’s lease with Silverstein Properties at 7 World Trade Center (pictured above) remains the only current implementation of the EAC. But one of the most interesting questions discussed in the FAQ arises from tenants’ concerns about the following scenario: a landlord’s energy-saving capital improvement results in pass-through operating expenses decreasing significantly, and dropping the tenant’s overall rent owed to the landlord below its original base rent. But under the terms of the EAC the tenant must still pay 80 percent of the predicted savings of the improvement to the landlord: a figure which could theoretically exceed that original base rent. So it seems that it would be a better deal for the tenant if the EAC had never been put into place. Consider the following from the FAQ:
Q: “In a typical modified gross lease, the tenant agrees to a “base rent” for the first year that includes a base operating expenditure (“OpEx”). Payment for annual increases in OpEx in addition to the base OpEx is the responsibility of the tenant. If an energy conservation measure is completed at the end of year 1 of a lease, might the reduction in OpEx drop below the base rent, thus requiring the tenant to pay the base rent in addition to 80 percent of the predicted savings [as required by the EAC as drafted]?”
A: “No. Escalations in non-energy OpEx are much larger than the savings from energy-related OpEx. Thus, even accounting for savings from energy-related OpEx, it is extremely unlikely that the overall OpEx would decrease. [See slide 19 of the EAC presentation for further details, available here.]”
Another short hypothetical may also help illustrate why this scenario should not be an issue for most types of modified gross leases. Suppose that the base rent for a given space is $20 per square foot with a $10 expense stop. Suppose in Year 1 the operating expenses are $12/sf, so the landlord performs a qualifying capital improvement in Year 2 that drops operating expenses to $8/sf. The tenant’s effective rent will still be $20/sf because the landlord is paying for the first $10 in operating expenses. But in this scenario using the EAC should still be a win for the landlord because its overall net operating income will increase on account of the lower operating expenses resulting from the capital improvement.
If you – or your organization – is interested in hosting Mr. Reale and his presentation, which discusses the issues in the FAQ and the EAC itself in much greater detail, you can contact him at firstname.lastname@example.org.