First, in the MPR preamble, the LEED v3 program expressly provides GBCI with the ability to revoke LEED certification “upon gaining knowledge of non-compliance with any applicable MPRs.” It is thus crucial that project teams consider and comply with each MPR, particularly if the project seeks to take advantage of a state- or local-level LEED-driven incentive program that is keyed to the receipt of formal certification. While we have yet to see LEED-certified project have its certification revoked, an interesting question could arise here if a state or local government that had provided a project with an incentive upon certification sough to recoup those incentives if the project was de-certified by GBCI. Even thornier would be the scenario where a project that was required to earn certification under a legislative mandate loses certification. The corresponding liability-related issues would of course flow downstream and impact each member of the project team. MPR 1 actually obligates every LEED-hopeful project to “be designed to comply with all applicable USA federal, state and local environmental laws and regulations in place where the project is located and at the time of design and construction.” Comprehensive legislative surveys and strong contract language emphasizing regulatory compliance will thus be a priority for project teams under the LEED v3 regime.

From a legal perspective, MPR 7 is perhaps the most important to consider: “all certified projects must commit to allow USGBC to access all available actual whole-project energy and water usage data in the future for research purposes.” Moreover, “[t]his commitment must carry forward if the building changes ownership.” For attorneys, it will be an interesting challenge to draft such a covenant that will bind subsequent purchases of real property (or, in the context of LEED-CS and LEED-CI 2009 MPRs, subsequent tenants). For owners and project teams, it will be imperative to recognize that such language must be translated into purchase agreements or leasing documents such that GBCI cannot revoke a project’s LEED certification. More generally, it will be interesting to see if any private owners balk at granting USGBC access to such data, and whether there are any local legal obstacles (in terms of building codes, utility regulations, etc.) that may make it difficult for owners to provide the data as required by LEED v3.

Applicable MPRs are set forth below as printed in the text of the New Construction and Major Renovations rating system. Note that I have also set forth MPR 6 below, which lays out certain timeframes that project teams should remain aware of. I anticipate that there will be much more analysis of these and other provisions in LEED v3 as more project teams become familiar with the terms and scope of the program; please feel free to suggest any additional legal issues that we may have missed in the comments below.

Minimum Program Requirements (“MPRs”) – LEED 2009 – New Construction and Major Renovations

• LEED Version 3 (USGBC)

The authors used a standard commercial real estate valuation formula that related the logarithm of the rent per square foot or sales price per square foot of each building cluster to a variety of hedonic building characteristics, including quality, amenities, age, and location. Some pertinent conclusions as set forth in the report are as follows:

• “The results suggest that the LEED rating has no statistically significant effect upon commercial rents, but the Energy Star rating is associated with rents higher by 3.3 percent.”

• With respect to sales price, “[w]hen the certification is reported separately for the Energy Star and the LEED systems, there is no evidence that hte latter certification is associated with higher selling prices.”

• “The premium in rents and values associated with an energy label varies considerably across buildings. It is positively related to the intensity of the climate surrounding the rated building; a label appears to add more value when heating and cooling expenses are likely to be a larger part of total occupancy cost.”

I am extremely curious to see the reaction to the RICS study in the coming weeks. Already, several major media outlets have reported that it demonstrates “certified green buildings rent and sell at a higher price than non-certified buildings,” failing to note the study’s conclusions about the role a LEED rating may play in obtaining that higher price.

I look forward to your comments on the merits of the study once you have had the opportunity to review it; the study is available for download via the link below.

• Doing Well By Doing Good Study (RICS)

As the world financial headquarters has shifted from Wall Street to Washington, D.C., many commentators are expecting that green building will be a common condition of allocation of federally funded real estate projects whether in the form of direct subsidies or grants or public/private partnerships. This article will briefly examine a small portion of the unique legal risks that should be considered by lenders and property owners and developers in regard to obtaining financing for green buildings. It will specifically focus on ways lenders should attempt to mitigate risk through a basic understanding of green building, the careful examination of leases, construction documents and loan document covenants.

Basic Understanding of Green Building

Lenders must have a basic understanding of green building before financing green properties. They should be aware of the multiple third party green building certification systems and the specific limitations of the systems. Lenders should have teams that are familiar with the United States Green Building Council’s (“USGBC”) Leadership in Energy and Environmental Design Green Building Rating System (“LEED”) and preferably underwriters or loan officers that are either LEED Accredited Professionals (“LEED APs”) or the newly designated LEED Green Associates. If a lender does not have this level of green building experience or accreditation then they should seek outside counsel with the necessary understanding to assist them in order to minimize exposure. This level of knowledge will provide lenders with the necessary background to properly assess risks in financing green real estate.

Review of Green Leases

Leases, at a commercial property, are the most important factor in determining the value of a property. Most loan officers and underwriters are well versed in determining the property value based upon the rental stream and term of a lease. They are not as experienced in assessing the risks that may be contained within a green lease. Attorneys must assist the lender in carefully examining how the green elements of the lease could impact the value of the property. The first consideration is determining the required green elements of the lease and what happens if they are not achieved. Does the lease mandate the leased premises or property achieve a certain LEED or other third party certification status? What happens if the leased premises or the property fails to achieve said status? The lender should inquire as to the status of the LEED or other third party certification requirements, determine whether the landlord is able to satisfy its requirements and what the impact might be if landlord fails to satisfy the requirements. From a lender’s perspective, it is more palatable to see a lease provision that provides that it is the parties’ intent to achieve a certain LEED or other third party certification standard, but the failure to achieve such standard will result in some form of lease abatement or minimal free rent period instead of lease termination. Lenders are able to properly assess the value of a property with a lease abatement or free rent period, but if lease termination is available to the tenant then it is unlikely the lender will proceed with the financing, especially considering the current credit environment.

The lender should also take a more careful review in the long term property operation and management requirements within a green lease. Green building requires an active long term management plan to maintain the efficiency characteristics of the property. Certain green building classification levels may require re-certification after a certain period of time to show the property still complies with the necessary third party standards. Lenders will want to make sure that developers thus select property management companies that are able to provide the necessary services and that the property management agreement details these requirements. They may also want to review the operations and maintenance (“O & M”) plans to ensure that they are in place that are designed to comply with the green building systems in place at the property.

Finally, if the property is leased to multiple tenants then lenders should examine each lease to ensure that there are not conflicting green lease provisions that could create further challenges. For example, the lender must be able to determine the differences if one tenant requires the premises achieve LEED Silver for Commercial Interiors and another tenant requires LEED Gold for Commercial Interiors and that the property achieve LEED Silver for New Construction. These specific provisions are not in direct conflict, but if the second tenant also required that all other leases over 10,000 square feet also achieve LEED Gold for Commercial Interiors then an issue would arise if the first lease was for 15,000 square feet. A lender should also understand how the costs of the utilities may be detailed within the lease. Lenders routinely underwrite properties where all utility costs are passed on to the tenant. As some tenants are moving into green leases, in part, to have lower long term utility costs, they may have lease provisions that cap utility costs. A lender will need to determine whether the landlord is able to satisfy such lease requirements, potentially before there is even a history of performance at the property.

Construction and Building Design

Lenders that provide construction financing for green building projects should be involved in the selection of the construction team and the review and negotiation of the construction documents. The risks of green building have been detailed by commentators in this and other publications, time and time again. If a lender is willing to provide construction financing during these difficult times then they should have far more influence in the selection of qualified and experienced green building professionals then they would have in years past. Developers will hopefully work with experienced professionals in building a green project, but lenders should also examine the green building experience of the architect, contractor and subcontractors and make the approval of such professionals a condition of the financing. Lenders should review the owner-architect agreement and construction contract to make sure the responsibilities in planning and constructing the green building are clearly detailed. They will also want to make sure that there are penalties to the appropriate parties for failure to deliver the required green building. These penalties should correspond with the leases. For instance, if a lease requires a LEED Silver Commercial Interiors space and failure to provide such space will result in a two-month free rental period, the construction contract and owner-architect agreement should contain provisions that requires either a holdback or penalty in the amount of the loss of two months of rental payments to landlord, provided the failure to achieve the standard is not the fault of the property owner. The landlord may not be able to make the mortgage payments without such a provision, and the lender will obviously want to protect itself from such a possibility.

The Greening of Loan Documents

In addition to the added due diligence considerations, lenders may also need to modify loan documents in providing financing for green building projects. The first consideration will be in determining whether additional escrows are required to mitigate the risk of free rent or rental abatements in connection with certain green considerations detailed within the lease. These determinations should be relatively straightforward for the lender and again are not necessarily unique to green building. The loan documents will also provide that the landlord shall either comply or materially comply with the leases. Lenders should carefully review these provisions and may need to detail that the green building provisions are material lease provisions and failure to comply with said provisions will constitute a default under the loan, as well as the lease. Lenders may also consider adding additional covenants that acknowledge the green lease requirements and provide the specific details as to how the landlord will comply with such requirements in order to avoid any potential ambiguity.

Conclusion

Green building will continue to grow and likely become the best practice in the construction and development industry. Lenders must thus become familiar with the unique risks associate with green building. They must also be able to mitigate the risks, from the lenders perspective, when providing financing for green buildings. This article briefly examines a small sample of these issues and strongly encourages lenders to assemble a “green team” when financing green real estate developments.

Interested in contributing to GRELJ? Contact Stephen Del Percio via email here.