Leases should be greener on the other side

July 10, 2023
Sustainable green building
Occupiers and landlords of commercial property are beginning to see the value in well-managed, energy-efficient buildings. As a result, we are seeing more and more demand for ‘green leases’.

But what are green leases exactly? Why are they so en vogue? And what should landlords, investors and occupiers of commercial property be aware of when entering into a green lease?

Our occupier advisory partner, David Thomas, joined forces with Liz McKillop Paley, partner specialising in investment at law firm, Shoosmiths LLP, to explore.

Green leases, also known as environmentally sustainable leases or responsible leases, are legally binding agreements which obligate both the landlord and a prospective tenant to promote the energy efficiency and environmental sustainability of the building being leased.

They have, in fact, been around for many years in various guises, coming in and out of fashion over time.

Today, they are very much back on the agenda, particularly now that the first phase of the Minimum Energy Efficiency Standards (MEES) has been implemented. Invariably, any new lease will now have some form of green clause in it, to promote the implementation of a range of energy-efficient measures.

David Thomas explains: “Green leases vary from ‘light’ to ‘dark’ green depending on the extent of the sustainability provisions contained within them. They can have many benefits – from the obvious merit of reducing a building’s environmental impact and encouraging sustainable building practices, to the more practical bonus of lowering utility bills and operating costs for both landlords and tenants.”

“With Environmental Social and Governance (ESG), climate change and the energy crisis firmly on the agenda of most Boards (both investor and occupier), a building with green credentials is likely to be more attractive to tenants and investors.

“It also has the potential to increase a property’s value if the building in question boasts renewable energy sources or can support a business in its drive to reduce waste or greenhouse gas emissions.  However, until there is a market standard, valuations will struggle to reflect the market and it will be driven by demand.”

What are the pros and cons of green leases?

By fully embracing sustainability clauses in leases, both landlords and tenants get to demonstrate their commitment to environmental sustainability and their own ESG agenda which, in turn, can enhance their reputation and provide a competitive advantage.

However, there are some potential drawbacks to embracing full ‘dark’ green lease drafting which it is worth being aware of.

Practically, adding in provisions to cover all environmental implications can, in some cases, more than double the length of the document.  The administrative burden that those provisions can create for both parties is also extensive, with the addition of reporting obligations, for example.

Remembering that leases are commercially negotiated documents, there can also be challenges where estates and portfolios have different leases granted at different times, each with differing green provision, so it can take time to fully introduce the clauses on lease renewals and new lettings.

But there are also opportunities, as Liz McKillop Paley, Partner at Shoosmiths, discusses.

“The are two core focus areas for the green lease currently. One is around the MEES and meeting the minimum Energy Performance Certificate (EPC) rating requirements for commercial buildings.

The first part of the Minimum Energy Efficiency Standards (MEES) came into effect on 1 April 2023, making it unlawful for a landlord to continue to let a commercial property with a sub-standard EPC rating (of ‘F’ or ‘G’), unless a valid exemption has been registered.

“With proposals for the minimum EPC rating to rise further to ‘C’ in 2027 and to ‘B’ in 2030, we are seeing more green clauses within lease agreements, focussing on tenants not being able to do anything that would impact a building’s EPC rating, or being allowed to commission their own EPC assessment, for example.

“Secondly, and where there is currently a gap, is the ability to collect and share energy usage data. This represents a huge opportunity for a much more collaborative and positive approach to these green lease clauses, and we expect to see this continue to evolve much further as time goes on.

“As tenants come to understand the fact that the landlord’s requirement for this information is not a “tick a box” exercise and landlords start to work with tenants to analyse this data and share it back with them to show trends and implement change together, the mutual benefit will become clear.  A critical part of the journey to net zero is the operational performance of our buildings and having actual rather than modelled data is key.”

Liz McKillop Paley, Partner at Shoosmiths.

The importance of a Green Memorandum of Understanding

Another way to achieve positive progress on a building’s energy efficiency, can be through the introduction of a Green Memorandum of Understanding (MoU).

It provides landlords and occupiers with a written framework for engagement on environmental issues, and sets out how the building’s environmental performance will be managed and improved by both parties.

David Thomas, comments: “In our experience, a Green MoU can prove to be a useful and practical tool to make swift progress on energy efficiency improvements. Unlike a green lease, it is not legally binding and allows landlords and tenants to focus on areas such as energy usage; data sharing; energy improvements and waste policies quickly, and then adapt or tighten these over time.”

The Better Buildings Partnership’s (BBP) Green Lease Toolkit, which is currently being updated, provides some invaluable insight for landlords and occupiers on the issue – from green lease principles and best practice recommendations to template green lease clauses.

Of course, it is vital to seek appropriate legal and property advice alongside this, to take into account further green lease or MoU considerations that are particular to your situation, which may not be covered by this toolkit.

This can include considerations in relation to dilapidations and licence to alterations where it would not make sense, say, for a tenant to be required to remove an improvement or addition to a building which has improved insulation or energy efficiency.

However, as an introduction to the increasingly en vogue issue of the green lease, the BBP’s toolkit is useful and will help to ensure that your lease is ‘greener on the other side.’

In the meantime, for support with a green lease requirement or issue, or to find out about our other energy and sustainability consultancy services, don’t hesitate to get in touch.