Green leases – here to stay

Properties with the best environmental credentials will attract tenants willing to pay a higher rent. However, that's not the end of the story. Steps must be taken to ensure that those tenants do not move in and undo all the good work, and those excellent environmental ratings must be maintained – but who does what and who pays for what? 

That's where green leases come in and will do so on a more regular basis, both to sustain the green premium and to meet ever increasing regulatory standards, such as the minimum energy efficiency standards in England & Wales.

Still in the evolution phase, green leases come in different shades.

Light green leases of the present

The success of a green lease relies a lot on co-operation between the parties, as much as it does on the existence of strict legal obligations. Setting out the shared aim of the parties to improve the environmental performance of the property is an important starting point. Recently, it has become common for landlords and occupiers to agree to co-operate and share data on environmental performance with the aim of identifying strategies to improve or sustain that performance.

There are no teeth to these types of obligations and neither party could force the other to comply if there was a breach. They are purely designed to get landlords and tenants thinking and talking about improvements that they can make. More onerous green clauses are often unacceptable to the tenant, but if the green premium is to be maintained and tenants are to be able to stand behind their environmental, social, and governance (ESG) credentials, both will have to move beyond this lightweight, light green starting point.

Darker green leases of the future

While tenants are already demanding better environmental credentials for their properties, they may at the same time be reluctant to take on any additional responsibilities which will result in additional cost to them. This tension between desire and reality will have to be addressed, as the green agenda is going in one direction only. Compromises will have to be found and sacrifices made to make the dark green lease a reality. The environment will therefore play an ever increasing role in lease negotiations, especially in relation to the following:

Consent for works 

One quite obvious area where an occupier could impact the environmental performance of a property is when they are carrying out fit out and alterations. Landlords are now frequently reviewing the environmental impact of any proposed works when they are considering whether to consent to the alterations. They will also be considering what impact those works would have on the building’s credentials such as its BREEAM (Building Research Establishment Environmental Assessment Method) rating. Occupiers may be asked, for example, to use local suppliers and/or sustainable materials for any planned works. Whether a court would hold that a landlord was reasonable in refusing consent to a tenant carrying out alterations to a property, because of an adverse environmental impact, remains to be seen.

Service charge 

In multi-let properties, landlords will want the right to carry out alterations to common areas and shared plant and equipment to improve energy efficiency and environmental performance. This will potentially mean additional cost to occupiers through increased service charges to pay for the initial works. While in the long run this may mean reduced energy costs, short term occupiers in place when the works are done may pay for them but never reap the benefits.

Rent review 

Landlords will be seeking higher rents for greener premises. Occupiers will in turn be pushing for the effect of any energy efficiency works paid for by the tenant to be disregarded at rent review, as ultimately the works will increase the value of the property and drive up hypothetical rents.

The circular economy  

The environmental impact of dilapidations at the end of a lease is becoming important to both landlords and tenants, particularly as leases become shorter. The trend for shorter leases results in a greater rate of tenant churn. If each tenant's fit out works are discarded every few years, the environmental impact is concerning. 

This is clearly wasteful, as well as being both environmentally and financially expensive, and is counter to the drive for a circular economy.

An occupier may therefore try to insist that their lease does not require them to remove any fit out works at lease termination (other than their branded equipment). They may have a strong argument where, for example, tenant alterations have improved the EPC rating of the property. It may be seen as unreasonable for the landlord to demand removal of the alterations at lease expiry.

A balance may have to be struck. If the landlord asks the tenant to remove the fit out, they may be required to prove that the removal is reasonably required for them to be able to relet the property. This shift towards an assumption against removal of a fit out would be a big departure from the current position where the tenant is usually required to remove their entire fit out when they leave a property. While it's not happening in practice very frequently at the moment, it seems to be a logical extension of the direction of travel.

Conclusion

Landlords and tenants can both benefit from improving the environmental performance of a building, but there is no doubt that the more onerous green lease provisions could prove unattractive, or even unviable to some potential occupiers.

On the plus side for occupiers, they will clearly benefit from cost savings through better energy efficiency across building management, services and utilities, which will also support their own sustainability targets. On the downside, a tenant in a short-term lease might be unwilling to implement costly improvements to a building if the payback from the work will only be realised after the lease has expired.

As time goes on, the ESG reporting requirements of organisations will increasingly mandate that large occupiers in particular need to implement at least some shade of green lease provisions in any new lettings, from a reputational perspective as much as any commitment to environmental change. And, far from viewing darker green leases as onerous, forward-thinking occupiers will prioritise boosting their own environmental credentials.

Green leases of all different shades will be here for a while yet.