Greening Leased Spaces: Opportunities and Challenges Craig McDonald, Sean Ivery and Claire M. Gagne, Navigant Consulting Kif Scheuer, Strategic Energy Innovations. ABSTRACT In market research conducted by the authors, tenants, brokers and owners of leased commercial office space identified the following as key barriers to expanding green building within the commercial sector: first cost, split incentives, lack of common definition for green and sustainable, lease type diversity, availability of qualified properties, and lack of communication between tenants and landlords. Developed with an advisory board that included California Department of General Services, JP Morgan, Bank of America, CB Richard Ellis, Thomas Properties, Southern California Gas, and the California Energy Commission, the Green Leasing Toolkit facilitates commercial green building by providing a comprehensive solution to the challenges created by the standard commercial leasing process. Despite these barriers, leased space can be greened within current lease structures – the principle requirements are to recognize that greening space requires embedding green considerations throughout the leasing process and establishing open communication between landlord and tenant. The Toolkit integrates energy, water, waste and other sustainability goals throughout the commercial leasing process, and enables landlord and tenant to align their green building objectives. Introduction Commercial office space is a hard to reach sector for green building: in California, less than 6% of the approximately 900 million square feet (MSF) of Class A and B1 office space is Energy Star or LEED certified (CoStar 2007).2 With leased spaces accounting for 90%, or 810 MSF, of the commercial office market, bringing green building into the mainstream will be closely linked with the greening of leased space. With advances in technology, increased costs for basic services, and growth in awareness, the number of and demand for green office buildings have grown rapidly. Yet green buildings still represent a small fraction of the total office building stock. Leased space presents a unique set of challenges for advancing the market adoption of green building practices. The California Sustainability Alliance, a project of Navigant Consulting funded by Southern California Gas Co., undertook the development of the Green Leasing Toolkit in order to precipitate market transformation in this important market segment. The Toolkit was developed with an advisory board that included representatives from California Department of General Services, JP Morgan, Bank of America, CB Richard Ellis, Thomas Properties, Southern California Gas, and the California Energy Commission. The Toolkit is being piloted in California and results from these pilots will be used to refine and expand the various tools. While 1 Classes A, B, and C are used to designate the quality and amenities associated with the space. Class A is refers to very high quality space in good location, with lobby and proximate amenities. Class B is a notch lower quality space, with class C representing the lowest quality (and lowest lease rates) space. 2 Based on data for the Sacramento, San Francisco Bay Area, San Diego, Los Angeles, and Orange County markets. 2008 ACEEE Summer Study on Energy Efficiency in Buildings 6-147 the focus of green leasing activity to date has been California, the tools, ideas and lesson learned can be applied throughout the nation. Market Assessment Market Growth & Drivers The market for green commercial office space in California is characterized by low but increasing availability, and rising demand. Market drivers include reduced implementation costs, increased savings, improving certification standards, rising public awareness and government policy. Of the 900 million square feet (MSF) of Class A and B commercial office space available throughout California, just 6% is certified through the U.S. Green Building Council’s Leadership in Energy and Environmental Design (LEED) and/or the U.S. Environmental Protection Agency’s Energy Star programs (Figure 1). Figure 1. Leased Composition of California Commercial Office Buildings Owner Occupied 10% Leased Green 5% Leased Not Green 85% CoStar, 2007. Based on a survey of the Sacramento, San Francisco Bay Area, San Diego, Los Angeles, and Orange County markets. In California, leased office space is the key target area for market growth in green building. There is an average annual lease turnover of 45 MSF and a total stock of approximately 900 MSF throughout the state. The most significant concentration of leased commercial space is occupied by the largest tenants, defined by those with at least 50,000 square feet of space, which account for approximately 50% of total commercial stock. The rate of construction of green buildings within the commercial sector has accelerated. According to global real estate investment company RREEF, the number of LEED projects has been growing over the past 3 years at a compound annual growth rate of 50-100 percent (Nelson 2007). In the period 2006-2007, the multi-tenant commercial sector has grown to represent 13.8 percent of LEED buildings, up from just 1 percent of all LEED buildings during the years 20002003 (Nelson 2007). McGraw Hill Construction predicts that the commercial office sector will experience 49 percent growth in green building in 2008 (USGBC 2008. 2008 ACEEE Summer Study on Energy Efficiency in Buildings 6-148 These growth trends are particularly true within the market for Class A office space. Among Class A tenants, green buildings offer a tangible way to demonstrate corporate values while maintaining a competitive edge. Within a few years, green building is likely to become a compulsory component of what defines Class A space (Nelson 2007). The impact of the market shift toward green building at the Class A level will trickle down to buildings in the Class B level and then to Class C spaces. The movement towards green commercial space has many underlying drivers including increasingly affordable first costs, savings improvements from higher energy and water costs, steadily improving certification standards, and rising public awareness of environmental issues such as climate change. First costs for more efficient technology will continue to come down as these technologies improve and become more widely adopted. Rising energy costs increase the relative savings from efficiency-based technology. Although certification standards, such as LEED, currently come with a high price tag, ongoing efforts to streamline the processes will make certification more accessible for smaller-scale projects and/or smaller-scale building developers and owners. Rising public awareness of climate change, energy security concerns, and the need for sustainable resource consumption will continue to provide momentum to invest in green building. Government policy is also a driver. In California, Governor Schwarzenegger set the tone for the State with Executive Order S-20-04 (CA July, 2004), also known as the “Green Building Initiative”, which called for a 20% reduction in electricity use in State buildings by 2015 (California Executive Order S-02-04). As directed by the Executive Order, LEED certification is also being pursued for State buildings that meet the following criteria: 1. 2. 3. new buildings of greater than 10,000 square feet must be at least LEED-Silver; new buildings of less than 10,000 square feet must meet LEED criteria but do not require certification; and existing buildings of greater than 50,000 square feet must be LEED certified. At the Federal level, the Energy Policy Act of 2005 established tax deductions which are available for energy-efficient commercial buildings and the Energy Independence and Security Act of 2007 set national goals for zero-net-energy new commercial buildings (The White House, 2005; CRS 2007). Through the Commercial Buildings Initiative, a new RD&D program to be administered by the Department of Energy, the Energy Independence and Security Act of 2007 establishes a target of zero-net-energy for all new commercial buildings by the year 2030 (CRS 2007). Barriers Barriers to advancing green building within the commercial buildings sector include: uncompetitive first costs, split incentives, defining green, lease type diversity, limited availability of qualified properties, and lack of communication between tenants and landlords. High initial costs, known as first costs, have long been a barrier to designing and retrofitting for more sustainable buildings, even when lifecycle costing for green technologies has proven them more economical than conventional options. As the first cost gap continues to narrow between green and non-green techniques, the case for green building has strengthened considerably. Several recent studies have demonstrated that the average cost for green buildings 2008 ACEEE Summer Study on Energy Efficiency in Buildings 6-149 is not significantly different than that for conventional construction (Mathiesson & Morris 2007; BDC 2006; LEED 2005). While the first costs for green space may be acceptable for new construction, any improvements to existing space require capital expenditures. Even with short paybacks, first costs remain a barrier in existing spaces, particularly given the split incentives. The business case for “going green” needs to be articulated more convincingly to a broader audience so that the issue of first cost can be addressed within the context of the long-term benefits of green design. Split incentives, where incentives for landlords and tenants do not align, remain an important barrier to the widespread uptake of green building practices across the commercial building industry. Leasing is the primary mechanism through which split incentives are created and perpetuated; landlords are either unwilling to cover upfront costs if the tenants alone benefit from the improvements and/or tenants may not be able to modify the property due to the constraints of their lease. A closely related barrier is the diversity of lease types. The typical realestate manager manages dozens of leases with a wide range of lease structures under strict time constraints. Since each lease structure results in a different balance of operational and maintenance responsibility between landlord and tenant, the issues of responsibilities for investments and operating costs have to be resolved differently for each type of lease. Such managers are concerned that green considerations will complicate the leasing process. Defining what is meant by “green” or “sustainable” has proven challenging for many industries, and the building industry is no exception. The lack of established benchmarks and criteria for assessing “green” has lead to limited ability for tenants to specify green requirements or for landlords to feature green space. Additionally, the two most well known national programs, LEED and Energy Star, have important limitations: LEED takes a very broad perspective to green while Energy Star focuses exclusively on energy efficiency.3 As a result, buildings that may fall short of meeting LEED specifications are left without a recognized mechanism to measure, account and validate their efforts despite having sustainability initiatives that extend beyond energy efficiency, the focus of the Energy Star program. Furthermore, current certification programs have not been designed to accommodate incremental greening, or the process of working towards certification during the normal course of business (i.e. equipment replacements and scheduled capital improvements). The CoStar database (www.costar.com), a resource used extensively by real estate professionals to identify target properties for clients, provides perfect illustration: LEED and Energy Star certification are the only searchable green criteria available in the CoStar database. Although some buildings may be in the process of greening their space, or landlords could be open to initiating the process with willing tenants, no established method of communicating these ideas is currently available. In a broader sense, communication between landlords, tenants and brokers around green building ideas is not optimal. Landlords and tenants do not have a standard method for communicating their real estate assets and needs, and as a result, many are unable to realize the financial benefits of green buildings. Despite expected increases in demand and supply of green office space, tenants are concerned that exclusive consideration of green buildings will result in “no competitive offers” while landlords fear that there will be “no market” for their green buildings. When it comes to articulating the desire to lease a green building or the willingness to build or retrofit green, both landlords and tenants have failed to communicate effectively. This failure has its roots in established leasing processes, in contract arrangements (such as 3 The EPA announced on March 3, 2008 that the Energy Star program would be expanded to include water efficiency as it relates to energy systems. 2008 ACEEE Summer Study on Energy Efficiency in Buildings 6-150 covenants4- managed by corporate real estate teams), and in the absence of a specific benchmark or set of criteria for green building. Solution: Green Leasing Toolkit The Green Leasing Toolkit is based on the dual premise that green building principles can be integrated into the standard leasing process provided that the philosophy is adopted throughout the entire leasing process and that open communication exists between landlord and tenant. Many of the issues identified as barriers to advancing commercial green building can be addressed through the leasing process provided that adequate communication exists. The Green Leasing Toolkit integrates tenant and landlord sustainability objectives within the framework of the entire leasing process: service provider selection; needs analysis and communication; request for proposal (RFP) and letter of intent (LOI) drafting; site due diligence; site selection; and the negotiation and drafting of realistic and enforceable lease language. These tools support tenants and landlords in educating their organizations, developing their own green leasing policies and requirements, communicating policies and requirements to the market, measuring and comparing the green building attributes of multiple buildings, and developing specific lease language provisions. The toolkit is available at www.sustainca.org/content/green_leases_toolkit. Description of Tools Green Policy Document: Linking Sustainability Goals to Leasing • • Definition: A policy statement in which an organization defines its intended sustainability goals as they relate to leased facilities. Key focus areas are energy and water use, waste recycling, and alternative transportation. Application: The sample green policy statement should be introduced to the various parties engaged in the leasing process, such as brokers, architects, landlords, etc. The statement communicates to both employees and outside vendors the sustainability practices the company expects in its office environment. Needs Analysis: Communicating Green Needs • • Definition: A process in which an organization meets with its broker and establishes the desired attributes of the leased space such as budget, location, image, services, and amenities. Application: Introduced during the needs analysis with the tenant’s broker. Request for Proposal: Establishing Green Initiatives Early • Definition: Once a short list of sites has been established, it is customary that the tenant will issue an RFP through its broker representative. The RFP is used for soliciting, evaluating, and selecting proposals from landlords and lays out the tenant’s basic 4 Covenants are existing contracts that may limit the materials, equipment, contractors, and designers that can be used for improvements on the leased space. 2008 ACEEE Summer Study on Energy Efficiency in Buildings 6-151 • requirements, definition of the premises, lease term, expansion and renewal options, rental rate, and tenant improvements. The Green RFP includes a tenant’s requirements relating to its green practices and how these will be structured into the lease document. Application: Working with their broker, the tenant can use the appropriate RFP language that best suits their needs. The landlord’s response to the Green RFP sections – usually in the form of a Letter of Intent (“LOI”) – will assist the tenant in their site selection process. LOI & Due Diligence: Comparing the Options and Making an Informed Decision • • Definition: After the tenant has received responses back from the short listed landlords – usually in the form of an LOI – the tenant will need to analyze the proposals against one another. This comparative analysis evaluates the financial (rent, expenses, TI allowances), the legal (term, options, use) and the operational terms. It is preferable that a tenant be able to compare the green characteristics of the particular deals as well. Application: Based on the information the landlord provided in response to the RFP, broker-provided research as well as internal diligence, the tenant can fill out the Due Diligence Scorecard. The Scorecard (Figure 2) assists the tenant in comparing building’s practices. Lease Provision Database: Integrating Your Green Initiatives into the Lease • • Definition: After the tenant has selected a site, the general business terms of the deal have typically been agreed upon and documented in an LOI. These business terms are then transferred into a legal lease document that will be reviewed and negotiated by attorneys from both sides. Just as is the case with other financial, legal or operational agreements between the landlord and tenant, it is important that green initiatives are properly structured within the lease. Application: The Green Lease Provision Database (samples included in Figure 3)is meant to provide the user with examples of lease language and concepts (sample provisions relating to building certification, transportation, water use, energy use, maintenance, and recycling are provided) as they pertain to a user’s particular occupancy situation (single tenant vs. multi tenant) or specific objectives (energy utilization, recycling , etc). These lease provisions are not intended to be used without the input of a qualified attorney who is experienced in commercial leasing matters. 2008 ACEEE Summer Study on Energy Efficiency in Buildings 6-152 Figure 2. Sample Green DueDiligence Scorecard Figure 3: Example Green Lease Provisions in the Database 2008 ACEEE Summer Study on Energy Efficiency in Buildings 6-153 Figure 3. Example Green Lease Provisions From the Database Additionally, the toolkit includes recommendations and approaches for addressing specific situations and issues including the following: • • Establishing aspirational goals of attaining LEED EB silver and/or an Energy Star Rating of 85 or better. For existing leased space, or space that one desires to lease that does not currently meet one’s green objectives, establish a mutually agreed upon path to greening the space over time consistent with sound financial practices including: ¾ Specifying Energy Star rated equipment whenever energy or water using equipment is being replaced; ¾ Conducting energy, water and waste audits every three to five years and automatic implementation of any and all measures with an acceptable payback period (recommend using at least a 5 year based on the volatility of energy costs and the importance of reducing one’s environmental footprint, but a shorter paybacks could be mutually agreed to); and ¾ Implementing capital upgrades with the tenant contributing to the annuitized costs up to the expected annual operating cost savings. This approach can be done now within most existing lease structures and could be a particularly powerful option. The toolkit and guidance provides a path for greening leased space, successfully addressing the barriers. Sub-metering is neither necessary nor sufficient for addressing the green leasing barriers. 2008 ACEEE Summer Study on Energy Efficiency in Buildings 6-154 Application Many of the advisors (including CBRE, JP Morgan, Bank of America, and Cushman Wakefield) in the development of toolkit are now piloting using tools from the toolkit. The California Department of General Services (DGS) is currently piloting the use of the toolkit. The DGS has a wide variety of leases and situations. Through these pilot tests, the tools will be refined and expanded. The early experience demonstrates the importance of: • • Establishing policies at the executive level – significant efforts at change management may be required. Staff making leases are often decentralized, operate independently, and the lease rates may be a factor in determining their compensation. It takes effort to get internal alignment. Including the green objectives in the RFP – once the RFP is issued, options and ability to insert green considerations become severely limited. Conclusions The toolkit is a repository of best practices that will be expanded based on experience. Organizations that wish to green their leased space can use the toolkit to shorten their learning and development time. Through an open dialog owners and tenants can successfully green leased space. Existing contractual and financial mechanisms can be applied to green leased space. The essential steps leading to a green lease include open dialog, developing goals, communicating goals, and incorporating green practices into ongoing capital and operating processes. The Toolkit provides specific guidance to facilitate opening this dialog, developing and communicating goals, and incorporating green practices into ongoing capital and operating processes. Early experience indicates that the tools are useful starting points, but that the framework, i.e. instilling the green objectives and policies throughout the entire leasing process is of paramount importance. References [BDC] Building Design + Construction. 2006. Green Buildings & the Bottom Line. Oak Brook, Ill: Building Design + Construction. [CA] California Executive Order S-02-04, July 2004, http://www.dot.ca.gov/hq/energy/ExecOrderS-20-04.htm CoStar, 2007, www.costar.com, provides data searchable database of leased office buildings that widely used by lease brokers and corporate real-estate managers [CRS] Congressional Research Service. 2007. Energy Independence & Security Act of 2007: A Summary of Major Provisions. Washington, D.C.: Congressional Research Service. 2008 ACEEE Summer Study on Energy Efficiency in Buildings 6-155 [EPA] Environmental Protection Agency. 2008. “EPA Tool Helps Communities Tap Into Energy Savings.” [http://yosemite.epa.gov/opa/admpress.nsf/bd4379a92ceceeac8525735900400c27/70195 53e604c49d8852574010067ce3f!OpenDocument] Washington, D.C.: U.S. Environmental Protection Agency. [LEED] Leadership in Energy and Environmental Design. 2005. LEED-EB Project Case Study: Thomas Properties Group Joe Serna Jr. Cal/EPA Headquarters. Washington, D.C.: U.S. Green Building Council. Mathiessen, Lisa Fay and Peter Morris. 2007. Cost of Green Revisited: Examining the Feasibility and Cost Impact of Sustainable Design in the Light of Increased Market Adoption. Los Angeles, Calif: Davis Langdon. Nelson, Andrew J. 2007. The Greening of U.S. Investment Real Estate- Market Fundamentals, Prospects and Opportunities. San Francisco, Calif: RREEF Research. The White House. 2005. “The Energy Bill: Good for Consumers, The Economy, and the Environment.” http://www.whitehouse.gov/news/releases/2005/07/20050729-9.html. Washington: D.C.: The White House. [USGBC] U.S. Green Building Council. 2005. LEED-EB Project Case Study: Thomas Properties Group Joe Serna Jr. Cal/EPA Headquarters. Washington, D.C.: U.S. Green Building Council. [USGBC] U.S. Green Building Council 2008, Green Building Facts Feb 2008, http://www.usgbc.org/DisplayPage.aspx?CMSPageID=1496 2008 ACEEE Summer Study on Energy Efficiency in Buildings 6-156