What is a green lease? Does the label matter and what does a green lease look like in 2023?
Embedding sustainability into leases is not new for 2023 – but thinking about it will be on many New Year to-do lists due to various factors including changing regulation in 2023. It's an opportunity to go back to basics - what are the issues for developing or reviewing a green lease position, are there common market and what ambitious thinking is pushing the boundaries?
Green lease terms and implementation of building/estate management practices are developing rapidly. Is today's normal appropriate for the full term of a lease granted now? Landlords (and in some cases occupiers) that have proactive environmental social and governance (ESG) agendas are driving change through ambitious contract provisions across their commercial relationships (including leasing) to meet future sustainability or net zero objectives. Others are influenced by the possibility of preferential finance or investment if environmental criteria are met.
But will that set a new market standard? Or will occupier resistance and potential deal delay in a difficult market mean that ambition is limited to assets and commercial relationships where the sustainability goals perfectly align? Even if a landlord doesn't have a sustainability agenda today, does lease flexibility to implement sustainable practices matter to future purchasers? It feels as if 2023 might answer these questions.
Green leases (or sustainable leases)
A "green lease" usually means a lease with provisions that promote improved energy performance of a building. Sometimes the intention is to go further and catch wider sustainability issues including water and waste management and other net zero objectives. There is no specific meaning or benchmark - at the moment reference to green provisions usually means there is some provision to address these areas. It could be any combination of the ideas discussed below - or something else.
Some landlords (inspired by projects such as the Better Building Partnership Responsible Property Management Toolkit (June 2021)) are looking at provisions beyond environmental performance into wider ESG issues - particularly social value generation and reporting. As the discussion moves beyond energy efficiency and the performance of the physical asset to include its use and contribution to its surroundings and community, it is increasingly common to refer to sustainable leases rather than green leases. For the time being green lease remains the phrase more widely understood.
The label doesn't matter (yet). Regulatory authorities are starting to look at how organisations label their ESG activities and it wouldn't be a stretch to see an attempt to introduce some sort of standard in the market for real estate assets (or the way they are managed) to be labelled "green" or "sustainable".
There is no market standard commercial position on sustainable lease clauses. The good news is that there is some consolidation around the basket of options for green leases and the required drafting - which leads to familiarity and understanding and helps with implementation.
Why have green / sustainable lease provisions?
There are many reasons - but the most common drivers appear to be:
- Occupier experience - Ideally more efficient premises (with lower operating costs) attract tenants and support rental value. Some occupiers want to be seen to be choosing sustainable premises. Sustainability provisions set out a contractual framework for supporting this and allocating responsibility and cost.
- Regulatory - Landlords have to proactively think about how to comply with more onerous energy efficiency regulation affecting landlords between now and 2030 in the minimum energy efficiency standards (MEES) (likely to be minimum EPC rating C by 2028 and B by 2030 - subject to exemptions) and build that into lease terms. Providing for MEES compliance and green leasing is not exactly the same thing but MEES changes in 2023 are focussing efforts (see below). More regulatory authorities are looking at how to regulate ESG claims, including the Financial Conduct Authority (FCA) proposals to tackle greenwashing, and compliance will inevitably filter down into contractual arrangements including leases where investment structures and/or owners are regulated.
- ESG reporting requirements - Some landlords are, or will be, subject to regulatory reporting requirements (or self-imposed disclosure requirements) and lease terms (particularly data sharing) are needed to collect data for reporting. Government is considering different measures to the current EPC and other benchmarks are being adopted voluntarily - e.g. NABERS UK has been launched to bring the concepts of the National Australian Built Environment Rating System (NABERS) to the UK office market.
- Strategic - Some landlords and occupiers have their own sustainability agendas and policies leading them to require specific sustainable practices to be built into contractual arrangements including leases.
Sustainable lease provisions in 2023
So why more focus in 2023?
1. High profile April 2023 MEES deadline
MEES have prohibited new leases of sub-standard rated non-domestic property since 2018. On 1 April 2023, non-domestic property will be brought within the prohibition on continuing to let (subject to exemptions). "Continue to let" means simply being a landlord - either freeholder or a tenant/landlord where there are subleases (although some very short and very long leases are excluded). "Sub-standard" means property with an energy performance certificate (EPC) rating of F or G (although as noted above, that is expected to change so that the minimum is C in 2027 and B in 2030 for non-domestic property). Although F & G rated buildings are not usually the assets where parties are looking at wide ranging sustainability interventions, MEES compliance will provide an opportunity to look at how to maintain and improve going forwards.
Compliance is a landlord issue but the benefit of increased energy efficiency is (or should be) lower occupier costs. So there is the basis for commercial collaboration on preserving and improving energy efficiency to suit both parties to a lease through a variety of transaction structures and contract provisions. Although some of the drafting to achieve MEES compliant outcomes would be considered "green" - some lease terms simply aimed at MEES compliance (e.g. requiring a tenant to make energy improvements to reach a certain standard) doesn't necessarily make a lease green.
2. International market practice
The growing interest and implementation of green leases and net zero contract provisions across other markets (particularly in Europe) makes it possible for organisations with international portfolios to adopt consistent strategy across borders. Overseas investors look at UK real estate with an increased awareness of sustainability issues and potential interventions.
3. BBP Green Lease Toolkit
The Better Buildings Partnership (BBP) is expected to update its Green Lease Toolkit in 2023 (see below). As an early market benchmark for green drafting, we expect the updated guidance and publicity around it to influence the market.
4. Property management practice, awareness and cost
Greater familiarity with and availability of green services and processes will make it easier to choose and implement new practices. Some of these practices and processes are no doubt already in place on some assets but not contractually reinforced.
5. Awareness and regulation of lawyers
The Law Society of England and Wales is expected to issue sustainability guidance to lawyers (both in terms of law firm management and transaction handling) meaning greater recognition of green and net zero issues.
Greater availability of drafting in published materials will have a greater influence on legal advice and practice as awareness and familiarity spreads.
Making green provisions work
To ensure green provisions in leases are capable of (1) agreement (without materially affecting the transaction), and (2) implementation by the property manager and occupier, it is best that proposals are:
- mutual - where appropriate, both landlord and tenant are obliged to do things in a sustainable way;
- demonstrable - property managers can point to specific examples of compliance or property management practices and activities to demonstrate the provision operating in real life; and
- enforceable - obligations are capable of monitoring and enforcement, and are actually monitored and enforced.
These principles make it easier to justify and negotiate into heads of terms and ultimately the leases. The key to agreement and implementation is to manage parties' expectations from the outset by avoiding vague principles seen as cost risk.
On contractual renewal leases, the introduction of sustainable lease provisions is a commercial point like any other. However, there is a perceived difficulty when renewing protected leases (i.e. leases with security of tenure under the Landlord and Tenant Act 1954). The resistance seems to be driven by fear of tackling the issue in case it slows down the negotiation or drives the occupier to look elsewhere or increases fees at a time when landlords are keen to keep occupiers in place. The same commercial and regulatory drivers exist so there is no reason not to at least consider the position on renewal.
Assuming sustainability will be new (or materially updated) in the new lease, the legal position for statutory renewals is well established. In the absence of agreement, the party proposing the new terms, must justify them and show reason based on essential fairness. Where provisions are workable and being properly implemented at an asset and (particularly for multi-lets) being incorporated into leases of other premises, then it is arguably fair and reasonable in the circumstances - especially where there is a demonstrable benefit to the occupier. Renewal terms are rarely litigated but the introduction of energy efficiency clauses to deal with MEES risk has already been considered by the County Court and it seems inevitable that the balance of implementation of a more sophisticated landlord sustainability regime and the cost and/or interference to the tenant will be litigated at some point.
If a landlord and tenant agree to sustainable processes or outcomes, should the lease set out this agreement? Clauses in the lease demonstrate a clear position for the duration of the term. However, it isn't as flexible as setting out the position in a separate document or handbook. A separate agreement can be more easily updated or changed to suit circumstances or a change in landlord. Keeping it out of the lease might avoid negotiation delay. Current practice is mixed, although many landlords seem to prefer lease terms for the commitment and certainty. It is possible, but not necessarily straightforward, to do both - a mixture of high level obligations in the lease and detail of how those should be implemented in a separate document prepared by the property managers in conjunction with a landlord's ESG managers.
What should those obligations be? The most commonly used and/or discussed in the market are:
- The Model Commercial Lease (MCL) sustainability schedule - The MCL is a freely available template lease maintained by a group of law firms (including Gowling WLG) working together to provide documents that reflect a fair market position. The optional sustainability drafting covering high-level co-operation on sustainability issues hasn't been materially updated for some time. It lags behind the more ambitious sustainability provisions appearing in leases, which is to be expected because MCL aims to reflect the market - and as noted, there is no market position.
- The Better Building Partnership (BBP) Green Lease Toolkit - These model clauses have been around for nearly 10 years and are the closest thing to a market standard that exists. They do not address more recent concerns however, such as the more onerous regulatory environment. Where green lease principles are to be included in leases, they often follow the structure and drafting of the BBP clauses. When BBP re-launches the toolkit this year (whether or not it is widely adopted) it will be seen as the new market benchmark for sustainable lease provisions.
- The Chancery Lane Project (TCLP) built environment net zero drafting - These template ambitious net zero clauses go well beyond what is normal in the market but help to drive the conversation of where lease provisions could be stretched. Some more ambitious landlords are looking at how the principles can be incorporated into their asset management and leases but they are not market norm. TCLP clauses are getting greater profile and we may see as they are tested to a greater extent in the market. If property managers are able to demonstrate the process and cost of compliance, they may well become more common.
Green leases - the building blocks
Choosing the right provisions depends on the property, the manager and the parties' objectives, (including their appetite for a sustainability agenda. The onus is on landlords to implement a package of meaningful measures without materially impacting the occupier's use of the property or financial liability. Talk of dark green, light green or anything in between is too simple. The most successful sustainable leases facilitate a package of measures that enable the particular property and parties to deliver benefits. Rating the level of ambition rather than measuring the outcomes is the wrong way round.
There will be bespoke measures for particular assets, landlords and occupiers - but the most common lease provisions are:
- General energy objective / co-operation - the focus of the current green clauses is the energy performance of the building but where strategy dictates, the stated objectives could embrace wider sustainability issues. The most effective provisions set out the objectives clearly with measurable outputs, but specificity risks incompatibility with the objectives of a future owner or a change in practice.
- Preserving energy efficiency - provisions aimed at preserving the current level of energy efficiency of premises are now standard in leases and so often fall outside of the green lease conversation. The main objective has been to prohibit tenants doing anything that would drag the landlord into a MEES compliance problem.
- Improvements - any concept of improvement in leases is controversial - why should an occupier work towards anything that creates a better investment for the landlord? However, landlords and tenants seem to be more willing to consider how to work together to improve energy efficiency and wider sustainability goals. This could be improving the physical fabric of the premises or by using the premises or energy in a particular way. Greater awareness has led to more conversations about how to collaborate on improving and how best to allocate cost of doing so. This may be implemented in express lease commitments or indirectly achieved through flexible service charge provisions.
- Renewable energy - some energy suppliers offer certified renewable energy which means obligations to procure renewable energy are more easily costed. Lease provisions range from endeavouring to procure renewable energy to absolute requirement to purchase energy that comes with a renewable certification so that premises' use of renewable energy can be evidenced.
- Recycling & waste management - it is increasingly common for property managers of multi-let buildings or estates to implement waste management plans. If not, general recycling obligations could be included, although they can be difficult to monitor. Where there is a plan, an express tenant obligation to comply with it would be appropriate - and the occupier is likely to be required to contribute to the cost of operating the plan, including monitoring and reporting, as part of the service charge.
- Sustainable materials in alterations, decoration and repair - attempting to avoid waste and pursue a net zero strategy, some leases oblige the parties to use sustainable materials. We have seen increasingly sophisticated definitions but expect some consolidation around the principles set out in TCLP's circular economy principles for leasing arrangements. Essentially this is a sliding scale of material choice from most to least sustainable - reused, sustainable, recycled, recyclable and then other, with the requirement being to consider the cost effectiveness and availability of materials at the top of the scale before using materials lower down. Similar concepts are appearing in the construction contracts.
- Service charge for landlord sustainability / energy performance projects - requiring the tenant to contribute to landlord led projects is a simple idea to sell - and where the service charge is capped, one that is easy for tenants to cost. Tenants will expect to see demonstrable benefit so landlords need to be confident that the projects will deliver - and be willing to fund any shortfall due to capped charges or voids. One key advantage of landlord led projects funded by service charge is the flexibility it offers a future owner to pursue different projects.
The implementation of these provisions and a wider selection of specific building interventions are being discussed in industry working groups, conferences and set out in the BBP Responsible Property Management Toolkit. No doubt this raising of awareness and sharing of knowledge will continue in 2023.
Data collection and sharing
Meaningful intervention and reporting needs an accurate picture of what is happening at a building. Information needs to be shared by landlords and occupiers, and requirements will vary depending on reporting goals. Data sharing provisions usually start from a position of confidentiality, but provisions need to work for the intended use of the data. Agreeing to keep data confidential between landlord and tenant is easy but not practical - data needs to be shared with property managers and probably group companies and consultants. Landlords may want to publicly report to investors and we have found occupiers are open to this with appropriate anonymity - which is not always possible depending on the nature of the premises and occupier. Occupiers may also want to publish data about the buildings they occupy.
More leases are allowing a third party to install data collection equipment and collect the data on the landlord's behalf. These providers often require direct consent from the occupier so that consent (or the ability to call for it) may also be included in the lease.
2023 - the year of realism and collaboration?
Before implementing new green lease clauses, landlords need to ask whether it is going to work. Contractual provisions on their own do nothing. The relevant property management processes for that asset or portfolio need to be put in place and compliance monitored and possibly enforced. Inclusion of provisions in leases only for the purposes of being able to say that the lease is green with no demonstrable action could lead to regulatory enforcement for greenwashing in the future. Now is the time for investors and occupiers to consider where they want to go with sustainable leasing and put in place the processes as well as the drafting to make it happen. Even if it's not the right time for one landlord to implement measures - should the lease provide for the framework for a future landlord to implement them?
Choosing the right sustainable provisions for leases is a collaborative exercise between landlords, property managers and legal advisers. Although they might not be involved in setting organisational or site specific sustainability agenda, the occupier point of view is also important. If it is not something an occupier can sign up to the whole exercise could be wasted.
If you would like to discuss sustainable leasing and the implications for your transactions, please contact your usual Gowling WLG real estate contact or speak to Ryan Davies (Knowledge Lawyer and member of The Chancery Lane Project Built Environment Advisory Group).