Rise of the ‘greener’ property lease

We have noticed a distinct shift in attitude from clients about this topic in recent months, so it’s worth exploring a little bit further about why it’s topical and what ‘green’ really means in a property leasing context.

So why bother?

I’m going to pick three main reasons, although there are undoubtedly others. Interestingly, only one of them has anything specifically to do with legal stuff.

1. Minimum Energy Efficiency Standards (MEES)

First up is MEES, or the Minimum Energy Efficiency Standards. These are now legally embedded into new leases and require a landlord to only let property which has a minimum EPC rating of E (subject to some limited exceptions).

New commercial lettings are already subject to the E standard, but the rules won’t kick in for existing tenancies until April 2023. However, there are lots of existing leases which will still be in place in April 2023 which don’t address MEES issues adequately (or at all) – issues like who is going to do the work, how they will get access to do it and who pays for the improvements.

The Government has been running (and intends to run during the course of 2022) even more consultations about trying to raise the compliance bar even higher, and rightly so (as Greta would argue). We’ve got to do a lot better if we have global ambitions to achieve net zero carbon emissions.

The ambition is to get commercial properties three steps up the ladder to a B by the end of the decade (to C by 2027 and to B by 2030). At the same time, the Government has handed local authorities (who have to police compliance and who still haven’t actually dished out any fines) the carrot to improve enforcement. Following a recent funding competition, the Government has now given a number of local authorities £100,000 of ‘start up’ funding to develop effective enforcement processes (initially for breaches of the almost identical rules applying to residential lettings). I’ve long suspected they’ll allow authorities to retain fine monies, so this could fairly quickly become a source of additional income for hard-pressed local authority budgets.

2. Environmental, Social and Governance (ESG)

Now we move on to ESG. This isn’t just about COP26 and protesters gluing themselves to the M25, this is about popular momentum starting to drive the agenda to live and work in a more sustainable way. Just ask any of your Gen Z employees (those under 24) and they’ll tell you that working for a business that operates in an ethical and sustainable way is one of their top influencing factors in picking a workplace.

If you don’t want those protesters gluing themselves to your building then you need to pay attention to public perception. The UK Green Building Council (UKGBC) forecasts around 40% of all greenhouse gas emissions emanate from the use and occupation of buildings.

For owners and operators of buildings there is an increased need to demonstrate their green credentials to investors. Grosvenor Estates is a good example of this: a commercial developer and institutional landlord committed to introducing ‘green terms’ into all of its new leases.

There’s also demand from tenants; after all, the buildings you occupy are a significant factor in your business’ contribution to generating greenhouse gases, so some see this as a more manageable area in which to reduce their carbon footprint.

Regulatory pressures are now being brought to bear. Guidance has recently been issued to occupational pension funds on how they need to consider the environmental profile of their investment activities. The Government is also consulting on ways to force banks into greener lending, by requiring them to demonstrate that their loan books have an average EPC C rating on them.

Finally, local authorities are also proactively moving to regulate future development by imposing specific environmental targets in new developments. As this becomes increasingly embedded in planning policy, designing and delivering greener buildings becomes unavoidable.

3. Making your building more (or less) valuable?

Recent research carried out by a number of the major surveying practices is increasingly coming to the conclusion that buildings with a higher environmental performance rating are attracting a premium with occupiers. A recent analysis of Grade A office rents in London suggested a 14% rent premium for top-rated buildings compared to ones which were simply rated as ‘good’. The converse is equally true – prospective tenants and buyers will be actively discounting the price of underperforming properties as they factor in the costs of both operating and upgrading sub-par buildings.

What’s not to like?

Like many new things, greener property leases still come with their drawbacks…

1. First of all is trying to work out which standard you want/need to be aiming for. There are a lot of them, and I only mention three below that relate to the running of buildings. If we’re talking about stuff in the buildings, how it’s operated and so on, we would have a screenful of acronyms – it’s bewildering, and likely to be a moving target as it’s notoriously difficult to get consensus on these things.
   
   Building Research Establishment’s Environmental Assessment Method (BREEAM) is probably the best known, and is certainly the longest-established standard which is widely used (with variations) on a global basis. Leadership in Energy and Environmental Design (LEED) is also mentioned in the same breath, although its origins are more in the American market.
   
   The newest kid on the block is the WELL Building Standard (WELL). A second version of WELL was launched last year. This takes a slightly different approach from BREEAM in that it is people-centric rather than an absolute measure of building performance. In fact, it’s possible to apply for ratings under both schemes. Whilst WELL still has a focus on environmental performance and the general ‘greenness’ of the building it is primarily about making it a ‘nice’ place to work, and protecting and enhancing the well-being of the building’s users. If the research is right that people want to come to the workplace because there’s a purpose to it, then improving the facilities to make it a more attractive place to spend time seems like the way to go.
    
2. Not everyone will buy in just because you want to build something green. I wanted to try and find something closer to home, and a site at Hills Road in Cambridge happened to catch my eye. The developer is promoting this as the first building in Cambridge designed to achieve both the BREEAM Outstanding and WELL Platinum ratings. Unfortunately it’s been unanimously refused at planning committee (despite a recommendation for approval), with one councillor describing the scheme as ‘thoroughly unpleasant and ill thought-through’. Perhaps the 200-space car park didn’t meet with their approval, but the design plans on the website are for something rather less radical than some green buildings that I’ve seen.
    
3. Finally – cost. No surprise that if you want a more environmentally-friendly building, it will almost certainly cost you more to build/convert it. A 2020 JLL report calculated that on average a BREEAM Outstanding rating will cost you a little under 10% more to achieve than a ‘very good’ one. So you need to be in it for the long haul; JLL concluded that the combination of rental premiums, reduction in yield (helped by lower void costs), and lower interest costs lead to a more positive cash flow and increase in return for greener buildings.

Next steps

Assuming you are persuaded greener clauses are coming one way or another, what should your next steps be? There’s a couple of key themes this article boils down to.

• Collect and manage data – in the immortal management mantra, you can’t manage what you don’t measure. So think about what data you’ll need, how you’ll get it (and from who) and what will you do with that data once you’ve got it. Collecting monthly electricity data is a burden, will you need that information to actually do something useful with it or could you make do with something less?
• Collaboration – this is a biggie. Sustainability in commercial buildings needs to be seen as a two-way street. Where it’s a multi-let arrangement, landlords have some ability to drive the agenda, ultimately through the service charge (if it allows them to), but where it’s single occupancy the landlord will need to work more closely with the tenant to get their objectives aligned.
• Retrofitting – not everyone starts with a blank canvas, indeed as the UKGBC says, the majority of the buildings that will be standing in 2050 have already been built. Where you’re doing works to existing stock it’s worth thinking about the who, when and how much questions. In many instances the EPC rating of a building can be improved very simply (and fairly cheaply) by replacing old lighting systems with LEDs and putting thermostatic heating controls onto existing radiator systems. In practice, unless you are an owner-occupier, that involves cooperation and a pragmatic approach to cost. If you are a tenant with a short-term lease then you will be reluctant to pay for improvements that you won’t get to see the benefits of. Conversely, as an incoming tenant you will probably be prepared to pay a bit more to occupy buildings with lower operating costs.