CERTIFICATE PROGRAM

Developed by:

With generous support from:

WEEK 4

PROJECT LEGAL INSTRUMENTS

COURSE INSTRUCTOR: Jack S. Nyman

Executive Director, The Steven L. Newman Real Estate Institute
Zicklin School of Business, Baruch College, The City University of New York

WEEK 4: LEARNING OBJECTIVES

1.

Explain split incentives. Where do they arise and what are some of the
approaches that can be employed to overcome them?

2.

Describe the objectives of writing a green lease. Discuss the kinds of

clauses that might be included, and explain the reasons for doing so.

3.

Identify the supply and demand sides of the industry scaling problem.
How does the scaling problem affect energy-efficiency upgrades?

4.

Explain why performance contracting is important to energy. Identify

the parties to energy performance contracts, and the constraints that
the parties must expect.

WEEK 4: REQUIRED READINGS

1.

A Model Energy Aligned Lease Provision, (PlaNYC).

2.

Working Together for Sustainability: The RMI-BOMA Guide for

Landlords & Tenants, (RMI-BOMA).

3.

Introduction to Energy Performance Contracting, (EPA).

4.

Introduction to Energy Savings Performance Contracts, (Dept. of

Energy).

5.

Energy Performance Contract Financing as a Strategy, (J.P. Morgan).

THE SPLIT INCENTIVE PROBLEM

Split Incentive: A transaction in which the benefits do not accrue to the
person who makes the investment.
Split incentives in energy: Building owner pays for retrofits, but cannot
recover savings from reduced energy use those accrue to tenant.

Owner invests
capital

Retrofits reduce
energy use

Tenant receives
benefits

Typically, savings from retrofits are passed through to the tenants:

Not in owners immediate interest to invest in improvements.

Savings, other benefits are left on the table.

Source: Energy-Aligned Lease Language: Solving the Split Incentive Problem, December 13, 2011, PlaNYC 2030.

HOW THE SPLIT INCENTIVE IMPEDES

COST RECOVERY
Owners can pass capital expenses through to tenants. However, even recovering
costs through rents can pose unique challenges:

Owner

Retrofits

Tenant

1. The useful life of the equipment may be too long to justify large upfront
investments;
2. Actual energy savings may be too complex to calculate;
3. Basing rents on predicted energy savings exposes tenants to shouldering
the costs of energy retrofits that underperform.

Source (in part): Energy-Aligned Lease Language: Solving the Split Incentive Problem, December 13, 2011, PlaNYC 2030

THE GREEN LEASE

The Green Lease
1. Revises traditional lease language to incentivize green practices
2. Begins with understanding property design, use, performance
3. Provides new eco-friendly provisions, such as:
a. An energy-aligned clause, to address the financing of energyefficient upgrades
b. A clause memorializing energy & water management practices
c. Language pertaining to waste disposal & recycling procedures
d. Prohibition on the use of substances that may adversely impact
the propertys air and water quality; sick building provisions
e. Integration of building activities with transportation options
f. Environmentally conscious regulation of tenant build-outs and
landlord-maintained common areas

HOW IS A GREEN LEASE DIFFERENT?

A green lease is similar to a traditional lease, but it is modified to:
1.
2.
3.
4.

Create incentives for both landlord and tenants to adopt

sustainable practices and conserve natural resources
Identify and memorialize these goals, and allocate
responsibilities to ensure the parties do their respective parts
Remove split incentives to facilitate green improvements
Increase use of sustainable materials within the property

PLANYC: AN ENERGY-ALIGNED LEASE

TO OVERCOME SPLIT INCENTIVES
Issue: Landlord
wants to base
recovery on
predicted savings

Issue: Tenants fear

agreeing to pay for
savings that might
not be realized.

Fact: Savings are

generally within
+/- 20% of predicted

Proposal: Base landlords cost recovery on

predicted savings; protect tenants against
predictable rates of underperformance.

Energy-Aligned Lease Provision:

Landlords annual cost recovery is set
to 80% of annual predicted savings:
The 20% Performance Buffer.

Source (part): Energy-Aligned Lease Language: Solving the Split Incentive Problem, December 13, 2011, PlaNYC 2030

THE 20 PERCENT PERFORMANCE BUFFER

Savings (OBSERVED) 80 - 120% Savings (PREDICTED)

1.
2.
3.
4.
5.

Immediate savings for most tenants

Costs borne (mainly) by immediate beneficiary the tenant
Landlord pays difference between tenants payment and
amortized payment
Landlord is ultimately responsible to lender/contractor
Improves long-term value of property

$
Tenants
Tenant pays to Landlord
Pro rata share of propertys utility bill
Pro rata share of 80% predicted utility savings

Landlord

Utility
Company

Lender/
Contractor

Landlord pays:
Propertys utility bill (with tenant funds)
Finance costs for upgrade (with tenant funds)

PLANYC: ENERGY-ALIGNED LEASE

Landlord may include the costs of certain Capital Improvements in
Operating Expenses pursuant to [this lease] in accordance with the
following:
(i) Capital Improvements Intended to Improve Energy Efficiency.
In the case of any Capital Improvement that the Independent Engineer
certifies in writing will, subject to reasonable assumptions and
qualifications, reduce the Buildings consumption of electricity, oil,
natural gas, steam, water or other utilities....

Source: Energy-Aligned Lease Language: Solving the Split Incentive Problem, December 13, 2011, PlaNYC 2030

PLANYC: ENERGY-ALIGNED LEASE

The costs of such Capital Improvement shall be deemed reduced by the

amount of any government or other incentives for energy efficiency
improvements actually received by Landlord to defray the costs of such
Capital Improvement, and shall further be reduced by any energy
efficiency tax credits or similar energy-efficiency-based tax incentives
actually accruing to Landlord as a result of such Capital Improvement.

Source: Energy-Aligned Lease Language: Solving the Split Incentive Problem, December 13, 2011, PlaNYC 2030

PLANYC: ENERGY-ALIGNED LEASE

For the purposes of this Section ,simple payback period means the
length of time (expressed in months) obtained by dividing (x) the
aggregate costs of any such Capital Improvement, by (y) the Projected
Annual Savings. By way of example: If the aggregate costs of such
Capital Improvement are $2,000,000 and the Projected Annual Savings
are $500,000, then the simple payback period for such Capital
Improvement is forty-eight (48) months.

Source: Energy-Aligned Lease Language: Solving the Split Incentive Problem, December 13, 2011, PlaNYC 2030

PLANYC: ENERGY-ALIGNED LEASE

[C]ontinuing for the duration of the Adjusted Payback Period ,
Landlord may include in Operating Expenses a portion of the aggregate
costs of such Capital Improvement equivalent to eighty percent (80%)
of the Projected Annual Savings, so that the aggregate costs of such
Capital Improvement will be fully amortized over one hundred twentyfive percent (125%) of the simple payback period.

Source: Energy-Aligned Lease Language: Solving the Split Incentive Problem, December 13, 2011, PlaNYC 2030

PLANYC: ENERGY-ALIGNED LEASE

PlaNYC approach:
1. A licensed engineer must sign off on predicted savings
2. All project costs are allocated to tenant(s)
3. Project costs exclude savings from tax credits, incentives, etc.
4. Amortization based on predicted savings, with 20%
performance buffer (with 125% extended payback period)
Potential variations:
1. Adjusting proportions of project costs borne by landlord,
tenant
2. Varying the width of performance buffer by project risk profile
3. Additional prerequisites or narrower definitions for types of
projects that may be selected
4. Varying scope of energy usage to which the terms are applied
Source (part): Energy-Aligned Lease Language: Solving the Split Incentive Problem, December 13, 2011, PlaNYC 2030

BASIC & PRESCRIPTIVE LEASE CONCEPTS

Basic concepts addressed by green leases may include:
1. Rent structure and operating expenses
2. Standards for the build-out of tenant improvements
3. Sustainable development principles and regulations
4. Regulation of use/disposal of hazardous materials
5. Recycling policies and procedures
6. Improvement-cost allocation (e.g., energy-aligned
clause, as seen in PlaNYC)
A more prescriptive lease can even detail:
1. Cleaning and maintenance products to be used
2. Water and energy conservation methods and targets
3. Use of alternative sources of energy
4. Indoor air-quality standards for common and tenant-occupied
spaces

BOMA INTERNATIONAL:
COMMERCIAL LEASE GUIDE
1.
2.
3.
4.

Original template was developed by Steven A. Teitelbaum, Esq.

Then a partner at the Jones Day law firm in Washington, D.C.
Expanded and greened with contributions by expert panelists
Clauses tend to be very landlord-friendly (not surprisingly)
The full document is comprised of:
a. A standard commercial lease template
b. Additional, embedded green-leasing language
c. Margin notes providing thorough explanations of hundreds
of specific legal issues addressed by the template language

Source: BOMA International and Steven A. Teitelbaum, Esq.

BOMA INTERNATIONAL:
COMMERCIAL LEASE GUIDE
ARTICLE 10: ALTERATIONS AND TENANT IMPROVEMENTS
(c) Any and all Tenant Improvement Work and/or Alterations
will be performed in accordance with Landlords sustainability
practices, including any third-party rating system concerning the
environmental compliance of the Building or the Premises, as the
same may change from time to time.
The clause continues:
Tenant further agrees to engage a qualified LEED or
similarly qualified professional during the design phase [and]
through implementation of any Work and/or Alterations, to
review all plans, material procurement, demolition, construction
and waste management procedures to ensure they are in full
conformance to Landlords sustainability practices, as aforesaid.

Source: BOMA International and Steven A. Teitelbaum, Esq.

BOMA INTERNATIONAL:
COMMERCIAL LEASE GUIDE
ARTICLE 6: USE; Section 6.4: Recycling & Waste Management
Tenant covenants and agrees, at its sole cost and expense: (a) to
comply with all present and future laws regarding the
collection, sorting, separation, and recycling of garbage, trash,
rubbish and other refuse; and (f) that Tenant shall pay all costs,
expenses, fines, penalties or damages that may be imposed by
reason of Tenants failure to comply.

Source: BOMA International and Steven A. Teitelbaum, Esq.

BOMA INTERNATIONAL:
COMMERCIAL LEASE GUIDE
ARTICLE 8: ASSIGNMENT AND SUBLETTING
It shall be a reasonable basis for Landlord to withhold its consent
if Tenant tenders for Landlords approval an assignment of this
Lease or a sublease of the Premises or any part of the Premises to
a proposed assignee/subtenant whose proposed use or operation
in the Premises may or will cause the Building or any part thereof
not to conform with the environmental and green building clauses
in this Lease.

Source: BOMA International and Steven A. Teitelbaum, Esq.

GREEN LEASES & ADEQUATE SPECIFICITY

Some specific topics that a green lease should address include:
1. Any idiosyncrasies of the land, building(s), or location, that would
make the use of standard lease provisions impossible, impractical, or
inequitable

2. Parameters for the use of any shared equipment in the course of the
tenancy, as well as allocation of responsibilities for maintaining and
servicing such equipment
3. Any land use, zoning, or building code regulations that may affect the
contemplated use of the property
4. Any unique objectives or reservations held by the landlord or tenant(s)

ADVANTAGES OF GREEN LEASES

According to Richard James, a British lawyer who specializes in commercial
real estate transactions, green leases frequently provide building owners with
the following benefits:
1. Reduced operating costs

2. Increased energy efficiency

3. Green floor space may be more attractive to prospective tenants; tends to
lease more quickly
4. Positive benefits for the owners and tenants

5. Improved reputation for corporate responsibility

6. Getting ahead of the game

http://www.placenorthwest.co.uk/richard-james-hill-dickinson.html

REASONS FOR LACK OF DEMAND AND

INDUSTRY SCALING PROBLEMS

Demand-Side Barriers

Supply-Side Barriers

1.
2.
3.
4.
5.

1.
2.
3.
4.
5.

Split Incentives
Unclear Benefits
Long / Complex Sales Cycle
First Cost Hurdles
Debt Constraints

Market Fragmentation
Complex Project Delivery
Underwriting
Deal Size
Debt Constraints

Source: United States Building Energy Efficiency Retrofits: Market Sizing and Financing Models, March 2012 (Pages 35-36).
Rockefeller Foundation / DB Climate Change Advisors.

ENERGY PERFORMANCE CONTRACTS

An energy performance contract (EPC) is an agreement in which an energy
service company (ESCO) takes responsibility for completing a retrofit on
behalf of a customer.
1. Service begins with an audit, includes an analysis of alternatives,
installation of equipment, and steps to verify the projects success.
2. The ESCO arranges financing. The customer repays the ESCO from the
savings that are generated by the retrofit.
3. Savings are guaranteed. If the savings fall short, the ESCO covers the
difference.
4. EPCs were pioneered by US government agencies to initiate energy-savings
projects without special Congressional appropriations. Today, EPCs are
used in many contexts. Individuals, governments, and private
organizations all enter into performance contracts to finance energysavings projects.

PERFORMANCE CONTRACTING:
PROS & CONS
Benefits:
1. No upfront costs to customer
2. Energy savings typically guaranteed
3. Projects can be initiated with
limited budget impacts
4. Convenience of having upgrade
managed by a single entity
Caveats:
1. EPCs may be challenging to obtain,
especially for small projects
(<$1M) and those in the private
sector
2. There is a potential divergence
between interests of ESCO,
customer
3. ESCOs may have limited experience
with specific markets
Photo: Diacritica, via Wikimedia Commons

PARTIES TO A PERFORMANCE CONTRACT

There are typically two or three parties to
an EPC:
1.

2.

3.

Customer/End User the

individual, business, or other
organization that seeks an energysaving upgrade.
ESCO/Performance Contractor
the ESCO or other entity that
implements and provides all
services for the energy-saving
upgrade.
Lender the bank, credit union, or
other financial institution that
finances the initial costs

PERFORMANCE CONTRACTING:
MARKET CONSTRAINTS
The EPA has identified the following market constraints for
specific market segments:
1. The federal and MUSH markets are resistant to EPC
projects because of regulations and intra-agency inertia
that resists significant changes and new program
implementation.
2. The commercial market is resistant because owners are
apprehensive about saddling their buildings with the
additional secured debt that is required to finance projects
3. The industrial market is challenged by the instability of
most American manufacturing firms; short-term financing
terms preclude the use of typical EPC repayment period.
4. More generally, a mismatch between required skill sets
and available labor continues to challenge the EPC market
across sectors.
MUSH: Municipal and State Governments, Universities, Schools, Hospitals
EPC: Energy Performance Contracting

Source: http://www.energystar.gov/ia/partners/spp_res/Introduction_to_Performance_Contracting.pdf

WEEK 4: IN-CLASS EXERCISES

1.

Explain split incentives. Where do they arise and what are some of the
approaches that can be employed to overcome them?

2.

Describe the objectives of writing a green lease. Discuss the kinds of

clauses that might be included, and explain the reasons for doing so.

3.

Identify the supply and demand sides of the industry scaling problem.
How does the scaling problem affect energy-efficiency upgrades?

4.

Explain why performance contracting is important to energy. Identify

the parties to energy performance contracts, and the constraints that
the parties must expect.
Submit a write-up of your responses via the Course Module.

WEEK 4: HOMEWORK
Develop two sample green lease provisions for a portfolio property.
Return to the portfolio property that you have selected. Draw on the
materials that youve studied this week, and in the past, to draft at least
two new lease provisions to encourage landlords and/or tenants to
engage in more energy-efficient behavior.
Next, summarize the objectives of each of your provisions, including
which parties behavior they are most likely to influence; and explain how
your objectives relate to the goal of encouraging both landlords and
tenants to take steps toward improved energy performance.