Real Property Law
Sustainability Clauses: A Growing Trend in Commercial Leases
By
J.J. Sherman, Law Offices of J.J. Sherman, P.C.
Jessie Staley, St. John’s University School of Law
What is a sustainability provision and why did my Landlord include it in my commercial lease?
Green leasing is becoming increasingly commonplace in the commercial leasing market. A Landlord may require its Tenants to use their leased premises both (a) in compliance with “green building” certifications that the Landlord seeks to obtain or to maintain, and (b) in compliance with state and local laws which continue to evolve to address resource sustainability.1
Green building certifications and ratings provide an incentive for owners to improve their building’s sustainability because they increase marketability to a growing number of eco-friendly investors and Tenants.
Owners may be further incentivized by potential tax deductions for energy efficiency. The Inflation Reduction Act expanded several tax deductions in 2022 so an owner may be able to deduct for upgrading equipment to improve a building’s energy efficiency. 2
Who should pay for the cost of obtaining a green rating and the cost of capital improvements that promote energy efficiency under a commercial lease?
Practically speaking, sustainability upgrades fall under the umbrella category of “capital improvements.” 3 If a commercial lease is structured as a gross lease, then the Landlord will be solely responsible for paying for capital improvements. If a commercial lease is structured as a triple net lease, then the Tenant will be responsible for paying its proportionate share of “common area expenses” as additional rent. Landlords often include the cost of obtaining and/or maintaining any green rating in the category of “common area expenses.” In addition, “capital improvements” are often included in the list of items considered “common area expenses” in a commercial lease. To protect themselves from surprise costs, Tenants will often negotiate that “capital improvements” may be included in “common area expenses” only to the extent they are required to comply with laws, ordinances, or regulations passed after the lease commencement date or to the extent the capital improvements will cause a material reduction in common area expenses, and in each instance, the cost of the “capital improvements” must be amortized on a straight line basis over its useful life, so as not to be hit with a huge improvement expense in any single year. At the end of the day, though, this is a negotiated point. Before signing a lease, a Tenant should ask its Landlord to disclose if the Landlord plans to make any capital improvements – including sustainability improvements – during the term of the lease – and then the parties can negotiate the allocation of costs for sustainability improvements based on the facts at hand.
What is reasonable for the Tenant to agree to?
In its effort to obtain or maintain green ratings, a Landlord might require that a Tenant’s use is environmentally sound and consistent with the Landlord’s sustainability practices and does not endanger the building’s Green Rating. The Landlord may also add that any Tenant build-out of the space must use “green” building materials. While Tenants support sustainability, Tenants also need to protect their rights to use the leased premises, and they need to avoid excessive costs or obligations. In that interest, Tenants may qualify the Landlord’s lease language to say that they’ll use “commercially reasonable efforts” to comply with “commercially reasonable” sustainability obligations. This qualifier is meant to protect the Tenant from default if their best attempts to comply are not perfect.
Additionally, Tenants may agree that they will be subject to the Landlord’s “green” building standards only to the extent the green building standards “do not affect the Tenant’s use of the Leased Premises or materially adversely affect the Tenant’s rights and obligations under the Lease.” 4
For the Landlord to perform energy efficiency upgrades, it needs access to the leased premises. The Tenant may negotiate language requiring notice from the Landlord and possibly even approval from the Tenant when the Landlord wishes to enter the premises for the purpose of performing sustainability improvements. This is especially important for work that may interrupt the Tenant’s use of the premises.
Overall, here are some items for Tenants to consider when negotiating the sustainability provisions in a commercial lease:
- Specificity: Make sure the lease lists specific “green” ratings and certifications.
- Reasonability: Protect the Tenant from unrealistic and costly standards with lease language that asserts “commercial reasonability.”
- Clarity: Clearly state what expenses related to green ratings and sustainability improvements may be included in “common area expenses” passed through to the Tenant.
For more information on this or other commercial real estate law topics, visit the website for Law Offices of J.J. Sherman, P.C.
This communication is for informational purposes only. It is not intended to create an attorney-client relationship or constitute an advertisement, a solicitation, or professional advice as to any particular situation. If this communication is considered advertising, then it is herewith identified as such. This communication does not constitute a guarantee, warranty or prediction regarding the result of representation. Prior results do not guarantee a similar outcome.
1 Under California’s Benchmarking program, utility companies are required to provide whole-building energy usage data, upon request, to the property owner, agent, or ENERGY STAR portfolio manager. Energy data is then reported by the property owner to the California Energy Commission, which publicly discloses the data online. A.B. 802, 2015-2016 Reg. Sess. (Cal. 2015).
2 Energy efficient commercial buildings deduction, IRS (last updated Oct. 25, 2024), https://www.irs.gov/credits-deductions/energy-efficient-commercial-buildings-deduction.
3 N.Y. Dep’t of Taxation & Finance, TB-ST-104, Capital Improvements (July 27, 2012).
4 Rita L. Feikema, Green Leasing, Practice Notes, https://plus.lexis.com/document/?pdmfid=1530671&crid=ee94eac6-b603-4459-a90b-4391dc9b718d&pddocfullpath=%2Fshared%2Fdocument%2Fanalytical-materials%2Furn:contentItem:5P98-SYC1-F7ND-G0B0-00000-00&pdworkfolderid=3d0a4794-d799-4572-bb8b-e93c07c9a093&pdopendocfromfolder=true&prid=8574be60-17f7-42b9-a134-02181db7e8ce&ecomp=9b_k&earg=3d0a4794-d799-4572-bb8b-e93c07c9a093 (Current as of: Sept. 25, 2024).