Lease Structure Key to Energy Savings

Lease Structure Key to Energy Savings

When office tenants pay only for their actual energy consumption, they inherently use less of it. Unfortunately, most tenants in “Class A” buildings have a lease structure called “fully-serviced” which does not account for how much energy each individual tenant uses, and therefore doesn’t motivate them to reduce their energy consumption because there’s no economic incentive.

Leasehold structures can generally fall into one of three categories:

• Triple Net (NNN):  In addition to paying Base Rent, the tenant is billed separately for property taxes, insurance, maintenance charges, utilities and janitorial services.

• Industrial Gross (IG):  All of the above expenses are included in the rental rate, with the exception of utilities and janitorial, which are paid separately by the tenant. This can also be called “Manufacturer’s Gross” (MG) or “Net of Utilities and Janitorial” (NUJ).

• Full-Service (FS):  In this lease structure, the tenant’s rental rate covers all of the above expenses, and is also sometimes referred to as a “Gross Lease”.  Any increases in Operating Expenses “OpEx” are passed through to the tenant as “Additional Rent”.  So for example, if the utility company decides to hike up the cost of their electricity, the tenants get stuck with the bill and pay according to their pro-rata percentage share of how much space they occupy in the building.

Turn off the lights behind you.  One day when you’re paying the bill you won’t forget! – Mom

So here’s the problem.  In a Full-Service lease, the landlord is not incentivized to implement energy-saving measures since they’re passing all increases through to the tenant.  And the tenant has no reason to try and save energy because doing so won’t reduce their monthly rent.

The logical solution is to sub-meter the tenant’s space so that they’re only paying for what they actually consume, and will realize the economic benefit from conserving energy.  This is much easier said than done, however.  Most Class A buildings simply aren’t designed to sub-meter individual tenant spaces, and most tenants do not have the necessary leverage to get the landlord to agree to pull them off the Full-Service lease.

Commercial real estate firm CB Richard Ellis found that separately metered buildings where tenants pay for what they consume, lower their energy costs on average by 21%.

So what do we do in the meantime while we wait for new buildings to be designed that can address this concern and take advantage of the huge opportunity for mass energy reduction in the workplace?  One option is to seek out buildings that already offer leaseholds on an Industrial Gross basis.  Typically you’ll see this in smaller, older buildings with a lower tenant density.  Or, if you are in an office tower and occupy several floors, you may have the necessary leverage to negotiate a lease that’s net of electric and get the landlord to agree to sub-meter your space.

As a broker, I always give preference to buildings that have leases structured as Industrial Gross.  In addition to the obvious benefit of saving money, I think employees appreciate being engaged and knowing that their energy-reducing actions have a positive impact and benefit.