Focus: Managing costs associated with improved
Services: Property & Projects
Industry Focus: Property
In our October 2011 Landlord and Tenant Alert we foreshadowed the commencement of the compulsory disclosure requirements of the Building Energy Efficiency Disclosure Act 2010 ("BEED") from 1 November 2011.
As a result of the BEED, tenant demand and other initiatives, the property industry is becoming increasingly conscious of the importance of sustainable development activities. Consequently, property owners and developers have had to factor in the additional costs required to implement initiatives aimed at improving the environmental performance of their properties. This Alert highlights the ways in which property owners and developers have sought to manage the costs associated with improved environmental performance through Green Leases and Environmental Upgrade Agreements.
What are Green Leases?
Green Leases are leases which contain clauses that are specifically designed to ensure that a building's rating (e.g. NABERS, Green Star) is maintained or even improved over the life of the lease.
Maintaining, or even improving, such ratings require cooperation from all occupants of the building. It is therefore important that, where necessary, leases impose certain obligations on tenants so as to ensure their cooperation in maintaining or improving the rating.
Green Leases are also designed to manage the cost consequences of maintaining or improving the building's rating. In this respect, many Green Leases seek to pass on some of the cost of implementing sustainability initiatives to the tenant.
What are the key concepts included in Green Leases?
Some of the key concepts that may be included in Green Leases are:
- general acknowledgements. These will typically require the tenant to adopt practices and procedures that maintain or improve a rating. This may include the right for the landlord to obtain certain energy usage information from the tenant in respect of the tenancy
- energy efficiency audits undertaken by the landlord. Energy efficiency audits may be required in order to allow the landlord to obtain certain NABERS ratings for the building. In these cases, the cost of the required energy audit may be able to be passed through to tenants as part of the outgoings payable under lease
- energy management plans. It is common for both landlords and tenants to have their own Energy management plan in order to ensure that a current NABERS rating is maintained. In order to ensure consistency between these plans, rights are usually conferred on the landlord to periodically review and approve the tenant's energy management plan
- renewable energy purchases. A landlord may wish to mitigate the risk that the building's rating is not maintained due to the energy performance of the building not going as planned. Landlords may therefore seek to purchase renewable energy to ensure that the required energy performance of the building is maintained. As such, a provision allowing the landlord to purchase renewable energy for the building to bolster the rating may be included in the lease. The costs of purchasing this renewable energy could in certain circumstances be passed through to the tenant.
What may tenants request of their landlords in Green Leases?
When it comes to negotiating a Green Lease with prospective tenants, landlords should be aware of some additional provisions that a tenant may expect to be included, including:
- separate metering of energy and water consumption for each tenant
- ensuring all systems are installed correctly and operated to maximum efficiency
- monitoring and adjustment obligations for air conditioning use, and
- any disputes arising out of the operation of Green Lease provisions are to be resolved by the dispute resolution process.
Environmental Upgrade Agreements
The Local Government Amendment (Environmental Upgrade) Act 2010 commenced on 18 February 2011 and introduced a mechanism in Part 2A of the Local Government Act 1993. This enables building owners to finance works that improve the energy, water or environmental efficiency or sustainability of a building through an Environmental Upgrade Agreement ("EUA").
An EUA is an agreement between the building owner, the local council and a finance provider under which:
- a building owner agrees to carry out environmental upgrade works
- a finance provider agrees to finance these works, and
- the local council agrees to levy a charge on the land for the repayment of the loan from the finance provider (referred to as an environmental upgrade charge).
The environmental upgrade charge imposed by the council is in fact a charge that remains on the land until the loan has been repaid in full, so subsequent purchasers of land that is subject to such a charge will be required to continue to pay the additional levy.
Participation in this scheme is however voluntary. At this stage, EUAs may only be entered into in respect of existing non-residential buildings or strata buildings that are the subject of a multi-residence strata scheme comprising more than 20 lots.
How does an EUA work?
An EUA must provide for the following:
- an outline of the environmental upgrade works that have been agreed by the parties to be carried out by the building owner
- the amount of the advance to be made by the finance provider and any relevant milestones for such advances, and
- the agreed repayment arrangements, including the amount of the charge to be levied by the council on the land and the dates on which the charge is to be levied.
Upon receipt of the environmental upgrade charge from the building owner, the council must pay those monies to the finance provider in accordance with the terms of the EUA.
The NSW Office of Environment and Heritage, in conjunction with key industry stakeholders, recently approved a template agreement for use by parties entering into an EUA for a non-residential building.
Who bears the cost of the environmental upgrade charge?
The environmental upgrade charge must be paid to the council within 28 days of the council serving notice on the person liable for payment of the charge. This will normally be either the owner of the building or, in the case of strata buildings, the owner's corporation of the relevant strata scheme who must decide whether the charge is to be paid from its sinking fund or administrative fund.
The ability for a building owner to recover the environment upgrade charge from tenants is limited to a reasonable estimate of the amount of the cost savings that tenants will enjoy as a result of the environmental upgrade works. This arrangement helps overcome the split incentive issue that is normally associated with net leasing arrangements. This occurs when landlords are reluctant to bear the cost of the environmental upgrade works because the landlord will not necessarily enjoy the benefit of reduced energy bills that tenants would without having to make a contribution to costs.
The ability to recover part of the expense from tenants however assumes that existing leases contain provisions that will allow the landlord to recover from the tenant any "new tax" imposed. The absence of such a provision may make it otherwise difficult for the landlord to recover the charge from the tenant.
Ultimately the way in which landlords and building owners seek to improve the environmental performance and sustainability of buildings requires careful consideration of the cost versus benefit analysis of the various options that are available. For example, although the ability to recover the cost of environmental upgrade works from tenants is limited under an EUA to the costs savings achieved, the terms of the loan from a finance provider under an EUA may be more favourable given the increased security for the loan afforded by the charge imposed on the land by council.
With the increase in focus and importance placed on the environmental performance of buildings, landlords should consider their current leasing arrangements more carefully so as to mitigate the impact that these changes may have on the landlord's operations.
DibbsBarker Landlord and Tenant seminar: The impact of competition law on leasing
Due to the overwhelming feedback received following last month's Landlord and Tenant Alert on the impact of competition law on leasing, DibbsBarker will be presenting a seminar on the topic. On 21 March 2012, Michael Sutton, a Senior Associate in DibbsBarker's commercial group will present on the competition issues that landlords and tenants need to consider when negotiating and enforcing obligations under a tenancy. Topics covered will include cartel conduct, exclusive dealing, third line forcing and unconscionable conduct. To register for this event, please click here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.