Wednesday, January 15, 2014
I occasionally write op-eds for the Idaho Statesman. I thought my most recent column might also be appropriate for this forum, as it makes the business case for energy benchmarking, doing away with the triple net lease, and making energy efficiency a part of a board director's fiduciary duty to shareholders. While these changes are common sense and de facto real estate practice in places like San Francisco, they are still emerging principles in secondary markets, such as Boise. In such locations, making the business case for green building is more effective than any discussion of climate change ever will be. Here is a link to the op-ed, the text of which is reproduced below:
Should the price of a building incorporate its operating costs?
If you were a building owner, would you want a 7 percent return on investment or a 10 percent ROI where the only difference between the two is how much you pay the power company?
From a shareholder perspective, any board director that said the difference doesn’t matter should be fired immediately. Such indifference to return should be a violation of a director’s obligation to maximize shareholder profits.
As a lawyer, it should be malpractice in representing a client in a sale of real estate or in negotiating a lease not to warn a client that a beat-up water heater in the basement could make a drastic difference in return.
But few real estate deals — sales or leases — disclose or even discuss energy use.
Several legal inventions have made this peculiar reality possible. Foremost, the most common commercial lease since the ’50s has been the “triple net” lease, which requires the lessee to bear the cost of operations. The justification was that the lessee should have the ability to use the space with the intensity desired, and the landlord should not be able to interfere with the lessee’s business by restricting access to things like heat or other utilities.
That makes sense. The problem, however, is that this strategy also gives the landlord zero incentive to make improvements to building efficiency, primarily because any cost would be incurred by the landlord and the benefit would be to the tenant’s bottom line.
What if tenants and landlords could somehow share upfront costs and share returns?
Smart developers have long realized that landlords do not directly pass along all long-term costs to tenants but instead incorporate them into the market rent. If all the other landlords are running junky energy-hog buildings, a landlord that runs an energy-efficient building need only command market rents to recognize a significant bump in return on investment, which in turn should increase building price. The Banner Bank building in Boise is a prime example, and the subject of a documentary at vimeo.com/63124103.
So why do so many landlords and tenants fail to consider true operating costs? Because this method of throwing money out the window is, as they say in “Fiddler on the Roof,” “tradition.”
Common sense is starting to weigh in two important ways. First, in many markets, the triple net lease is increasingly a thing of the past. Other lease strategies developed over the past five years — admittedly more complicated — share risks and burdens of energy efficiency.
Second, an increasing number of cities and states are mandating that owners of large commercial buildings either disclose energy use on a yearly basis or at the time of sale. The requirement is known as benchmarking and is required in California, Washington state and eight large cities. Benchmarking makes it easier for buyer and seller, landlord and tenant, to have an informed conversation about operating costs. That has an important secondary effect: it makes it easier to make operating costs a part of the building price and the lease.
Idaho and Boise should consider such a policy as a matter of efficiency, but primarily as a matter of smart business. Without reporting requirements, the tradition of throwing money out the window — or more properly, giving it to the utility companies — will continue unabated. Reporting would provide valuable information to business, provide an incentive for landlords and tenants to work together to maximize returns and profits, ensure that buyers and sellers accurately reflect the price of a building, and reduce the need for more costly energy infrastructure. That’s good for all of our wallets.
Stephen R. Miller