Lease Structure
Much of the discussion regarding the operating expense provisions of a green lease centers around the concept of so-called “split incentives” and how to structure the lease itself to address the question of how the parties to the lease share – or if they share – in the costs and benefits associated with a green building. Many have opined a green lease needs to be structured as a modified gross lease (i.e., base year, expense stop or stipulated base), as a triple net lease structure purportedly does not provide a landlord with economic incentives to undertake green initiatives. While this may be true in the case of a single tenant building with a long term lease, most buildings that are not owner-occupied have multiple tenants and the majority of those leases are for terms less than seven years. Moreover, the theory triple net leases should not be green leases overlooks many practical realities including (1) landlords will be faced with vacancy at some point, (2) when vacancies do occur even the grossing up of utility and cleaning expenses will not fully insulate a landlord from having to absorb some of the building’s utility and cleaning expenses, and (3) the increased building value resulting from green initiatives inures to the landlord’s benefit irrespective of lease structure. Beyond these considerations, the pending decision by FASB as to whether it will replace FASB Statement No. 13 Accounting for Leases, could have the effect of driving tenants away from using modified gross leases.
First, with respect to triple net leases and vacancy, nearly all buildings – green or not – will face at least some vacancy over the long term. By implementing green building systems and procedures the landlord can reduce those operating expenses it would otherwise incur with vacancy in the building. A building will still incur some amount of base-building electric, HVAC and common area cleaning costs even if it is entirely vacant.