Office leases & landlord investment in energy efficiency

Abstract

What is the relationship between the structure of leases in the Boston office rental market and how much landlords invest in energy efficient building systems for their existing buildings? I am drawn to this question because it seems to me that there is technology available that would allow the operation of for-rent office buildings to be more efficient in their consumption of energy than they currently are. I investigate this question with the hope that by characterizing the problem, we can start to solve it. To this end, I interview 35 players in the real estate market in Boston in order to determine the relationship between leases and landlord investment in energy efficiency, and if there is any way to increase such investment. The most significant finding of this study is that the lease does not determine the way the market works, rather the market determines the way the leases are written. The result at this time for the Boston market is that leases simply do not incentivize the landlords to make investments in energy efficiency because the tenants do not want to pay for the landlords to do it. The landlords are unable to make significant profit from these upgrades due to existing recapture clauses and operating expense allocation in existing leases, and the payback period on many of these investments does not satisfy the investment horizon of many commercial landlords. They lack pressure and motivation from their tenants, as evidenced by the tenants' refusal to pay higher rents for more efficient buildings. Finally, there is no perception of a premium, in the form of a lower cap rate, paid by the capital markets at the time of sale.

(cont.) This is a very complex issue, with no single, clear resolution. There have been many suggestions as to how this problem may be solved, ranging from a complete change in lease structure, to government intervention through efficiency mandates or taxes, to a laissez faire stance that will allow the market to take care of the problem. I think that none of these in isolation will solve the problem, but that a combination of them all may ameliorate many of the issues. Perhaps the best combination would be to mandate performance or to tax excessive consumption while at the same time developing leases that better address how to share costs and benefits. By doing this, we will set appropriate minimum goals, and provide suitable tools to achieve them. Without both of those pieces, it seems unlikely that much progress will be made.