In order for a property to be truly energy efficient, the interests of both the owner and residents must be aligned in favor of sustainability. Unfortunately, traditional lease arrangements often do the opposite, and skew the interests of both parties. For instance, if a lease includes fixed utility costs, the resident has no financial incentive to use sustainable practices; if the lease dictates that the resident pays for utilities, the owner has less incentive to pay for energy efficiency improvements in resident spaces because he or she will not be able to take advantage of the subsequent financial benefits which go to the resident.

In the past few years Commercial and Retail Leases have been developed as a solution to this conundrum. Also known as High Performance Leases or Energy Efficient Leases, these agreements aim to foster cooperation between owners and residents to achieve efficiency in the operation of the building, despite differing financial interests. As a part of these agreements, residents and owners choose a building rating system and commit to a philosophical agreement towards continuing sustainability. In addition, both parties are provided with other substantive benefits: As a part of the negotiation process, Residents can demand efficiency improvements for the building’s heating and cooling systems, in addition to shell upgrades, which lower utility costs and provide a better environment. Owners can demand that residents use sustainable materials and efficient practices, allowing the owner to meet social responsibility requirements and market a truly sustainable building, providing the opportunity for higher rental income and occupancy rates.

To accomplish this, leases require an Energy Management Plan to dictate how each party uses energy, and to maintain a target level of operation. Additionally, all utilities servicing each resident space, as well as common areas, are metered and tracked to allow for the ever-important monitoring and management of energy and water use. Representatives from the owner and residents are needed to implement and oversee this plan.

Shifting improvements from capital expenses to operating expenses helps overcome the split-incentive problem, as owners are often able to recoup fromresident costs designated as operating expenses. A standard lease should have a section outlining what items may be considered operating expenses and therefore passed on to residents.

How to overcome the “split-incentive” barrier to energy efficiency

This barrier occurs when property leases are not structured in a way that promotes energy savings.

  • Under most gross leases, for example, residents have no incentive to save energy in their leased space because energy expenses are paid by the building owner.
  • Under most net leases, building owners have no incentive to invest in efficiency for their building systems because the operating expenses are passed through to residents, who therefore receive all the energy cost savings. In this structure, energy costs may be allocated based on resident square footage, which does not always accurately reflect actual energy usage.

Leases (also known as energy-aligned leases, high-performance leases, or energy-efficient leases) align the financial and energy incentives of building owners and residents so they can work together to save money, conserve resources, and ensure the efficient operation of buildings.

Another View on this Issue

Designing behavioral programs that are successful is a science. Split Incentive Leases help residents make smarter decisions about their energy use and also help them save on their bills. This positions the owner as a trusted energy advisor as well as a brand residents can trust—positive outcomes in any market, since levels of resident trust and satisfaction are leading indicators of financial performance and asset value.

 

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