The City of New York Mayor’s Office of Long-Term Planning and Sustainability recently completed its Model Energy Aligned Lease and announced its use in a transaction at the 7 World Trade Center Building. I think the innovative approach with the Energy Aligned Lease Language is a good step forward for trying to manage the “split incentive.” However, when I read the press release and the lease language, it struck me that success of the approach still depends on the building performing substantially as modeled since there is no actual performance verification. While the 80% pass thru provides some hedge, it appears that a Tenant with a short-term lease could find itself on the short end of the stick if actual energy savings falls significantly short of expectations. Not that such ever happens in the real world….
Taking the example in the Model Energy Aligned Lease Language itself in section 1(b)(i), assume that the $2,000,000 in Landlord’s capital improvements is “projected” to result in $500,000 in energy savings, which can then be passed through to Tenant at $400,000 per year for 5 years at the 80% rate. Let’s then assume the base energy cost without the capital improvements was $1,500,000 a year (e.g., the improvements are “projected” to result in a 33% energy reduction – a notable outcome).
What happens if energy consumption is only actually reduced by 10% for whatever reason, rather than the anticipated 33%?
Tenant’s Outlay:
Energy cost ($1,500,000 x 90%) $1,350,000
Capital Ex pass thru based on “anticipated” savings $ 400,000
Total Annual Outlay for 5 years $1,750,000
Total Annual year 6 + $1,350,000
Now I am just a lawyer and not a finance guy so someone please correct me if I am wrong, but query whether this is a good outcome for a Tenant with a 5-10 year lease who would have otherwise paid $1,500,000 a year without the capital improvements being made. For example, at the end of year 7, Tenant would have paid $11,450,000 under the Energy Aligned Lease under this scenario, but would have paid only $10,500,000 without the energy improvements. If I am not wrong, then the point is that with the Energy Aligned Lease approach, much still depends on actual building performance aligning fairly closely with projected or modeled performance (or having a very long-term lease over which to recoup the shortfall). From what I understand from the building performance experts, the alignment between modeled and actual performance is no sure thing and some buildings are performing far worse than anticipated.
Perhaps the Model Energy Aligned Lease Language should be backstopped somehow by a provision that allows reconciliation if actual energy use is significantly greater than that projected? The plaNYC document “Model Energy Aligned Lease: Detailing language to help solve the split incentive problem” provides that “Moreover, using projected savings avoids having to monitor actual savings, which can be prohibitively expensive.” Again, as merely an attorney, I would let others opine on whether it would in fact be “prohibitively expensive” to establish a baseline and monitor actual energy savings.
In sum, kudos for the forward thinking by the folks in NY in developing this model language. However, as with all model language, careful evaluation should be conducted to fully understand the implications to you or your party in interest based on the specific facts before dropping the Model Energy Aligned Language into a lease.
Submitted by Paul D’Arelli of Berger Singerman
Filed under: Uncategorized Tagged: | cap-ex, energy aligned lease, energy savings, green lease, lease, leasing, pass through cost, split incentive
