ESG policies have seen a proliferation of green leases in high-end property deals

A green lease is the generic term used to describe a lease for commercial property that contains provisions dealing with energy, environmental, sustainability and social matters.

They are part of wider ESG (environmental, social and governance) and sustainability initiatives that have taken root across the real estate industry.

"There is no prescribed format or exhaustive list of things to be included and it is an evolving concept, but generally speaking green leases contain provisions and obligations on tenants and landlords setting out how the building is to be operated, occupied and managed in an environmentally and socially sustainable way," says Conor Treacy, partner in real estate department at law firm William Fry.

They can include obligations on tenants to maintain a building’s sustainable or energy performance certification, and typically provide for both parties to share data and work together to achieve and maintain certain standards.

“You have to do your due diligence and, if you are serious about ESG, you have to look at what the landlord is doing because the only way you can make a difference, either as a landlord or as a tenant, on this front is if all the partners work together,” he adds.

The best bet is to opt for a property built (or remediated) to international environmental standards such as BREEAM (Building Research Establishment Environmental Assessment Method) or the LEED (Leadership in Energy and Environmental Design). That way you have independent certification standing over the landlord’s claims.

Having such certification is increasingly a tool of competitive advantage as businesses look to lower their carbon footprint. If you’re a building owner these days you simply can’t expect to land major US multinational, or certain State bodies at home, if your building doesn’t align with their values, according to Treacy.

“That’s what gets you the tenant, and that’s what determines the asset value, and the rental value,” he says.

Innovations

Standards such as LEED do not just include things like lighting and heating, but additional elements such as air quality and noise pollution, as well as innovations such as green living roofs, rainfall harvesting. It even includes elements such as how many staff cycle to work, and the space available for them to park their bikes.

Institutional property investors such as pension funds all have very serious ESG policies too, which has also contributed to the proliferation of green leases at the higher end of property transaction values.

These will trickle down to every building over time, predicts Treacy, helped by European building regulations that will start with new developments.

While there is no prescribed standard at present, in the future there will be, he predicts.

In the meantime Ireland's property market is well positioned on that front thanks to the high proportion of US MNCs here. "Many of these US MNCs such as the Airbnbs and the Twitters have very ordered and deliberate policies on things like green leasing. We in Ireland have a chance to be international leaders in this space," he adds.

Green leases have a role to play as part of the wider green financing boom, according to Grit Young, M&A partner, EY Ireland.

For investors leasing returns are generally stable, making them particularly attractive to pension funds. With green leases “you are investing in something that benefits the planet as well”, she says.

“People want to understand that they are doing the right thing for the planet, both as individuals and as institutional investors.”

The latter are moving to diversify away from brown and polluting sectors, helped by fear of government actions, such as levies which may be coming down the tracks for such polluting activities, which perhaps they hadn’t factored into their forecasts previously.

Financial services institutions are worried about the possibility of a financial crisis caused by climate change. If 90 per cent of your property is polluting, that’s a poor strategy right now, says Young .

Right projects

Billions of euro worth of green bonds are being raised and although it is a “drop in the ocean” in terms of what is required to combat climate change, finding the right projects to invest in is difficult, she says.

Right now demand far outstrips supply. For tenants vying to secure long-term green leases that might give rise to risk, she cautions. Some green equipment is still relatively immature, and has not had time to be fully tested over time and in use. “It’s really important to do your due diligence beforehand to ensure you are not paying too much,” she advises.

Moreover if governments do not move from a financial point of view in the way they are expected to, such assets may not look so good anymore. If Brexit and Covid have shown us anything it’s that we really have no idea what is around the corner.

The value of any business is assessed on the basis of its ability to generate cash in the future, and the amount of risk around that cash generation.

Right now a polluting company’s cash-generation ability will be significantly greater than that of a greener rival which takes significant steps to mitigate pollution, say Young. However, if you anticipate levies, then your polluting rival’s cash-generation prospects will go down while yours go up.

“It would be unwise to overlook the financial dimension. It should be yield plus environmental benefit,” says Young. “Sometimes you can forget the yield if the environmental benefit is so great, but you should be thinking of both.”