With 40% of global CO2 emissions coming from the real estate sector, there are increasing concerns about its contribution to greenhouse gas emissions. Governments, investors and the public are all looking for methods to reduce the environmental impact of the sector, aiming to reach net-zero emissions by 2050. Green leases are key to increasing collaboration to reduce the negative impacts and improve efficiency in the industry.

What is a green lease?

Green leases contain additional provisions (green clauses) that impose an obligation on landlords and tenants to manage and reduce the environmental impact of a property. This is through improvements; both the landlord and tenant will benefit from mitigating the sustainability risk of a property, and by making these improvements.

Green clauses contained in leases can be separated into two groups: light green clauses and dark green clauses. Light green clauses are not legally binding and require limited action from parties. Usually, light green clauses only extend to improving energy efficiency. Examples may include entering into a memorandum of understanding, which can offer more flexibility to parties and sits outside the lease agreement. Dark green clauses are legally binding and often require much more action and commitment. They will usually cover more issues than just energy efficiency. Examples of dark green clauses could include a landlord offering a reduced rent if energy efficiency targets are met.

How can green clauses affect tenants?

In most circumstances, landlords will need to cover the costs of making a building more energy efficient. If costs are not covered by a landlord, the lease may not be appealing or viable for a tenant, especially when considering those with a shorter contractual term. Some green clauses may impose mutual obligations on the landlord and tenant to make the building more environmentally friendly. These obligations don’t have to be costly to a tenant, they may simply be obligated to turn off all the lights at the end of the day. On the other hand, a green clause may be more onerous, for example, a tenant may be obligated to keep energy usage below a certain limit and in return the landlord may offer a reduced rent.

When negotiating green lease terms, a tenant will need to keep in mind that their landlord may be bound by planning requirements/conditions and therefore there may be less room for negotiation in some clauses.

How can green leases/clauses affect landlords?

As noted above, the expectation is that landlords will front the costs for any environmental improvements to their property, drafted in the green lease. However, there is the option of drafting a clause into the green lease to allow them to recover some of the costs incurred from the tenant. Landlords can also benefit financially from ensuring that their properties comply with the green regulations, as when it comes time to sell, an environmentally sustainable property is far more attractive to a potential buyer than a property that requires a large outlay for improvements upon purchase. The more obvious benefits for landlords include the reduction of utility costs and an improved reputation of the landlord. Landlords do run the risk of the tenant not wanting to incur the costs of the environmental improvements, meaning there is a heavy reliance from the landlord on the demand for the green lease properties.

MEES regulations – What are they and what effect do they have on green leases?

Minimum Energy Efficiency Standards, better known as MEES regulations, came into force on 1 April 2018. The regulations outline that if an EPC (Energy Performance Certificate) rating is below a rating of E (F or G), the landlord runs the risk of financial and legal penalties. The lease is seen as unlawful. The only way for a landlord to protect themselves from penalties is to submit a valid exemption.

As of April 2023, the MEES Regulations now apply to the granting, renewal, extension of leases and also on the continuation of an existing lease. As of writing, there have been proposals made to increase the EPC rating which are due to take effect in 2027 and subsequently in 2030. The target for commercial properties is for all landlords to be able to present a valid EPC with a rating of B or higher (where cost effective) by the end of 2030. There is an understanding from the government that not all properties will be able to meet the minimum EPC rating, but landlords need to be seen as making every (cost-effective) effort to employ measures to improve the overall EPC rating.

Penalties for non-compliance

Landlords in breach of the MEES Regulations could face financial and reputational penalties but non-compliance is not seen as a criminal offence.

The financial penalties can be calculated as follows:

• Less than three months non-compliance - up to 10% of rateable value capped at £50,000.
• Three months or more of non-compliance - up to 20% of rateable value capped at £150,000.

Conclusion

As with any other form of lease, green leases have their pros and cons and the responsibility ultimately lies with the landlord as to whether their properties will adhere to current regulations. The Government’s hope is that green leases will go a long way to helping them achieve their goal of being net-zero carbon by 2050. Time will tell whether this target can realistically be met.

For more information

For more information on green leases and how they may affect you, please contact me.