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Split Incentive and the Green Lease

Net leases create a "split incentive" when it comes to making energy-efficiency improvements to commercial buildings. A "green lease" includes terms that share the benefits of lower utility bills. (podcast)

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The "split incentive" is a barrier to making buildings more energy efficient. A "green lease" is one way around it.


When a company owns the building they occupy, they can justify the up-front cost of energy-efficient upgrades based on the energy savings. That isn't always the case in leased buildings.

Split incentives happen when those responsible for paying energy bills are different than those making capital investment decisions. The most common form of split incentives is in leased buildings where tenants pay the energy bills, but owners pay for upgrades.

The incentive to save energy is in the wrong place because the people who can make it happen are not the ones who will realize the savings when those utility bills go down. The tenant isn't responsible for capital improvements, like HVAC, but the landlord isn't responsible for the energy bills. Tenants often are charged for energy consumption on a per-square-foot basis, so even if they save energy, they don't get the full financial benefit. Energy used in common areas, like lobbies and parking lots, is paid for by tenants but completely out of their control.

Green leases are one way around this problem. Owners and tenants can agree on lease terms that share the benefits of lower utility bills, so owners will have an incentive to make the investments.

Leasing agents are often hesitant to add terms that complicate their lease. Once the lease is signed, it's not likely to change for three to five years. It's up to the prospective tenant to ask for green lease terms during negotiations.


The split incentive struck Bloomberg's proposed plan for NY buildings. The plan would have requred energy audits and the repairs to correct sources of energy waste.

"Rohit T. Aggarwala, director of the mayor's Office of Long-Term Planning and Sustainability, said a major sticking point for buildings was that, under some leases, owners who may have paid the upfront costs of retrofitting may not have been able to pass the costs to tenants benefiting from lower electricity bills. Councilman Gennaro said the issue introduced 'an element of unfairness and inequitable burden sharing' to the retrofit plan."
(New York Times 12/4/09)

If passed, the revised plan would still require energy audits, but not mandate energy-efficiency retrofits.

Just like you say, the split incentive is THE main barrier on why the commercial real estate market does not invest into energy efficiency projects and large retrofitting projects on their buildings. The building owner pays and the tenant saves. In most cases you are talking about millions of dollars in CapEx to replace failing HVAC systems etc. The traditional ESCO's of the world have been making performance guarantees for 30 years in the university and municipality markets, but they can't do the same in commercial real estate because of the split incentive.

One solution that we have been using since 2001 to this split incentive problem is the Managed Energy Services Agreement. We actually invest our own capital into the retrofits and we carry all the performance risks. It's very different from what the ESCO's have been doing.