Green Leases and the Pathway to Net Zero Emissions

What are Green Leases?

In Australia, Green Leases are typically office or retail leases which provide for a framework under which the landlord and/or tenant are required to achieve key energy efficiency, sustainability and reporting metrics over the relevant lease term. The key “Green” provisions – which may be the subject of negotiation between landlord and tenant – may cover such things as:

• energy efficiency – including through energy efficient installations, measures and energy sourced from alternative/green sources;
• water reduction measures – including through the design of fixtures, fittings and the re-use of water;
• built environment – with a particular focus on lighting, ventilation, acoustics, temperature and occupant comfort;
• metering – including a requirement to have the relevant premises separately metered and/or the ability for tenant to purchase power and achieve energy efficiency; and
• new technology adoption – including through the adoption of new innovative technologies and PropTech installations.

What are the key considerations (and pitfalls to avoid) for landlords in using Green Leases?

Landlords should consider:

• identifying the key attributes of what is expected from the tenant from a sustainability perspective as part of finalising heads of agreement;
• the lease should be flexible enough to respond to changing circumstances and the variability of sustainability requirements while also ensuring that there are active obligations on a tenant, as required. For example, the relevant provisions will need to accommodate changes to regulatory requirements and not be so proscriptive as to limit the intention to maintain a sustainable and efficient building;
• particular attention should be given to whether breaches of the relevant Green Lease provisions invoke termination rights, potential adjustments, incentive suspensions and/or dispute resolution mechanisms. Depending on the situation, landlords may prefer for the parties to work collaboratively towards implementing the Green Lease provisions as reasonable or best endeavours obligations only – with breaches giving rise to appropriate consultation and cure;
• the cost distribution of sustainability initiatives may be unequal (i.e., there may be a ‘split incentive’ for sustainability works or programmes between landlord and tenant). For example, where a landlord incurs costs to improve the sustainability infrastructure of the building (whether up-front or during the term of the lease), it may be the tenant that benefits through reduced building outgoings (in the case of a net lease). However, where a tenant pays no building outgoings (in the case of a gross lease), the landlord benefits from the increased rental cash flow;
• as a counterpoint to the cost considerations above, Green Lease measures may be used to ensure that building tenants (as a whole) enjoy higher building amenity – leading to potentially higher rents and greater tenant retention (and longer WALEs) than may otherwise be the case; and
• robust data monitoring, collection and retention systems (e.g. for energy or water usage) to achieve what is required from a sustainability perspective and also comply with privacy and data security requirements.

What role do Green Leases have to play in the pathway to “Net Zero”?

Under the Climate Change Act 2022 (Cth) (Act), Australia has legislated to target for a reduction in Australia’s greenhouse gas emissions to zero by 2050 (Net Zero Target), with an interim target requiring the reduction of emissions by 43% by 2030 compared to 2005 levels.[1] This target has been put in place amidst Australia’s total emissions trending marginally downwards since 2020.[2]

The built environment sector has been identified by the Department of Climate Change, Energy, the Environment and Water (Department) as one of the key six sectors forming part of the emissions reduction plans that underpin the Net Zero Target. While the Department has stated there is no intention to set emissions reduction targets on a sector specific basis, the Department will develop a “Built Environment” Plan covering commercial (and other) buildings in order to implement emissions reduction strategies in that sector.[3]

Although details of the “Built Environment” Plan are not presently known,[4] we anticipate the plan will highlight an increased focus on sustainability in the commercial real estate market which, in turn, will play into an increased need for Green Leases across that sector. Landlords should therefore consider future-proofing their investments by carefully examining the details of their Green Leases in consultation with their legal advisors as to whether their leases properly address all issues.

Amidst this backdrop, Green Leases that are negotiated between landlords and tenants may need to increasingly accommodate:

• potential building code changes - as part of the push towards net-zero emissions, there may be the potential for revised building codes and regulations that mandate higher energy efficiency standards for new and existing commercial buildings (such as the proposal to include a future minimum standard for embodied carbon in the 2028 National Construction Code). This may affect the design, construction, and renovation of office spaces and landlords should consider how this may impact obligations on tenants and complying with reporting requirements;
• climate related reporting - providing greater transparency around exposure to climate related risks and opportunities (both for landlord and tenants) in light of Australia’s recent mandatory climate reporting regime which is now in effect;
• changing tenant environmental expectations - tenants may increasingly seek buildings with recognized sustainability certifications (e.g., NABERS, Green Star ratings) as part of ESG internal compliance efforts and social licence brand alignment efforts. This trend could lead to higher demand for ‘green buildings’, potentially increasing rental values for such properties while decreasing demand for older, less efficient buildings;
• different operational requirements - properties that do not meet new sustainability standards may face higher operational costs due to increased energy expenses (for example in HVAC infrastructure) and potential penalties for non-compliance with regulations. This could impact the overall financial viability of certain properties and influence tenant occupancy rates (and market rents); and
• changing investment and financing expectations - investors are increasingly considering environmental, social, and governance (ESG) factors in their investment decisions. Similarly, insurers and financiers are looking at risk coverage and asset hazards as part of their underwriting processes. Properties that align with net-zero targets may attract more investment and more favourable financing terms, while those that do not may struggle to secure funding. Landlords may stand to benefit where they can appropriately include these environmental compliance requirements in their leases with tenants.

How does this compare to what is available overseas?

Green Leases concepts are used widely in other jurisdictions – and a variety of partnerships, toolkits and directives assist landlords, tenants and their advisors navigate green initiatives into practice. For example:

• in the UK, the market-demand lead approach has resulted in the establishment of the Better Buildings Partnership (BPP UK) which, since 2008, has provided a shared avenue for landlord/tenant dialogue on the use of Green Leases in commercial buildings in the UK. The BPP UK provides a number of shared (and generally free) resources for landlords and tenants, including:
  • model green lease clauses;
  • general advice on preparing heads of agreement with Green Lease content; and
  • practical case studies and indicative market positions on building management, sustainable use, data sharing and metering, extending landlords rights to do works, tenant alterations, waste management, make good obligations and the use of renewable energy sources in commercial buildings.

The BPP UK resources remain (generally) free and up to date following an extensive update to the BPP UK Toolkit in January 2024.

• in the EU, a mandated approach under the revised Energy Performance of Buildings Directive entered into force with effect from 28 May 2024 and imposes a number of measures that are designed to target, among other things:
  • the gradual introduction of minimum energy performance standards for non-residential buildings based on national thresholds to trigger the renovation of buildings with the lowest energy performance;
  • an enhanced standard for new buildings to be zero-emission and the calculation of whole life-cycle carbon for new buildings;
  • increased deployment of solar technologies on all new buildings and certain existing non-residential buildings where technically and economically feasible, and ensuring that new buildings are solar-ready;
  • a gradual phase-out of boilers powered by fossil fuels, in conjunction with the end of subsidies to stand-alone boilers powered by fossil fuelswith effect from 1 January 2025; and
  • the roll-out of recharging points for electric vehicles in buildings, removing barriers to their installation, enabling smart charging and introducing measures for bike parking in buildings; and
  • data collection and sharing, to improve knowledge on the building stock and awareness on energy consumption in buildings.