Playbook: Leasing Best Practices

Leasing Best Practices for Building Performance Standard Compliance

Washington’s Clean Buildings Act and Seattle’s Building Emissions Performance Standard

Context on Building Performance Standards and leases

Sustainability, and energy efficiency, have moved from largely voluntary, market-driven issues to regulatory and compliance issues. This includes the development and implementation of Building Performance Standards across the country. BPS are a new regulatory tool, designed to improve the long term efficiency of existing buildings, by closing the “code gap.”

And because BPS requirements always fall to owners, yet in leased buildings tenant(s) control exert significant control over building performance through utility usage, BPS will require owners and tenants to work together, in ways they never have before. This puts leases - as the contract that defines the landlord / tenant relationship and establishes roles and responsibilities - in the spotlight.

“Traditional leases simply do not meet the regulatory requirements, and practical implications of BPS laws, which is why they need to be revised.”

Building Performance Standards are still relatively new. The first BPS law was implemented in Washington D.C. in 2018. Washington was the first jurisdiction to implement a state-wide performance standard in 2019 with the Clean Buildings Act (HB 1257); Seattle followed with its Building Emission Performance Standard (affectionally known as BEPS) in 2024.

As the name implies, Building Performance Standards set performance (not proscriptive) requirements on buildings. Under Washington state law, “performance” is based on an EUI target (EUIt), the City of Seattle uses Greenhouse Gas Intensity targets (GHGI).

We have heard from the real estate community that leasing-related guidance would benefit the industry, which is why we created this Leasing Best Practices Guide.

In this resource, we share some of the common issues, general best practices, and additional considerations. We are providing this information to help serve communities that have questions and to support broader decarbonization work, which is a key social justice issue.

That said, we need to be clear this general resource is for educational and informational purposes only. It is not legal advice, it does not create an attorney-lawyer relationship, and should not be used as a substitute for competent legal advice from a lawyer you have retained and who has agreed to reprsent you.

Leasing Best Practices

First, building owners will want to figure out whether their building falls under the scope of one or more standards. Buildings in Seattle are, for example, likely to fall under both the state Clean Buildings Act and Seattle’s BEPS.

• Is your building in scope, and which standard(s) apply?

• Is your building in or out of compliance (and if out, by how much)?

• If the building is out of compliance, are any incentives available to reduce costs of compliance?

• What type of lease(s) govern the building, how do they treat key issues, and when do they expire?

• What is the tenant mix and is the project sub-metered?

• Are there any additional goals or requirements that may be related to BPS compliance (i.e. investor or market-driven climate goals, climate reporting requirements, etc.)

Compliance falls to building owners

While Building Performance Standards are not, as the name implies, standardized (i.e. they all have slightly different requirements), one commonality is that their requirements always fall to building “owners.” For example, under the Clean Buildings Act:

“Z3.1 General Compliance. The building owner of a covered building must report compliance with the standard to the AHJ in accordance with the compliance schedule established under Section Z3.2 and every five years thereafter.” (emphasis added).

This is why leases are so important; leases are the contract that defines the owner / tenant relationship; they outline roles and responsibilities. But BPS laws place a legal performance requirement on owners, who largely do not have physical control over tenant spaces or tenant’s use of utilities (which dictate performance). Leases are the link.

Until now, owners had no real reason to care about tenant utility use - they would pass through those costs by baking them into the rent, or having tenants individually pay their own utilities. The shift comes because now owners are very invested in their tenant(s) utility usage - because owners are responsible, real penalties are at stake and those penalties also fall to the owners (for the most part, read on).

Best Practices for Common Lease Provisions and Issues

Below are examples of some of the common lease provisions that may be impacted by BPS compliance, followed by example language or key considerations.

Key lease topics we will cover:

1. Compliance with “All Applicable Laws”

2. Capital Expenditures and Operating Expenses

3. Fines and Penalties

4. Access to Premises

5. Utility use

6. Definition of Premises and Use

7. Data Sharing

8. Default

9. Assignment / Sublease

10. Third Party Certification

Compliance with “All Applicable laws”

As BPS are relatively new, most leases do not even mention their requirements, and parties may hope to rely on blanket provisions like compliance with “all applicable laws.” The problem with that is that these blanket provisions never even contemplated performance driven laws.

Consider clearly defining relevant requirements to include BPS and other climate-driven laws that may impact the asset or the lease.

Ex. consider calling out the specific BPS law and providing the statutory / code section, again leaving flexibility for if/when things change.

Lease structure and the “Split Incentive”

Before explaining cost recovery clauses, it is important to have a quick explainer on the Split Incentive. Traditionally, reference to the Split Incentive has been used by owners as a defense as to why it does not make financial sense to implement sustainability measures that increase efficiency (energy or water) - the owner pays for those capital improvements, but the tenant benefits in the form of reduced utility bills. Pretty simple economics.

Owners have little financial incentive to invest in efficiency upgrades, because they (generally) don’t benefit from lower energy bills (the common areas being a potential exception). Tenants have little incentive to join in investing in building upgrades, because they don’t own the building and cannot capture the long-term value of improvements (they likely will not lease long enough to recoup their investment).

In our view, the Split Incentive defense is significantly reduced in jurisdictions that have Building Performance Standards, because the question is no longer whether owners need to be “incentivized” to perform efficiency upgrades; for buildings that exceed regulatory thresholds, it is a regulatory compliance issue and a legal requirement.

But, some common lease formats address the Split Incentive differently -through their treatment of Capital Expenditures (CapEx) and Operating Expenses (OpEx) so it’s worth summarizing those. Again, these definitions vary, but since these terms always come up in conversations involving the Split Incentive, below is one way to define these lease structures:

Gross lease - tenants presented with an “all in” number they pay each month that includes rent plus some (undisclosed) percentage of operating expenses (the owner pays utilities and passes through a percentage). Because there is no transparency regarding utility usage, and utilities are not tied to actual tenant use (spread across the building) tenants are generally not incentivized to use resources efficiently.

Triple Net - tenant pays specified rent PLUS taxes, maintenance and insurance (the “triple", if you were wondering) and tenant directly pays for utilities. Tenants may be incentivized to reduce utility usage, because their bill is directly tied to use; that said, in many markets, rent is significantly more than utility bills, so efficiency improvements that only translate to small reductions in utility bills may not actually “incentivize” tenants to conserve resources.

Obviously this is a simplification as all leases are different, and there are many different “buckets,” including Modified Gross leases, etc. But regardless of what you call them, owner / tenant dynamics and motivations can be significantly influenced by lease structure.

“For purposes of BPS costs of compliance, the focus should be on transparency and fairness.”

It matters less what the lease is called, and more how the mechanics of the lease impact the parties; specifically, how CapEx and OpEx are treated in the lease - because who pays these costs determines the motivations, and obligations, of owners and tenant(s). This is why it is important to read every lease carefully - it’s less about what the lease is called and more about how the lease treats key issues.

This brings us to treatment of CapEx and OpEx in the lease.

Capital Expenditures

Determine whether Capital Expenditures can include any expenditures related to BPS compliance - this is a tricky one. One approach, to manage the Split Incentive and foster collaboration among owners and tenants, is to clearly state that Capital Expenditures that are for the purpose of compliance with BPS (and reducing utility usage) can be passed through in a fair and transparent way.

For example, IMT’s Model Performance Based Lease Template (July 2021) provides the following sample language; 

OpEx generally shall not include CapEx, except, OpEx shall include…“capital expenditures made primarily to reduce Operating Expenses which costs shall not exceed, over the Term, the reduction realized; provided, all such permitted capital expenditures together with interest thereon at [   ]% per annum shall be amortized for purposes of this Lease over the shorter of: (a) their useful lives or (b) in the case of an item made primarily to reduce Operating Expenses, the period during which the reasonably estimated savings in Operating Expenses equals the expenditures….”

Another example from REALPac Office Green Lease, National Standard Lease for Single-Building Projects (1.05 - 2021).

The Tenant shall pay its Proportionate Share of Operating Costs to the Landlord. Subject to certain exclusions, Operating Costs includes the costs of:

“making alterations, replacements or additions to the Project intended to reduce Operating Costs, utility consumption, and / or Greenhouse Gas emissions, improve the operation of the Project and the systems, facilities and equipment serving the Project, or maintain their operation, or improve resilience of the Project.”

This type of provision is also commonly known as a “Cost Recovery Clause.” Even though BPS requirements - including CapEx necessary to meet performance targets - legally fall to the owner, adding a cost-recovery clause can make the owner/tenant relationship feel more balanced from a cost of compliance perspective.

Below are two more examples of cost recovery clauses from the Institute for Market Transformation’s (IMT) Green Lease Language Examples:

Example 1. “All costs of any capital improvements made to the building that reduce the building’s energy expenses, shall be cost capitalized and hereafter amortized as an annual Operating Expense under generally accepted accounting principles, only the yearly amortized portion of which shall be included in Operating Expenses. In no event shall the charge for yearly amortization be more than the actual reduction in Operating Expenses.” Source: IMT

Example 2. “Landlord may include the costs of certain capital improvements [intended to] [that] improve energy efficiency in operating expenses. The amount passed through by Landlord to Tenant in any one year shall not exceed the prorated capital cost of that improvement over the expected life cycle term of that improvement [and shall not exceed in any year the amount of operating expenses actually saved by that improvement]. Interest/the cost of capital can be included.” Source: GSA (site no longer available)

Applying the above examples, key aspects of a cost-recovery clause, which balances out the impacts of the Split Incentive, are:

• Identification of the types of costs that can be passed through

• Description of how they will be passed through (deemed capital improvements / included in operating expenses)

• Cap on costs or amortization schedule, so that costs are are fair and transparent, given the benefits to the tenant and the lease term

Fines and Penalties

This is probably the most common question we get asked, from both owners and tenants: what about penalties?

All BPS, including the CBA and BEPS include the ability of the regulatory entity to assess fines for non-compliance (circumstances vary). Penalties can be significant; if you want to calculate potential penalties under the CBA, Commerce has provided a penalties estimator.

Many “traditional” leases exclude from OpEx any fines incurred exclusively by the Landlord. For example, OpEx shall not include “fines or penalties incurred due to a violation by Landlord of any Applicable Law…”

This makes sense because it’s not fair for tenants to pay for owner mistakes, unsafe conditions, or negligence. 

Owners and Tenants in BPS jurisdictions may want to clarify whether any BPS-related fines can or cannot be passed through. And if so, what process will be used to calculate individual tenant’s share?

There is one interesting wrinkle where the City of Seattle has developed a pathway to directly fine tenants, but only in the context of failing to provide data (more on that below).

Access to Premises

BPS requirements mean that owners may need to access tenant spaces more frequently than in non-BPS jurisdictions; to perform repairs, conduct testing, install or check sub-meters, inspect the cause of performance issues, etc.

This is also a key consideration for Healthy Buildings, in the context of IAQ sensors, etc.

Owners may want to include a broader right to access the Premises to read or maintain submeters/sensors, perform upgrade work, inspect potential issues (i.e. Use)

Utility use

To meet performance targets, particularly in large, multi-tenant buildings, owners may want or need to set “energy budgets” for individual tenants.

Energy Budget Example

Landlord shall provide Tenant with a calculation of its maximum allowable energy consumption within the Premises (“Tenant’s Maximum Consumption”) and an associated fee for Tenant’s consumption of energy above Tenant’s Maximum Consumption, which shall be measured by Landlord in its commercially reasonable judgment on a pro rata basis (“Tenant’s Excess Usage Fee”).  In the event Tenant’s energy consumption in the Building exceeds Tenant’s Max Consumption, Tenant shall owe the Tenant’s Excess Usage Fee to Landlord as additional rent.  

As another example, Rocky Mountain Institute has made the Boulder Commons (Net Zero Energy) lease available. This is obviously in a different context, but NZE and BPS share many common performance-driven aspects; the lease is from 2017 and heavily redacted, but it is an interesting case study.

If setting an energy budget based on square feet, also consider tenant “Use” of the space (budgets can and likely should vary based on tenant Use, not just square footage), described in the next section.

Definition of “Premises” and “Use”

The Premises should always be clearly defined in a lease, but particularly if setting an energy budget that is tied to the tenant’s square foot calculation.

Ex. triple check the square foot calculations. Tenants will want to make sure they have actual control over the spaces they are deemed responsible for.

As noted above, consider any impacts of Use, or balance of tenants, if some are expected to be high utility users.

In some instances, owners may need to reasonably limit use, or be very clear on what the Premises can be used for (including if sub-leased).

Ex. Owner may want to reserve the ability to “reasonably” limit resource-intense activities or otherwise place certain limits on tenant’s Use, to correct compliance issues, with carve outs that these restrictions cannot significantly impact the tenant’s business operations.

Data Sharing

Data is the new sustainability currency. And setting an energy budget is pointless if owners and tenants don’t have the data they need to understand their usage and comply. An increasing number of tenants are also looking for whole building or at least common area usage, to confirm that owners are operating the entire building in an efficient manner or for other corporate reporting requirements.

Owners also need building-wide data to benchmark their building and comply with the applicable performance standard. It can be difficult (if not impossible) to comply with the CBA or BEPS if they cannot access tenant utility data, so a couple points about this challenge:

Washington state law 

19.27A.170(8) For any covered Tier 1 commercial building with three or more tenants, an electric or gas utility must, upon request of the building owner, provide the building owner with aggregated monthly energy consumption data without requiring prior consent from tenants.

If a building has three or fewer occupants, building owners likely need to secure permission from account holders to authorize release of data - leases are a great way to obtain and confirm this authorization.

Seattle Municipal Code

Chapter 22.925.130.B.  Unless otherwise restricted by state or City regulations, tenants shall allow building owners access to mechanical systems and utility information as necessary to comply with the terms of this Chapter 22.925.

Owners can help avoid administrative headaches by updating leases to clarify data format, cost sharing, confidentiality, quality assurance, and other tenant data considerations.

It’s a stickier issue if an owner needs de-aggregated data to understand which tenants may be causing the problem. Put another way, whole building data is one thing, but if a building is out of compliance, owners need to understand how individual tenant use may be impacting overall building usage. This is where sub-metering and energy budgets (above) can make the difference.

Perhaps in response to owner complaints or concerns regarding obstreperous tenants, there is also a specific call-out in the Seattle Municipal Code, to address owners who cannot get tenant data. The city can directly fine these tenants:

Chapter 22.925.180.B

B.If the Director determines that a tenant has failed to allow access to mechanical systems or provide utility information to a building owner as required under Section 22.925.130, the Director may, in addition to any other remedy authorized by law or equity, impose a fine on the tenant as follows….

And for multi-family buildings, data privacy for residential tenants is an even more challenging issue, which is why we recommend that multifamily owners start now by assessing their lease templates and working collaboratively with tenants. If you have specific questions, we can help.

Default Provisions

All commercial leases contain clauses related to default, which address important issues like failure to pay rent or maintain insurance. 

Performance-based issues can be tricky, because tenant usage could vary seasonally or for other tenant-driven reasons (for example, high occupancy during key sales cycles).

To accommodate for fluctuations, owners and tenants may want to also consider creating a separate type of default for these performance-based issues, which can help reinforce some of the collaborative aspects of performance-based leases.

That said, there’s a balance - we generally want BPS requirements to be treated like the compliance issues they are, and if a party is in default, they are in default. That said, owners and tenants may want to consider a separate “Green Default” provision that mandates a limited meet and confer requirement to (hopefully) quickly resolve more minor issues (and catch them before they become “major” issues).

Some common characteristics of a “Green Default” provision:

• Parties acknowledge a shared goal (Certification, Net Zero, Performance metric)

• In event of issues / deficiencies related to those shared goals, discovering party will timely bring to other party’s attention

• Owner will provide timely and specific notice; tenant agrees to timeline to respond and/or meet to address the issue (technical experts may also need to join, i.e. commissioning professionals, certification expert)

• Hopefully the parties work it out; if they are (1) unable to resolve the issue after a certain time, (2) if the tenant simply fails to respond, or (3) if the tenant does not implement agreed remediation measures, the standard Default provision is triggered.

In addition to performance requirements, Green Default provisions can also work well for other sustainability goals that may fluctuate or require some training, such as composting, janitorial issues, etc.

Assignment and Sublease

If tenants have the ability to assign or sublease, utility budgets, Use restrictions, and related provisions need to flow through to any subleases or assignments.

Ex. be sure to include any “Use” restrictions, Access to Premises provisions, etc., in subleases.

Owners and tenants with embodied carbon goals may also want to outline some restrictions on embodied carbon impacts for large Tenant Improvements. Some example language can be found in Willow’s Clause, from the Chancery Lane Project.

Third party certification

If third party certification (i.e. LEED) is important to a tenant, and the owner has agreed to pursue or maintain certification, tenants may want some written agreement, and / or some financial penalty if the owner is ultimately unwilling or unable to achieve certification. This could happen if certification became difficult and costly, and an owner wanted to abandon the effort, but the tenant’s stakeholders wanted or required leasing in a certified space.

If a tenant is relying on the owner pursuing certification, consider some type of tenant allowance (if in the TI phase) or payment if certification is not achieved.

Other Considerations

The above outlines general lease provisions that may be impacted by building performance standards. Below are a few additional considerations:

—> Play the long game. Most jurisdictions have been clear that the first targets are only a starting point; Seattle has specifically stated this with the graph at this link (image at right). Especially when considering expensive Capital Improvements, play the long game and make those investments count towards future compliance requirements. And try to account for these requirements in leases, as most leases will last longer than the review cycle for performance standards (i.e. both the Clean Buildings Act and BEPS have 5-year compliance cycles).

—> Don’t leave money on the table. Incentives are available from various sources; a few key resources:

• Tier 1 Early Adopter Incentive Program: Tier 1 Early Adopter Incentive guidebook (PDF).

• Tier 2 Early Adopter Incentive program: Tier 2 Early Adopter Incentive program guidebook (PDF).

• The CBPS grant and incentive webpage has lots of information about funding opportunities.

—> Don’t wait. “Waiting for the litigation” is likely not an effective strategy. While litigation has been filed against building performance standards in other states/localities, that litigation has largely been unsuccessful. You can look up the status of climate litigation, including BPS litigation, using this free tool.

—> Look for synergies. If you are going through the effort of revising a lease or a lease template, consider how your lease may align with other goals or requirements. For example, the latest version of LEED, LEED v5, provides up to 6 points under the Green Leases credit (BD+C, Core and Shell, IPc2). If a project is pursuing both CBA or BEPS compliance and LEED v5, consider whether lease updates meet both requirements.

Resources:

Free, industry resources are available below.

Institute for Market Transformation:

• Building Performance Standard Resources

• Getting Started with Performance Based Leasing

• Green Lease Language Examples

BOMA International: Green Lease Guide

REALPac Office Green Lease: National Standard Lease for Single-Building Projects

Where can I get more help and information?

In addition to the resources linked above, we support clients who need their leases reviewed and revised for BPS compliance, strategic guidance, and other issues. We have several options options, depending on client need and budget, including flat rate, hourly, and subscription services, as well as a more discrete lease review to analyze and assess potential exposure and options.

DISCLAIMER: this blog post / resource is provided as a free resource to communities who need information on these topics. It contains general information, for educational and informational purposes only. It is not legal advice, and is not a substitute for retaining a lawyer in your jurisdiction to address your specific needs. Every project and every lease is unique and the law is inherently fact specific. General information, including this blog, should not be used as a substitute for competent legal advice from a lawyer you have retained and who has agreed to represent you.