The place of green leases in retail

WHAT SIGNIFICANCE WILL THESE AGREEMENTS HAVE IN RETAIL PROPERTY IN THE FUTURE AND HOW CAN THEY BENEFIT OCCUPATIONAL RELATIONSHIPS?

WHAT IS A GREEN LEASE?

While there is not an internationally standardised model of classifying leases as ‘green’, they are broadly understood to refer to a lease or supplementary agreement that includes clauses intended to help manage and improve the environmental and social performance of a building. Green leases are predominantly about a landlord’s desire to reduce their Scope 3 emissions; those outside of their direct control and related to tenant activity. They are intended to influence improvements to energy usage and waste, which if not combatted can negatively impact on a landlord’s ESG credentials, as well as those of the occupier.

Green leases vary in their objectives (see box), but the key components typically require:

1. A declaration of commitment by both the landlord and the tenant to operate the building sustainably. This includes things such as reducing energy consumption, emissions, resource and waste.
2. An agreement in place that sustainability data will be shared in both directions to facilitate optimal performance.

A green lease can do much more than just improve environmental performance and manage compliance. Using data collection, it has the potential to enhance an organisation’s reputation through benchmarking, improve the wellbeing of the building’s occupants, attract and retain talent through shared core values, and provide assurance for tenants that their ESG priorities will be met.

WHO BENEFITS?

It has been found that the majority of an average commercial building’s greenhouse gas emissions and environmental impacts come from tenantoccupied areas. Therefore, the best way to reduce negative impacts and improve the efficiency and productivity of the whole building is through collaboration between tenant and landlord. Retail tenants with their own ESG policy are likely to want to make improvements anyway, although that doesn’t mean tenants will automatically be compliant.

As well as having their own challenges in reaching a net zero future, retailers continue to face major headwinds that significantly reduce profitability, not least the fact that more than 90% of their emissions are often associated with manufacture, logistics and storage rather than their actual shops. A more environmentally friendly fit-out of their store may have a high cost, but in turn reduce the cost of operating the space; yet the environmental performance of stores might not be at the top of their priority given the investment required to reduce the carbon footprint of their Scope 3/supply chain. Tenants with business rates or service charges may also see this as another financial burden that benefits the landlord more than the tenant.

Green leases have the potential to create advantages for both parties, turning a historically transactional relationship into a supportive and collaborative dynamic, with both parties working collectively to tackle a long-term issue and improve the performance of a building through fostering better communication and providing a platform for discussion.

IMPLEMENTATION REQUIRES COOPERATION

With the occupational market as it is, landlords might, despite best intentions, lack the leverage to install green clauses into new leases should the retailer refuse to agree to them. A landlord’s success rate of implementation could vary significantly by location. Adding these clauses into existing leases could prove even more challenging, particularly when dealing with a multi-tenanted building with different lease lengths. Beginning a process to change the lease of some tenants and not others will have implications for service charges, which are difficult to manage. Furthermore, the protections provided by the Landlord and Tenant Act 1954 mean that lease renewals must be provided substantially on the same terms as the existing lease, making the introduction of new green lease clauses impossible.

Just how legally binding green leases are remains to be seen. In many cases it might prove to be more about providing a framework within which the landlord and tenant agree to behave. Or perhaps the obligation to co-operate is legally binding, whereas the actual outcome is not. Some of the terms point more to a responsibility to act in as sustainable approach as possible, but the language tends to be flexible on whether this would come at an additional cost to the tenant.

More ambitious green leases might include obligations and targets formalised through Heads of Terms which become legally binding, with a breach resulting in financial penalties or a dispute resolution process. However, even if binding, many ‘green’ clauses may be difficult to enforce. Duties to exercise ‘reasonable endeavours’ and to ‘cooperate’ lack specificity and may not be satisfactorily enforceable in English contract law, and as such are difficult to prove if breached.

Both parties need to buy into the mutual benefits of collaboration. The key obligation from the tenant should be to co-operate with the landlord’s reasonable environmental initiatives aimed at improving the environmental performance of the building, unless this would materially increase the tenant’s costs of operating its business.

WHO IS USING THEM?

With attention on sustainability factors increasing, green leases are set to become the market standard in the UK market, although are not yet commonplace. There is little evidence that green leases have gained any traction in Europe to date.

The Better Building Partnership (BBP) has provided leadership on green leases as a tool to improve the sustainability of existing commercial buildings. So far, the evidence shows they are most likely to be promoted by the landlord and are more prevalent in offices than in the retail sector

However, there are an increasing number of examples where corporate responsibility acts as a key driver for occupiers – such as Marks & Spencer, who has been adopting green leases for some time. Brands that have their own published ESG or net zero strategy will find it hard to try and strike these clauses out of their agreements.

Green leases are moving up the agenda and are now standard at regional shopping centres such as Meadowhall in Sheffield. However, this isn’t the experience seen in other parts of the market. There is a definite push back from many retailers, not least because they tend to result in additional costs. We’ve often seen retail landlords’ clauses being diluted, and what actually ends up in a lease can be quite different to the Heads of Terms - if the landlord is desperate to get the occupier in, they will more readily concede green clauses.

Other landlords may take a harder line, especially the more institutional landlords, given their requirement to adhere to ESG agenda. It’s no coincidence that Savills Retail Agency has secured green leases in deals with major landlords such as British Land, Columbia Threadneedle, Lasalle, L&G, M&G, New River, PGIM and Savills Investment Management (Savills IM). Yet on deals outside of key ownerships or brands, green leases are far less widespread.

So, as is often the case in the retail sector, the most progressive lease arrangements are likely to be within the highest performing locations and those with the lowest void rates. Green leases are unlikely to feature prominently in lower quality retail locations or those under fragmented ownership in the immediate future.

WILL THEY BECOME COMMONPLACE?

We have mixed experiences of landlords getting these through. In our view, both landlords and occupiers can benefit from applying the various types of green lease clauses. If property owners and occupiers are to deliver against sustainability and carbon commitments and live up to the promises made to future generations to protect the environment, it’s clear they need to work collaboratively to achieve substantial improvements in operation and behaviour.

There is little doubt that green leases will become part of standard lease terms rather than something unique. The Savills IM Annual Sustainability Report 2019 revealed that 73% of institutional investors see green lease clauses being universally implemented between tenants and real estate investment managers by July 2029, with an average consensus pinpointing September 2026.

This prediction is only slightly behind claims made by the United Nationssupported Principle for Responsible Investment (PRI) Investible Policy Response project. This project anticipates that governments across the globe will significantly step up their policy responses to tackle climate change from 2025 onwards and notes that compulsory green leases would be a highly effective instrument.

As 80% of buildings standing today will still be in use in 50 years, tackling the sustainability of real estate cannot solely be focused on design and construction of new buildings. It’s imperative that we consider the sustainable long-term use of existing assets and how they’re adapted: green leases are just one tool that will help us reach this goal.