Debunking the Myth of Split Incentives – A Focus on Mutual Benefits of High Performance Improvements
We have all heard the excuse: Landlords argue that they are disincentivized to invest in high performance improvements for their buildings because the tenants would enjoy the benefits that the reduced operating expenses would create. Yet these very same landlords seldom hesitate to spend significant dollars on making aesthetic upgrades to their lobbies and other common areas. There isn’t a single dime that the landlords recover from their existing tenants because of the funds spent on these projects. The objective is clearly to make their properties more attractive to potential new tenants and to position them to retain their existing tenants.
So, what’s the difference between installing a shiny new lobby vs. replacing an old, balky chiller with a new high efficiency model that will not only reduce operating expenses, but also measurably reduce the carbon emissions of the property? Absolutely nothing. In fact, it might actually be the case that existing and prospective tenants would prefer that the landlord make the high-performance investment since that would support the fight against climate change, a trend that is growing in importance for tenants. Locating their offices in a building that can demonstrate actual carbon reductions would figure favorably in their calculations if this corporate goal is achieved.
The Benefits of Property Improvements for Both Property Manager and Tenant
There are other immediate benefits that the landlord realizes from high performance investments. The landlord will save money since these investments will reduce the costs the landlord is responsible for in vacant spaces. It will reduce the base year costs for all new tenants, thereby increasing the landlord’s profit margins. This margin is further enhanced if the landlord raises its base rental rates because the building is now greener than its competition, and therefore more attractive. It might also encourage existing tenants to stay since it demonstrates the landlord’s commitment to operate the building efficiently by implementing best practices. This serves to reduce the tenant’s cost of occupancy by controlling the growth of operating expense escalations. Based on the likely pay-back periods of 3–7 years for most such high-performance projects, the resulting cost savings would create an increase in overall property value. Using the low cap rates prevalent in the market today, the increase in value would far exceed the invested capital.
Let’s not forget the growing incidence of legislation that mandates carbon reductions, with fines and penalties levied against buildings that don’t measure up. According to the Institute for Market Transformation (IMT), there are over 30 state and municipal entities across the nation which have some sort of legislation already in place, with many others contemplating similar action. You may have heard about New York City’s new climate action regulations during IREM’s Energy & Sustainability webinar in April (https://vimeo.com/424814027). The fines are substantial for those buildings that fail to reduce their carbon footprint significantly over the next 4–10 years.
Overcoming the Split Incentive
Besides, there are tools available to help overcome the dreaded “split incentive”! The Department of Energy and the IMT have developed a green lease that incorporates verbiage allowing a landlord to recover capital investments to the extent that cost savings are realized. IREM and other industry groups have resources that landlords can use to educate and inform tenants on the benefits of supporting sustainability initiatives. This would pay additional dividends because tenants who are engaged in the process can help address the 40-60% of a building’s overall energy use attributable to tenants’ direct consumption. See how IREM® can help equip you with the tools needed to future proof your properties, overcome the split incentive, and learn about our education and certification programs please visit https://iremnyc.org/
About the Author
Nicholas E. Stolatis, CPM®, RPA, LEED-AP BD&C
Nick is a principal of EPN Real Estate Services, Inc., a property management, leasing and development firm in Westchester, NY. He spent the majority of his career at TIAA, ultimately as Senior Director-Global Sustainability and Enterprise Initiatives where he created the company’s award winning Global Real Estate Sustainability Initiative and supported their Corporate Social Responsibility and Impact Investing platforms on a domestic and international level.
In addition to being treasurer of IREM NYC, Nick is active with a number of major real estate education and advocacy organizations. He is also one of 19 subject matter experts from around the world selected by the World Bank’s International Property Measurement Standards Coalition (IPMSC) to serve on the Standards Setting Committee. Nick currently teaches at Fordham University’s graduate program in real estate. He has lectured, moderated and presented on numerous panels for a variety of industry groups, and authored several articles and a white paper on industry related matters.
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