Commercial Investment Real Estate March/April 2013 - Page 38

year. T e landlord recoups all of its costs in 12.5 years and owns a system that’s still got about the same length of life remaining. Fur- thermore, af er the tenant vacates, the build- ing’s inclusive costs of occupancy have gone down, making it a more attractive rental. CAM Expenses Charged to Tenants. Numerous commercial leases require tenants to reimburse the landlord for common area maintenance costs, which could include envi- ronmental upgrades. For example, replacing obsolete T-12 f uorescent tubes with T-8 lamps can provide 40-watt illumination with 22 watts, a savings of 45 percent of the electrical cost with some additional savings in air con- ditioning since less heat is produced. Same as in the triple net lease example above, the landlord can replace the old lighting when it chooses, as long as tenants are protected by an engineering opinion on cost recovery and the same simple payback formula. As in the triple net example, the tenants’ day-to-day expenses are reduced or will not increase above what they would have other- wise paid. T e landlord reaps the long-term benefits of newer equipment — delayed bulb changes and ballasts replacements and reduced air conditioning use. Gross Leases. In gross leases without pass- through cost increases, the landlord pays all of the utilities, so it’s benef cial to replace equipment whenever there is a net savings of utilities over the amortized replacement costs. However, to calculate return on invest- ment, the landlord must determine the cur- rent usage standards. For example, experts can install measuring devices over long peri- ods of time to determine illumination needs during times of day and seasons, measure the workday air balances and air quality (volatile organics and CO 2 levels), air tempering, and shading needs from beginning to end of the work days and under various outside climate conditions. But tenants may object to electrical engi- neers or HVAC technicians probing their ceilings during working hours. In fact, some tenants may object even to work done on weekends or evenings because it disrupts their business hours or is considered a security risk. To solve this issue, leases should have a broad cooperation clause allowing reason- able access to landlord’s representatives and experts at any time during the term to analyze and upgrade and not just to repair systems. While all f nancial returns accrue to the landlord, tenants have reduced risk of equipment failure and enjoy modern advances in lighting or HVAC. Also, the car- bon footprint, water consumption, or sewage burden is reduced. Modified Gross Leases. With tenants paying increases in operating charges over a base year, it is always in the landlord’s inter- est to make capital improvements when reduced operating charges will exceed the investment. For example, replacing working metal window blinds with insulating double-lay- ered cloth blinds reduces natural gas used for heating and electricity used for cooling. T e new shades have a 20-year life and cost $70,000. T e mechanical engineer provides a detailed opinion that yearly costs for natural gas for heating and electricity for air condi- tioning will decline by about $6,000. If savings from reduced heating and air- conditioning use are dif cult to estimate with precision, use the EAC method here and do a payback schedule over the shortest time that would result in not charging more than 80 percent of the yearly savings. With an amortized cost of $4,800 per year with a $6,000 utilities savings, a tenant’s portion of the passed-through increases are actually reduced by its share of the $1,200 annual savings. In those spaces where ten- ants are still below the base-year expense level or in vacant spaces, the landlord would reduce its expenses based upon the total building savings of $6,000 per year. When the Lease Is Silent Without permissive lease language, a land- lord must obtain the tenant’s approval. Our practice has shown that this is best done through an assumptive close. When sending the annual pass-through statement, attach a spreadsheet showing detailed operating costs in comparison to those of the base year and list the amortized amounts of capital investments that reduce those expenses. These expenses are foot- noted for each item. T e property manager also calls the tenants and explains the ratio- nale and what they gain. In multitenant buildings, a few holdout tenants should not scuttle your improve- ments since the reduced f nancial savings combined with the intangible benefits of newer equipment and higher tenant satisfac- tion from better HVAC or lighting could still justify upgrading. For small, private investors competing against deep-pocket institutions, it’s hard to f nd attractive new properties at the right price. However, money invested in upgrad- ing equipment in your existing buildings will of en yield higher returns than new projects. An environmentally responsible property is more competitive and more attractive to ten- ants both new and old. And, it’s just the right thing to do. Miles Schlosberg, based in Anchorage, Alaska, is involved in commercial real estate develop- ment, construction, and investment in Alaska, Florida, and Washington state. Contact him at Carl D. Kuhn, CCIM, is a broker with Jack White Commercial in Anchorage. Contact him at The authors thank Gordon Timmerman; John T. Moore; Brian Player, PE; Mark Miller; and Brian Schmid, PE, for their assistance. RESOURCES • New York City’s Model Energy Aligned Clause is explained in detail at • Building Owners and Managers Association International’s Guide to Writing a Commercial Real Estate Lease, Including Green Lease Language is a helpful discussion of some of the pitfalls involved in charging tenants for capital improvements that reduce operating expenses. Go to and click on “Sustainability.” March | April | 2013 Commercial Investment Real Estate