With the alarming statistic that real estate is responsible for around 40% of all carbon emissions in the UK and 2050's net-zero carbon target edging ever closer, attitudes towards environmental issues in the property sector are evolving.
Sustainability is now high on the agenda for responsible owners and occupiers, who realise that if we are to meet targets and effect change we need to look beyond basic green lease clauses. These innovative thinkers are considering how to make their portfolios more sustainable, and one of their targets is the economic and environmental impact of conventional reinstatement practices.
Commercial leases in the UK traditionally require tenants to reinstate premises at the end of the term, removing any alterations or additions and making good. There may be caveats, conditions or carve-outs where certain fixtures and fittings are agreed to be left as they are, but the most common position is that the tenant must hand back the premises without any of its alterations or additions. The intention is that a reinstated space should be easier to re-let, reducing costs and delays for the landlord or the next occupier and minimising void periods.
But suppose a tenant is required by the lease to carry out reinstatement works even where this makes no sense in terms of sustainability? Or the works are made obsolete by the plans of the owner or next occupier? The occupier may even be carrying out works in accordance with its obligations only for these to be duplicated or altered by the owners – for example, reinstating inefficient lighting systems that will then be removed by an owner so they can install LEDs instead.
Owners and occupiers are now trying to address these situations and to find a way to deal with reinstatement obligations more sustainably.
We should of course note that a financial settlement is often agreed in lieu of reinstatement liabilities, and this can go some way to avoiding duplication of works and wasting materials, and that the traditional approach may still work in certain circumstances.
However, reinstatement is still a fairly blunt tool. There are undoubtedly times when it is less appropriate and may result in good, or at least serviceable, alterations being removed, or works being duplicated regardless of the financial and environmental costs. This wastefulness is at odds with the shift towards sustainability.
Responsible companies are looking not only at how they run their own businesses but also how they manage their portfolios as owners and occupiers, their supply chains, and their service procurement methods. In a time when social media can swiftly build or damage a corporate reputation and employees and consumers have increased expectations, it is a brave business that does not at least pay lip service to environmental, social and governance issues.
Attitudes towards sustainability do of course vary; some see it as an economic necessity, driven by the need to keep customers and investors happy; some as a good thing to do; and others consider it a core part of their business practices. But how is the shift being reflected in practical terms?
We are hearing about green premiums being placed on the rental and capital values for more environmentally friendly buildings, which are often easier to let and should in the long term retain their value better than less sustainable sites. In fact, it is predicted that owners of less sustainable buildings will suffer so-called brown discounts on capital values and struggle with lower and slower letting rates.
Given that consumer are only likely to move towards more sustainable behaviour – and regulation will encourage this – it seems inevitable that a considerable differential will open up between green premiums and brown discounts.
Rather than reinstating, the outgoing tenant will be able to leave behind some alterations and additions that can then be used by the next occupier.
For example rather than doing a full strip-out, an occupier vacating a retail unit can leave behind flooring, lighting and finishes in good condition. This would not only save the outgoing tenant money as its strip-out is limited, but the landlord might also find premises easier to let, while the incoming tenant saves the cost of a full fit-out as well.
We are also seeing that fit-outs are beginning to prefer a less-is-more approach, with more exposed brickwork and plant for instance. Again this means that reinstatement obligations should be much less significant than for fully fitted-out premises.
There is clearly a trend towards considering the environmental as well as economic cost of reinstatement. It seems inevitable that this will continue, due to changing occupier and investor expectations, greater attention to both the environment and the preservation of capital, and increased regulation and controls.
'It seems inevitable that a considerable differential will open up between green premiums and brown discounts'
The starting point for understanding an occupier's reinstatement obligations is to look at their lease and any licences for alterations or other relevant documents. Having done so, some innovative clients are seeking advice on changes they can make to the terms of their leases, including the reinstatement provisions.
First, we are seeing agreements to prescribe at the start of the lease some or all of the reinstatement works and other terminal liabilities of the tenant. This could be by way of a confirmed figure for reinstatement costs in lieu of dilapidations, or rate per square metre, possibly combined with the rent or in the form of premium payment spread across the term of the lease.
The effect of such arrangements is that what works are actually carried out at the end of the term is at the discretion of the landlord, under whose control they remain. This also enables tenants to minimise the cost of leaving the premises, and to calculate the cost of the full life cycle of the lease from the start. Second, commercial property advisers are drafting provisions whereby the occupier is not obliged to reinstate the premises if doing so will adversely affect its energy performance. Sometimes this provision might include a caveat allowing the landlord to override it where reasonably required for proposed reuse or reletting.
Alternatively, occupiers may be able to leave the fit-out as far as it serves a sustainable purpose. We are seeing specific carve-outs in this regard; for example, not requiring the carpeting to be replaced at the end of a lease unless it is necessary, or having tenants agree a price for it so that they satisfy their liability to reinstate but without unnecessary and wasteful replacement.
Third, some landlords are requiring that occupiers covenant to use the property as sustainably as possible. Tenants are also now asking owners to give reciprocal assurances about how they operate, not only during the lease but at the expiry and reinstatement stages. While this is asked for less frequently than the occupier’s covenant, we expect it to occur more often in future.
We predict that tying tenant obligations to sustainability criteria and limiting or setting a cash value for reinstatement is likely to become more common. All-inclusive leases look set to become more popular, where reinstatement is at the tenant's cost, spread across the lease term and at the landlord's discretion. We also expect more intelligent reuse of premises, fixtures, fittings and furniture.
Overall, as with so much in real estate, we anticipate the need for greater communication and cooperation between occupiers and owners as 2050 approaches, to enable all parties to achieve their environmental goal
Related competencies include: Legal/regulatory compliance, Strategic real estate consultancy, Sustainability