New York City’s Split Incentive “Trifecta”

By: Elizabeth Stein, EDF Attorney

Today, New York City is pioneering a new solution to the long-studied problem of the “split incentive” that prevents commercial landlords and office tenants from saving money and cutting pollution with energy efficiency.   This is not just an academic exercise – the solution will be rolled out in the heart of Manhattan, at the Gold LEED-certified 7 World Trade Center site, and modeled in the government’s own leases across the city.  This can be a game-changer for energy efficiency nationally.

Energy efficiency is the fastest, most cost-effective way to reduce greenhouse gas (GHG) emissions in the United States. Americans waste an extraordinary amount of energy in inefficient buildings – and that means we’re wasting money too. In New York City, buildings account for a staggering 80% of the city’s carbon emissions and $15 billion in energy costs.  Applying today’s technology, many buildings could cut energy use by between 20 and 40% through investments that have the potential to pay for themselves.  Investments in energy efficiency will reduce greenhouse gas emissions, lower energy costs, and create jobs when we need them most.

Today’s commercial leases, however, stand in the way of unleashing that savings stream –  hence the split incentive conundrum.  Why would a landlord upgrade a building’s energy systems if the cost savings accrue only to the tenant?  Something as simple as the way a lease is drafted can block access to the cheapest and fastest way to solve air and climate pollution.

To solve this problem,  Mayor Bloomberg’s administration teamed up with EDF, NRDC, NYSERDA, real estate consultants HR&A and Cycle-7, and senior real estate attorney, Marc Rauch, among others, to reinvent the commercial lease in a way that lines up the incentives so that landlords and tenants will want to upgrade their buildings and cut waste.  The new lease language is simple, straightforward, and can be used by any commercial building, anywhere.

The basic idea is to realign the business deal on energy costs, so that both landlords and tenants are motivated to stop wasting energy.  Under the new lease announced today, part of the cost savings from energy efficiencies are made available to pay for upgrades to cleaner technology.  Tenants save money and buildings end up with newer lighting and heating and air conditioning systems that cost less to operate.  The new lease also solves a tough measurement and verification challenge by applying an easy-to-understand discount to the upfront cost-savings projections obtained by a landlord’s engineer, in order to protect against variances between cost savings projections and realities over time.

By changing the business deal between landlord and tenant, the lease structure announced today creates a way to save money, cut pollution, and modernize building systems.  It’s the ultimate win-win for New York City’s commercial landlords, tenants – and for any of us who breathe the air in a city with lots of power plants.  I think of this as a split incentive “trifecta:” it’s being adopted by the private sector in a true market transaction at the World Trade Center site, the City itself is committing to use the approach in leases where it is a tenant, and the Real Estate Board of New York (REBNY), New York City’s leading real estate trade association, is speaking favorably about the solution.

This is a great example of what can happen when government, advocates, and the private sector roll up their sleeves together to solve a problem.  This forward-thinking business deal serves as a model for every commercial building in the country.  Help us spread the word, and let’s see if we can use this to open up the marketplace for energy efficiency globally.

For more information, please see the City’s Energy Aligned Lease fact sheet and model language.