Squabbles between landlords and tenants are nothing new. But the unprecedented pressures that efforts to reduce carbon emissions are putting on both parties may just be serious enough to make working together the only option.
That, at least, is what a group of commercial property REITs and their tenants set out to do during a forum at a ritzy hotel in downtown Toronto this month.
Put on by First Capital REIT, the event brought together commercial landlords — including Choice Properties REIT, Crombie REIT and CT REIT — and some of the biggest retail tenants in the country — among them Canadian Tire Corp. Ltd., Dollarama Inc., Loblaw Cos. Ltd., Empire Co. Ltd.’s Sobeys, Bank of Montreal, Royal Bank of Canada, Bank of Nova Scotia and TD Bank — for a solutions-focused discussion about the decarbonization of retail buildings in Canada.
Real estate’s role when it comes to meeting the ambitious emissions reduction targets required to combat climate change and to collectively get to net zero is hard to overstate. The construction and operation of buildings contribute the largest chunk of global energy-related greenhouse gas emissions at 40 per cent and, according to the federal government, buildings alone were the third-largest source of emissions nationally in 2020, coming in just behind the oil and gas industry and transportation.
For commercial property landlords, one of the long-standing questions is whether tenants are prepared to pay more in order to reach sustainability goals. Quantitative evidence around a “green premium” is sparse, although anecdotal signs and initial research indicate that tenants are increasingly willing to pay more rent for top-performing buildings, justifying the investments needed to adopt the most carbon-efficient systems.
Still, cost responsibility is a key area of contention between landlords and tenants, especially when it comes to existing leases.
“We have recently come to the realization that no one can attain these ambitious targets and goals by themselves,” Jordan Robbins, chief operating officer at First Capital REIT, said in an interview. “So it’s all well and good if we, First Capital, are motivated to try to reduce our carbon footprint and carbon emissions to ultimately get to net zero. But if we’re motivated and the tenants are not, it won’t matter, because we won’t be able to move the needle enough.”
While landlords control big picture systems within a building, such as electrical, heating and ventilation, many factors depend on the tenants themselves, including choices of lighting, energy-consuming equipment and behavioural patterns.
Each tenant also faces challenges specific to their industry. Major grocery chains, such as Loblaw, for example, must keep significant stores of product refrigerated at all times.
“For our direct emissions, electricity and refrigerants are the biggest contributing factor,” Alain Brandon, vice-president of government relations and corporate responsibility at Loblaw, said in an interview. “That’s where a ton of our focus is on — getting our electricity usage down, becoming more efficient as a company and also refrigerant conversions in our stores…. For new stores, our focus is getting zero-emission type refrigerant systems like CO2.”
Among the hurdles the sides face are older lease documents, especially those that were agreed to more than a decade ago, which can restrict a landlord’s ability to modify the tenant’s space.
“For example, if we were to do certain works that may reduce their utility costs, they could argue — notwithstanding that they get the benefit — that they’re not responsible for any of the costs pursuant to many of those lease documents,” Robbins said.
How to split the costs fairly in those situations and settling on what is important to both sides becomes the challenge.
“How can we modify leases to the extent required to make it so that it’s fair and equitable?” Robbins said. “And that both the landlord and the tenant bear a portion of the burden of the front-end costs given we will all benefit in the long term?”
So-called green leases are a solution that has helped some stakeholders and tenants find common ground.
In 2008, the Real Property Association of Canada (RealPac) drafted Canada’s first National Standard Green Lease.
How can we modify leases to the extent required to make it so that it’s fair and equitable?
Jordan Robbins, chief operating officer, First Capital REIT
“Green leases provide a vision for those shared responsibilities over long periods,” said Darryl Neate, vice-president of ESG at RealPac. “They address topics in areas of sustainability as well as health and well-being.”
A committee of sustainability experts, lawyers and space planning specialists as well as professionals with the LEED (Leadership in Energy and Environmental Design) accreditation conducted research around the world in order to customize a green lease that could be used in all Canadian provinces. The most recent version was updated in 2021.
Although Neate believes that most landlords and tenants are aligned around sustainability targets and best practices for commercial spaces, there are instances where smaller firms operating with greater financial constraints may have different targets.
“Leases are long-term documents that turn over fairly infrequently. So, in the instances where a landlord takes a leading approach around sustainability, there can be a little bit of a conflict with the expectations of those firms,” Neate said.
For those who have long-term leases that pre-date many of today’s environmental concerns, other solutions are needed.
Jon Douglas, director of global sustainability in corporate real estate at the Royal Bank of Canada, said landlords and tenants need to pro-actively come to an agreement that is in the best interest of both parties, without having to use a lease clause.
“We can’t wait for our lease renewals to put a green lease in to get what we need to get done,” Douglas said. “We’ve signed five-, 10-, 15-year leases. That’s a long time out.”
Douglas said RBC has initiated engagement programs with its landlords to accelerate the process.
“We’re reaching out to them because we understand what they’re facing from their partners on the pension fund side, the institutional money that’s feeding into real estate, they have to respond to those targets,” he said. “We all are collectively on this journey.”
While many in the industry acknowledge they are still in the “early days” when it comes to divvying up the financial responsibilities between stakeholders and tenants, there is growing urgency to find solutions, in part driven by investors, who Neate said “are playing a strong role in accelerating the conversation around net zero.”
Investors in the real estate sector are particularly aware of the importance of ESG initiatives. The 2019 PERE ESG Investor Survey found that 70 per cent of institutional investors have an explicit ESG policy in place, and 95 per cent of respondents report that ESG principles play a role in their investment decisions.
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Real estate investors also want to ensure global standards are being met through groups such as the Science Based Targets initiative (SBTi), which helps businesses chart a path to their climate goal and to track progress.
In July, Choice Properties Real Estate Investment became the first Canadian REIT to have its emissions reduction targets validated by SBTi.
Shortly after the forum was held, First Capital REIT announced that its 2030 greenhouse gas (GHG) reduction targets had also been validated and approved by SBTi.
According to FCR, its science-based emissions reduction target is to achieve a reduction of 46 per cent in Scope 1 and Scope 2 emissions by 2030. It has also committed to reduce its Scope 3 emissions by 28 per cent by 2030, and has set long-term emissions reduction targets with the SBTi in line with reaching net zero by 2050.
“The overarching theme is that it is imperative to set that target. Without setting a target, you can talk ad nauseam and not move the ball forward,” Robbins said. “I think that a base target, in line with international targets, are critical for us to advance and frankly, I think the retailers and our retail landlord peers see it the same way.”
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