This blog post is for you if:

• You're a CRE REIT, fund or building owner.
• You want an ROI on building energy projects for your NNN and gross lease buildings,
• You want better buildings and lower energy costs for your tenants,
• You want an ROI on any building energy improvement for your tenants,
• You want to find a way to increase income in your fully leased buildings without having to raise rates for your tenants,
• You want to join other building owners, funds, and REITs that have received over $6,000,000 in efficiency dividends for implementing energy projects and eliminating the split incentive issue between them and their tenants.
  

Reducing tenant expenses is essential in today's commercial real estate landscape. One of the fastest ways to reduce tenant OpEx (especially in NNN and Modified Gross leases) is through energy efficiency upgrades that modernize buildings for your tenants and reduce their OpEx through lower energy costs.

The harsh reality of NNN leases with base years or base stops is the split incentive. Building owners shoulder 100% of project costs while tenants get all the energy savings. Split incentives block nearly every building improvement initiative, even HVAC optimization and LED lighting retrofits that often generate substantial above-market returns. Building owners can't take on projects that offer zero ROI. The result? Building projects don't get budgeted, causing a significant setback for every party involved.

This blog post will explore the NNN split incentive problem and how it affects tenants in commercial real estate leases. We'll also introduce the concept of efficiency dividends, which can help overcome this issue and benefit both building owners and tenants.

What is the NNN Split Incentive Problem?

The NNN split incentive problem refers to the disconnect between building owners and tenants when investing in energy efficiency measures. In a triple net (and modifed gross lease with base years or base stops), tenants are responsible for paying a portion of the property's operating expenses, including utilities. If the building owner invests in energy efficiency upgrades, tenants may benefit from lower energy bills without sharing the cost of the upgrades. This creates a split incentive, where the owner has little financial incentive to invest in energy efficiency upgrades, while the tenants enjoy the benefits.

How Does the NNN Split Incentive Problem Affect Tenants?

The split incentive problem can negatively affect commercial tenants in several ways, including:

• Uncomfortable temperatures, poor air quality, and inadequate lighting negatively impact productivity and well-being,
• High energy bills can limit the resources available for other business expenses, ultimately making the building less competitive for the tenant,
• Outdated buildings make tenants want to lease in different, more modernized buildings.
  

These issues can create a challenging situation for tenants, who may feel trapped in a lease with outdated and inefficient energy systems.

Is there a solution to eliminate the split incentive?

Yes - and it's similar to the cell tower and billboard ancillary income leases you might already be used to. Measured and verified reductions in energy usage can eliminate the split incentive through Efficiency Dividends. In short, breaking the split incentive requires finding a way for the tenant and building owner to realize energy savings without changing the lease structure.

What are Efficiency Dividends?

Efficiency Dividends combined with verified energy savings create a unique financial opportunity for Building Owners to break the split incentive and generate new revenue - just for doing what they're already doing. Both parties can benefit from the building improvements by sharing the financial benefits of energy efficiency upgrades between building owners and tenants. Building owners invest in energy efficiency upgrades and share a percentage of the resulting savings with tenants. The savings share creates a win-win situation, where both parties can enjoy the benefits of energy efficiency upgrades.

Efficiency dividends can:

• Create a financial incentive for building owners to invest in energy efficiency upgrades.
• Improve the comfort and productivity of commercial tenants.
• Reduce energy bills for both building owners and tenants.
• Help CRE firms achieve sustainability and net zero goals and reduce carbon footprints.
  

At Carbon Lighthouse, we specialize in helping building owners implement energy efficiency upgrades and overcome the split incentive problem. Our team of experts works with building owners to identify the most effective upgrades, implement them, and share the savings with tenants. We can create a more sustainable and comfortable workplace for everyone by working together.

What other organizations have used Efficiency Dividends?

It's first worth noting that Efficiency Dividends are a financial product Carbon Lighthouse has used with CRE building owners, REITs, and firms since 2016. Since then, we've issued over $6,000,000 in Efficiency Dividends generated from energy improvements in their buildings.

While we're the first organization to apply the concept to CRE, other institutions regularly use this tool. The International Monetary Fund used this process to drive fiscal efficiency within their country members back in 2008. The parallels between what Efficiency Dividends accomplished for member IMF countries and businesses are striking.

Specifically, Efficiency dividends can help companies in several ways, including:

1. Cost savings - By identifying and eliminating waste, companies can reduce operating costs, increasing profitability and improving their financial performance.
2. Improved productivity - Efficiency dividends can help companies to streamline their operations, reducing the time and effort required to produce goods or provide services. Streamlined operations can lead to improved productivity, higher-quality outputs, and more efficient use of resources.
3. Increased competitiveness - Companies operating more efficiently can offer their products or services at lower prices, making them more competitive.
4. Better customer satisfaction - Efficiency dividends can enable companies to provide better customer service, faster response times, and more reliable products - leading to increased customer loyalty and satisfaction.
5. Environmental sustainability: By reducing waste and improving efficiency, companies can reduce their environmental impact, benefitting the environment and enhancing their reputation with customers who value sustainability.
   

Overall, efficiency dividends can help companies improve their financial performance, increase their competitiveness, and provide better value to their customers while contributing to environmental sustainability.

Efficiency Dividends in Action

Let's take a closer look at how efficiency dividends can work in practice. Suppose a building owner invests in LED lighting retrofits that cost $150,000, resulting in an annual energy reduction of $30,000. Under a traditional NNN or Modified Gross Lease structure, the building owner would be responsible for shouldering the $150,000 LED upgrade cost and not receive any financial benefit from the resulting energy savings.

However, under an efficiency dividend structure, the building owner would receive most of the energy savings, incentivizing them to invest in the upgrades. In this example, the building owner might receive $20,000 annually, with the remaining $10,000 passed on to tenants as lower utility bills.

The Benefits of Efficiency Dividends in CRE with Medical Office Buildings, Hotels, Office and more:

Efficiency dividends offer several benefits to both building owners and tenants, including:

• Financial savings: Building owners can receive a return on their investment in energy efficiency upgrades, while tenants benefit from lower energy bills.
• Improved comfort: Upgraded HVAC systems and lighting can enhance the comfort and productivity of commercial tenants.
• Reduced environmental impact: Energy efficiency upgrades can help achieve sustainability goals and reduce carbon footprint.
• Increased property value: Energy-efficient buildings are more attractive to tenants and can command higher rents and property values.
• Better tenant retention: Tenants are more likely to renew their lease and remain in a building with energy-efficient systems and lower utility bills.
  

Efficiency dividends offer a practical and effective solution to the NNN split incentive problem. By sharing the financial benefits of energy efficiency upgrades between building owners and tenants, both parties can benefit from the upgrades. This solution creates a win-win situation where building owners can improve the value of their property, and tenants can enjoy a more comfortable and sustainable workspace.

At Carbon Lighthouse, we specialize in helping building owners implement energy efficiency upgrades and overcome the split incentive problem. Our team of experts works with building owners to identify the most effective upgrades, implement them, and share the savings with tenants. We also provide ongoing support to ensure the program's success and regularly report on energy savings.

Conclusion

The NNN split incentive problem can make it difficult for building owners to invest in energy efficiency upgrades, which can benefit tenants in the long run. However, efficiency dividends solve this problem by sharing the financial benefits of energy efficiency upgrades between building owners and tenants. We can create a more sustainable and comfortable workplace for everyone by working together.

• Efficiency dividends offer financial savings, improved comfort, reduced environmental impact, increased property value, and better tenant retention. Implementing efficiency dividends requires collaboration between building owners and tenants, and education is crucial to the program's success.
  

Contact Carbon Lighthouse today to learn how we can help you overcome the split incentive problem and implement energy efficiency upgrades in your commercial building.

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