01 Mar 2012

Carbon pricing - what does it mean for the property sector?

by Crystal Eggleton, Peter McMahon

The property sector will be particularly affected by the flow-on effects of the carbon price.

From 1 July 2012, around 500 of Australia's largest emitters will need to pay for their greenhouse gas emissions under the Clean Energy Act 2011. The property sector is unlikely to see any significant direct liability under the Clean Energy Act 2011 because very few, if any, businesses in the property sector are likely to be classified as large emitters. However, the property sector will be particularly affected by the flow-on effects of the carbon price, largely because the property sector accounts for a large amount of the final energy use in Australia.

The property sector will be impacted in two key ways – increased construction costs and a potential impact on profit for building owners.

It is generally recognised that construction costs will rise following the introduction of the carbon price mechanism next year, although there is uncertainty in the market as to how much construction costs will actually rise. However, the property sector consumes a lot of electricity, steel, aluminium, concrete and glass – items that are expected to see sharp price rises as the big emitters liable to pay the "carbon tax" increase their prices to recoup their costs.

I'm not emissions-intensive, so why should I care?

Although operating a commercial building is not sufficiently emissions-intensive to trigger an obligation for building owners to purchase carbon permits under the Clean Energy Act, the carbon price mechanism can still have a significant impact on building owners, particularly for owners of buildings with gross leases where the ability to pass through the costs increases under the lease arrangements is restricted.

For buildings with "gross leases" in place (ie. a lease where the rent is inclusive of outgoings), the building owner will be responsible for costs increases whereas if the rent is not inclusive of outgoings (a "net lease"), the building owners will be able to pass through the increased costs and the tenants will have to bear these costs.

Accordingly, owners and managers should review their existing leases to determine their current liability and, if necessary, commence action to improve their ability to pass through costs by revising contractual provisions to the extent possible. Acting early may prevent responsibility for future cost increases. It may be that the lease provisions permit changes to the lease arising from changes in law. Alternatively, special legislative provisions such as retail leases legislation may prohibit such changes.

What should building owners do before entering a new lease?

Before entering into new leases, building owners should consider:

  • if a "gross lease" is proposed, whether the margins are sufficient to cover the increased costs;
  • the way in which rent reviews will be impacted by the carbon price mechanism, for example, whether fixed increases will be sufficient to offset rising costs or the possibility that market rents are likely to increase more for energy efficient building than non-energy efficient buildings;
  • whether the new lease contains obligations on the tenant to adopt energy efficient and waste management measures to control carbon costs by reducing energy use; and
  • whether the lease allows for increased costs recovery by:
  • deeming carbon permit costs and the costs of any abatement activities undertaken by building owners as recoverable outgoings (it is arguable that theses costs are capital or non-recurring expenses and therefore generally not recoverable); and
  • including a properly drafted outgoings recovery clause.

What should tenants do before entering a new lease?

Conversely, tenants should also consider the following matters before entering into new leases:

  • in the case of CPI-related rent increases, whether the lease addresses an expected carbon price-related inflation spike in CPI;
  • whether the new lease contains obligations on the landlord to adopt energy efficient and waste management measures to control carbon costs by reducing energy use; and
  • in the case of a "semi-gross lease", whether it is appropriate to include a cap on the increases in outgoings in line with the rent review.

With careful monitoring of the above issues, the property sector can manage the flow-on effects of the carbon price mechanism.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.