Recent years have seen a stark increase in extreme weather events around the world. In late 2024, unprecedented rainfall led to catastrophic flooding in the Valencia region of Spain, resulting in extensive loss of life and damage to property. The Los Angeles wildfires of January 2025 were another devastating reminder of the extreme risks posed by climate-related disasters. Causing an estimated $30bn (£22.4bn) of damage to residential and commercial properties across 50,000 acres, the impact of the fires and the process of rebuilding will continue for some time.
More frequent and extreme weather events, such as wildfires, hurricanes, flooding and coastal erosion, as well as the deterioration of buildings and infrastructure as a result of extreme temperatures, are anticipated around the world, as the impact of climate change is felt. It is clear the risks posed by these extreme weather events can no longer be viewed as “worst-case” scenarios and that the real estate industry must be proactive in adapting to this new reality.
Insurance
The insurance industry is already reacting. In high-risk coastal areas of the US, for example, insurance premiums are increasing. In some areas, insurers are exiting the market altogether, or providing significantly reduced cover on altered terms. Insurance policies are also evolving, with increasing numbers of exclusions and deductibles. Insurers are imposing new conditions, making cover contingent on certain resilience and risk mitigation works being carried out, including the construction of flood defences and the use of fire-resistant materials.
The widening insurance protection gap has prompted some governments to legislate. Italy has recently joined Spain and France by introducing a new law requiring businesses to put in place mandatory climate insurance to cover damage from natural disasters. Insurers are required, by law, to provide such policies and the Italian government has set up a €5bn reinsurance fund to support this. Other countries will no doubt follow suit.
Whether through increased insurance premiums, the carrying out of risk mitigation works or dealing with the consequences of uninsured damage, it is clear the cost of dealing with climate-related risk poses a significant threat to the real estate industry. For landlords and tenants, the question, as ever, is who bears that cost?
Evolving green leases
Landlords and tenants have been grappling with the same dilemma for some years, so far as it relates to the cost of energy efficiency and decarbonisation works. Over the past decade, the property industry has seen the evolution of “green leases”, moving from “light green” vague statements of intent, through to more concrete medium and darker shades of green, requiring affirmative action. The main focus of green leases to date has been on the long term and improving the sustainability credentials of properties, however, and their evolution has been largely dictated by statutory obligations and the operational and financial requirements and capabilities of landlords and tenants.
It is inevitable that the focus now needs to accelerate and expand to enable landlords and tenants to deal with the more immediate risks associated with climate change.
Green lease negotiations are generally underpinned by a unanimous desire on the part of both landlords and tenants to improve the sustainability credentials of their properties, coupled with a lack of consensus around how the responsibility and costs of such improvements should be borne. The Better Buildings Partnership’s Green Lease Toolkit has sought to help landlords and tenants achieve a just position, by setting out key principles, including that where a tenant benefits from works carried out by its landlord (eg by way of resulting reduced utility costs) then the tenant should contribute to the cost of those works.
In the case of works to improve a property’s energy efficiency, it can be challenging to demonstrate and quantify such cost savings and the period over which they need to be achieved, in order to calculate how much a tenant should contribute. In the case of climate-change resilience works, the question of whether a tenant benefits may be clear cut, particularly where the insurability of the premises depends on those works being carried out. However, quantifying and agreeing the amount of any contribution to such works is likely to require significant negotiation and will depend on multiple factors.
What should landlords think about?
For landlords, achieving a full repairing and insuring lease will usually be their primary goal. In short, landlords want to be able to recover the costs they incur in managing their estates from their tenants, in full. These costs include rising insurance premiums and the cost of carrying out repairs and upgrades to buildings as a result of climate risk. Landlords usually seek to include certain protections in their leases.
These include:
- Reimbursement of the full costs of the landlord insuring the premises, by requiring tenants to pay insurance rent in addition to their yearly rent and service charge;
- Ensuring that responsibility for the cost of remedying damage or destruction caused by uninsured risks sits with their tenants, whether through the tenants’ own repairing obligations, or through the landlord’s ability to recover the costs of repair and reinstatement through a service charge;
- Reserving rights to make improvements to the premises, and seeking to pass the capital expenditure they incur in doing so to their tenants, via a robust service charge regime; and
- With the increased cost of insurance and upgrades to premises resulting from climate-risk, landlords are likely to be increasingly resistant to agreeing inclusive rents or capped service charges.
What should tenants think about?
Tenants, conversely, will be keen to limit their exposure to expenditure, above and beyond their rent. Their argument is that if they do not have a capital interest in the property, they should not be responsible for paying for capital works, which inherently benefit the landlord, through rentalisation. Tenants often seek to protect their position by including the following kinds of provisions in their leases:
Inclusive or capped rents/service charge, giving the tenant greater certainty of cost and protecting against significant increases in contributions, beyond indexation;
Where rents are not inclusive, tenants will usually seek to tighten the service charge provisions in their leases, to include a clear list of exclusions, so that landlords cannot recover certain costs from them – such costs often include capital works/improvements to the building;
Tenants have, in recent years, been generally successful in arguing that the risks associated with uninsured damage should remain with the landlord, albeit that it is usually at the landlord’s option whether to reinstate such damage, or terminate the lease.
Ultimately, the question of who bears which risks and costs depends on a multitude of factors, including the commercial negotiating position of the respective parties, the nature of the property and the duration of the tenant’s interest in the property.
Why landlords and tenants need to work together
While market-standard practice surrounding green lease clauses has evolved relatively gradually in terms of improving energy efficiency, when it comes to who bears the cost of mitigating climate-related risks, the situation is arguably more urgent and both landlords and tenants have a lot to lose.
Well-advised landlords and tenants, particularly those with properties located in higher-risk areas, should be proactive in auditing their leases, to identify where they support the mitigation of climate-related risk and where they fall short. When agreeing terms for new leases, the issue of how climate-related risk and associated costs are shared between landlords and tenants should be considered carefully.
The latest iteration of the Green Lease Toolkit reflects the importance of the issue by expanding the definition of “environmental performance” of premises to include resilience to anticipated climate change effects. This relatively simple change has wide-reaching consequences and recognises the need for landlords and tenants to work together and take tangible steps to deal with these risks. However, this element of the expanded definition from the Toolkit has not found its way into the recently released latest edition of the Model Commercial Lease.
The MCL seeks to reflect the present market, which hasn’t perhaps yet arrived at the same conclusion. It is surely only a matter of time before it has to. The insurability of the property and its viability as an asset may eventually depend on it.
Elizabeth Fevyer is a legal director at Eversheds Sutherland
