ESG in real estate finance, part 2: Considering societal impact

Property lenders are considering how to incorporate the S of ESG into loan deals.

In addition to further exposing the immediate risk of climate change, the pandemic has put a renewed focus on health and wellbeing, and prompted the real estate industry to think deeper about the social impact of its activities. However, lenders’ progress on social impact is less advanced than their progress on the environment.

“True social loans are still yet to be seen for the real estate market because we lack market standards,” says Thomas Garnier, originator in Natixis’s green and sustainable hub.

He says the International Capital Market Association’s Social Bond Principles are one potential framework for real estate lenders to use, particularly when financing asset classes with a clear social focus, such as social care facilities or affordable housing.

However, Garnier believes meaningful social financing needs to be seen in the context of all aspects of ESG pertaining to the asset and the borrower. He offers an example: “You might finance social housing with poor energy-efficiency. It delivers on the social impact, but it is incomplete since the tenants will have to bear the cost of an energy inefficient asset. They will pay lower rent but a high energy bill.”

The built environment’s impact on society is a broad topic that remains subject to considerable debate. Some view the social risk in real estate investment in owning buildings that do not measure up to the standards of health and wellbeing that are coming to be expected in an increasingly customer-oriented industry. Others believe some sectors, such as healthcare and social housing, are inherently socially focused, and that this makes them good long-term investments.

Thomas Garnier
Garnier: “True social loans are still yet to be seen for the real estate market because we lack market standards”

Although the thinking around the S is less defined than around the E, it is set to become a huge focus in real estate. Just as investors have made green investment a priority, many in the industry expect the scope to expand to include socially conscious investing. Impact strategies – through which managers promise to make investments with a positive environmental and societal impact, while delivering a return for their investors – are already growing in prominence in the real estate sector.

This suggests that the demand for finance that encourages and rewards such investment will follow. Lenders are therefore considering the metrics that could feature in such financing deals.

Our sources indicated such metrics could feature wellbeing targets, through which buildings could be made safer, more accessible and more resilient. The International WELL Building Institute’s WELL Building Standards, a performance-based certification designed to encourage occupier health in building design, were cited as a measure that is gaining traction in the industry.

Social security

There are hopes that the LMA’s Social Loan Principles – currently a work in progress – will provide lenders and sponsors with similar frameworks to the green and sustainable loan principles already published by the finance industry body. In the meantime, the UN Sustainable Development Goals – a list of 17 metrics – are providing some investors with a guide. In a 2020 survey of 25 real estate companies, sustainability benchmark GRESB found evidence of firms making commitments to 13 of the UN metrics, to some extent.

For some in the lending industry, sector choice is crucial to making social impact part of debt strategies. UK investment manager M&G Investments has a track record of lending against social housing and has exposure to 130 UK housing associations. Mark Davie, the firm’s head of social housing, says there is a direct societal impact in financing social housing in a country with a housing shortage.

Davie: “There is a direct societal impact in financing social housing in a country with a housing shortage”

“Housing associations have strict governance codes in place that are monitored by the regulator,” he says. “In terms of social impact, they serve their communities by providing affordable homes. But social housing goes beyond that. It is about placemaking and providing support for tenants. Some housing associations have vulnerable clients who they help to apply for social benefits, for example.”

In January, M&G provided a £25 million (€28 million) facility to the charitable housing association EastendHomes for the construction of 142 units in deprived areas of London. Existing properties will be upgraded as part of the deal.

For Roland Fuchs, head of European real estate finance for Allianz Real Estate, the German insurer’s property management arm, being a socially focused lender does not simply mean financing buildings with a clear societal benefit, such as community healthcare facilities or affordable housing. He says a holistic view of ESG is necessary: “The S part in a green loan, therefore, is not solely addressed by financing social buildings, like hospitals. It is considered by looking at the lender and borrower’s ESG policies and governance frameworks, which include social and governance elements.”

Reward winners

Examples of real estate loans structured with incentives for the borrower’s socially focused activities are rare. However, some in the market have pioneered lending deals with a reward mechanism pegged to pre-agreed societal targets.

In March 2020, the UK arm of Japan’s Sumitomo Mitsui Banking Corporation provided a “socially linked” revolving credit facility to the UK-listed Catalyst Housing Association. The facility was structured to make a margin reduction available to the borrower if it met targets to help its tenants, including vulnerable people and those on low incomes, maximise their income.

Booth: “We wanted to make sure we were able to set a target that we were keen to promote internally but where we could also see the benefit through a margin reduction”

“Our community investment team has been supporting our customers during the pandemic,” explains Michaela Booth, director of corporate finance at Catalyst. “We help people with training, supporting them to get back to employment. We wanted to make sure we were able to set a target that we were keen to promote internally but where we could also see the benefit through a margin reduction.”

Booth says the deal participants used the UN goals as the benchmark for the performance indicators – specifically UN goal number eight, which addresses productive employment and decent work for all.

Sarel: “When it comes to socially minded lending, debt providers can get as creative as they consider with regards to loan structures”

For some, the lack of standard metrics around social impact in real estate lending deals means there is a licence for property lenders to get creative. Nathalie Sarel, executive director of sustainable banking at French banking group Crédit Agricole, says this was the case with the first “shared solidarity” product in the real estate loan sector.

In June 2020, the bank provided a €150 million, five-year “solidarity-based” revolving credit facility to French property company Icade. The deal included a mechanism by which the lenders, two arms of Crédit Agricole, waived part of their remuneration. The funds, matched by the borrower, were allocated to covid-19 vaccine research by the Paris-based Institut Pasteur. “When it comes to socially minded lending, debt providers can get as creative as they consider with regards to loan structures,” Sarel says.

Piur: “The positive aspect of sustainable finance products is that you can think out of your box”

Such deals demonstrate that working social metrics into a real estate finance deal is possible, but they remain outliers. Nevertheless, Alexander Piur, head of sustainability at Dutch bank ING’s real estate finance team, argues there is significant scope for debt providers to experiment in this area.

“The positive aspect of sustainable finance products is that you can think out of your box,” he says. “The market is growing, and new products are going to be developed. [KPI setting] is not rocket science. That gives a lot of flexibility.”

THE EU’S FINANCIAL ESG ROADMAP

March 2021 Sustainable Finance Disclosures Regulation comes into force. Asset managers and pension funds with more than 500 employees are required to define entity-level ESG policies and make ESG disclosures in pre-contractual documents.

Q1 2021 The European Commission is expected to start a review of its Non-Financial Reporting Directive governing corporate ESG disclosures.

January 2022 The deadline for asset managers to submit annual product-level ESG disclosures in line with SFDR.

2022 Asset managers are required to report on climate mitigation and adaptation in line with the EU Taxonomy, which is designed to identify sustainable economic activity.


Read more:
ESG in real estate finance: How a loan can be good for the environment
ESG in real estate finance: How governance fits in