What ESG means for real estate finance

Effectively one step removed from real estate assets, lenders have not been at the forefront of the industry’s sustainability commitments. However, recent sustainable financing initiatives suggest times may be changing.

Recent chatter circulating the real estate finance industry suggests sustainability is starting to ascend lenders’ agendas. A case in point; in April, ING Real Estate Finance provided the first ever commercial real estate loan to be priced in relation to a borrower’s GRESB performance rating.

The recipient, French real estate investment trust Gecina, was provided with a €150 million ‘sustainable improvement loan’, with its margin dependent on performance against a set of environmental, social and governance (ESG) criteria, as set out by GRESB. Both lender and borrower have hailed the deal as a sign of a real estate market that is starting to put its money where its mouth is when it comes to ethical practices.

Commenting to Real Estate Capital at the time, Nicolas Dutreuil, Gecina’s chief financial officer, described the deal as “a matter of conviction”.

Gecina – which has a GRESB score of 93/100, ranking fourth among REITs globally – will be entitled to margin discounts across the seven-year revolving credit facility if it faithfully honours its ESG commitments. On the other hand, in the event of underperformance, it can expect to be penalised with an increase in margin.

Gecina will be surely incentivised to improve its GRESB score – or at the very least remain at the same level. Meanwhile, for some lenders, sustainability no longer represents a woolly concept to which they are expected to pay lip service. Rather, they appear to be increasingly looking to tap into Europe’s burgeoning green lending market.

“Ethical investing is coming of age and clearly gaining momentum,” says Hein Wegdam, ING’s director of sustainable real estate products.

“Having a sustainable strategy has become a competitive advantage. Investors are demanding green investments, while financiers are starting to reward owners of green buildings with improved loan rates. Financial institutions themselves are now required to give more disclosure on green lending.”

ESG has not always been seen to be within the wheelhouse of lenders. In contrast to investors, which can opt to only buy buildings that tick certain sustainability criteria, those providing debt finance to property investors are effectively one step removed from the actual asset.

In the view of Bruce Davis, managing director and co-founder of Abundance Investment, a green finance company, “the role of finance in real estate development has historically been a passive one. Lenders in the main were primarily interested in the risk to their capital and placed little value – and sometimes greater risk – on developments that provided social or environmental outcomes”.

However, there is evidence to suggest times are changing and lenders are willing to adopt the ESG agenda through their financing deals. In a similar vein to the INGGecina deal, in March Natixis Assurances and Ivanhoé Cambridge announced they been awarded Europe’s first green-labelled commercial real estate loan accreditation by the Climate Bonds Initiative (CBI), to finance the development of its DUO project in Paris. The €480 million debt facility, written last November by a consortium of banks, will finance the construction of mixed-use towers in the French capital.

The loan – provided by a banking syndicate comprised of BNP Paribas, Crédit Agricole Corporate & Investment Bank, pbb Deutsche Pfandbriefbank, La Banque Postale, Natixis and Banque Européenne du Crédit Mutuel – is the first of its kind to be accredited by the not-for-profit CBI. To obtain CBI certification, DUO first had to be assessed by Oekom, a sustainability research firm, which verified that the project met the standard for low-carbon commercial buildings, while establishing the structure for reporting the monitoring of environmental certifications, energy consumption and carbon emissions.

Elsewhere, in the UK, Lloyds has sought to get in on the green act. According to Madeleine McDougall, the bank’s global head of commercial real estate, it is “close to allocating the full £1 billion (€1.1 billion) of sustainable loans” as part of its Green Lending Initiative. The scheme, launched in 2016, was designed to subsidise loan margin discounts of up to 20 basis points for borrowers who commit to energy efficiency targets on the commercial properties underlying the loans.

In May, the bank also launched a £2 billion Clean Growth Finance scheme, offering discounted finance to clients committed to investing in low-carbon projects. “The Clean Growth Finance scheme means we’re now able to support even more transactions, including SME clients within the real estate sector,” says McDougall. “Under both initiatives, clients benefit from a margin discount by agreeing to meet a set of tailored green covenants.”

One such client is Manchester Science Partnerships (MSP), a technology and science park operator, which Lloyds provided with a £50 million debt package through the Green Lending Initiative earlier this year to help refinance its portfolio in the northern English city. In exchange for discounted funding, MSP has pledged £600,000 in sustainable improvements to its existing estate, reducing the annual energy intensity of its assets by 3.5 percent, while also increasing the amount of energy its buildings use from renewable sources by a further 10 percent.

“Our Green Lending Initiative remains the only scheme of its kind in the UK market by allowing borrowers to use the financing as they see fit, providing they hit the key performance indicators agreed in the covenants, rather than other green or sustainable loans that must be tied to spending on specific ESG projects,” says McDougall.

McDougall also cites Lloyds’ €600 million syndicated refinancing for Unibail-Rodamco last year as further evidence of the “strong appetite for our Green Lending Initiative deals”. The five-year revolving credit facility – which has two one-year extension options – enables the Paris-based group to refinance a 2011 debt facility while providing liquidity for general corporate purposes.

“We have recently launched a new greener investment policy that frames our lending decisions right across the group, including our industry sector teams like commercial real estate,” reveals McDougall. “This includes a commitment not to finance the development of new coal-fired power stations, for example.”


The latest figures suggest the ESG agenda is being gradually adopted across wider financial markets. According to CBI reports, $156.7 billion of green bonds were issued in the capital markets during 2017, which are forecast to hit $250 billion by the end of this year.
In March, the Loan Market Association published its Green Loan Principles, a framework of market standards and guidelines aimed at providing a consistent methodology for use across the wholesale green loan market.

Across the real estate equity market, progress is being made. In light of targets set out by the World Green Buildings Council that all new buildings must be net-zero carbon by 2030, and all buildings by 2050, GRESB recently reported the sector’s year-on-year greenhouse gas emissions were down by 4.9 percent, coupled with a 2.5 percent reduction in energy consumption in 2018.

GRESB ratings are also gaining traction among direct property investors. Despite having first been introduced in 2010, the GRESB benchmarking system has also come to the fore in allowing players in the real estate space to accurately gauge how they are faring in their environmental and social performance. Such is the acceptance of the Amsterdam-based organisation’s system, some 850 property companies and real estate funds completed its real estate assessment last year. In 2010, only 198 chose to do the same.

While real estate equity players are gradually adopting ESG-specific measures into their activities, many in the banking and finance part of the industry are yet to get to grips with the agenda. Those that are adopting sustainability measures are therefore setting standards.

Berlin Hyp, for example, is another property lender keen to demonstrate its burnished green credentials. In October, the German bank launched its third green Pfandbrief, of €500 million, cementing its place as one of the most active issuers of green bonds in the European commercial real estate sector.

“Since debuting with the first Green Pfandbrief in 2015, we have issued six green bonds with a total volume of €3 billion, half of them being green covered bonds and the other half being green senior unsecured bonds,” says Gero Bergmann, member of the board of management.

Bergmann is keen to wax lyrical on how his bank has gone about incorporating ESG into its lending practices. For instance, loans for green buildings are incentivised with a discount of 10bps, he says. Elsewhere, Berlin Hyp has established a Green Building Commission and is a firm partner with the CBI.

Growth in the green bond market is ample evidence, says Bergmann, that more financiers are set to follow in the footsteps of Berlin Hyp, although “there is still a lack of binding classification as to what is green and what is social”.

“Clear classifications are necessary – especially for investors,” he says. “That is why Berlin Hyp is among the founding members of the Energy Efficient Mortgages Initiative [EEMI], which is aimed at delivering a standardised European framework and data collection process for energy-efficient mortgages, with favourable financing conditions for energy-efficient buildings and energy-saving renovations.”


So what types of sustainable finance are real estate borrowers looking for? It is a choice that is very much contingent on property companies’ respective corporate social responsibility criteria and compatibility with lenders. In the case of Gecina’s recent deal with ING, for instance, green bonds were never on the table, reveals Dutreuil.

“Usual green financings such as green bonds were not satisfying for us, as the CSR performance of the borrower over the long term is not linked to the financial performance. And, therefore, it could appear to be only a marketing tool,” he says.

“That’s why we took advantage of our last refinancing campaign to conclude our first sustainable improvement loan with ING, whose CSR convictions are strong enough to accept the loan’s margin fluctuates with our own CSR performance.”

AccorHotels is another borrower to have entered into a sustainability-linked loan recently. Earlier this year, the hotel group took out a new €1.2bn revolving credit facility from a syndicate of 15 banks, with its margin tied to its ESG performance. The facility, signed in July, has a five-year tenor with two one-year options and replaces an undrawn €1.8bn facility signed in June 2014.

“Credit facilities and bonds are two of the financing tools that a corporate like Accor-Hotels uses for general purposes,” explains Jean-Jacques Morin, the hotelier’s deputy chief executive officer. “As we had to renew our previous credit facility, which was maturing, we decided to explore options, with a view to integrate ESG criteria, which we did.

“However, this does not mean we could not be interested in green bonds at some stage, but this would require a green purpose, whereas the credit facility is assessed on the issuer’s ESG performance.”

Serving as further testament to the potential scope for today’s property financing deals to be arranged in reference to ESG criteria, in October Accor-Hotels acquired its head offices in Paris for €363 million in a transaction financed by a €300 million, eight-year green mortgage loan, with an annual coupon of 1.8 percent.

“The deal was established in line with Green Loan Principles, the green mortgage loan benefits from a second opinion by the extra-financial rating agency Sustainalytics,” reveals Morin.

Just as it has done in a wider context in other industries, the sustainability agenda within real estate finance circles has morphed and evolved in recent years. Whereas ‘green’ appeared to be the watchword to begin with, more focus is now being afforded to the social and governance sides of things.

“At first the market focus was mainly on green assets,” says ING’s Wegdam. “This was easiest to measure, improve and report on. The scope is now broadening to the social impact and the well-being of the actual asset users.”

McDougall mirrors this sentiment, referring to another financing package Lloyds awarded earlier in the year as part of its Green Lending Initiative – in this case provided to the Ethical Property Company to the tune of £27 million.

“The genesis of the Green Lending Initiative was both part of the group’s wider commitment to promote sustainability in a carbon-intensive segment of the economy and an acknowledgement of how the parameters of the global CRE investment market are changing,” she explains.

“The financing we put in place for Ethical Property underscores this approach. While environmental credentials drove its inclusion in our Green Lending Initiative, the work the company undertakes to provide affordable workspace to charities and social enterprises resonated with some of our own pledges around tackling social disadvantage, building employability and championing diversity.”

Berlin Hyp’s Bergmann agrees: “The Sustainability agenda has moved from just green to ESG, although I’d say climate change is the most present issue,” he says.

“ESG criteria in investment decisions will reduce inefficiencies in the decision-making process and the introduction of environmental, social and governance criteria will improve the overall conduct of organisations considering all stakeholders. Thus, any activities in sustainability will have a positive impact on society.”

In a nutshell, the notion of impact investing has gained traction, by which real estate assets are judged against whether they bring to bear a positive impact on society. The growing influence of “large pension and sovereign funds within the capital market has also increased demand for assets and asset owners in possession of broad ESG credentials”, believes McDougall.

According to Belinda Chain, partner and head of asset financing at Europa Capital, who handles the firm’s borrowing activities, investors have come to associate clearly-defined ESG with increased productivity and stronger returns. It is a strategy which makes good business sense. However, she counters that impact investing should form the key part of a company’s philosophy, and “certainly extends beyond BREAM ratings for buildings and GRESB scores”.

There’s also every reason for real estate debt fund managers to get behind ESG, as evidenced by news earlier in the year that M&G Investments had launched a private debt fund which will plough investment into green real estate and social housing projects. Only five years ago – when debt investment was seen as something that took place almost exclusively in relation to private equity, with the latter expected to take responsibility for ESG – such a move might have been almost unthinkable.

That said, it is still early days for ESG in real estate finance and it remains a niche landscape. Recent loans tied to GRESB scores or CBI accreditations still fall on the side of novelty and further such deals will be needed before there is justifiable talk of a firm trend across the property debt space.

However, this last year alone, the sustainable real estate finance market has undoubtedly taken some of its biggest strides yet in its assimilation of ESG as a key component of how it goes about lending.