Sustainability is no longer a mere buzzword for the commercial real estate industry. The property investment community has adopted the agenda and there is an increasing onus on real estate finance providers to catch up.
Amsterdam-based GRESB, a body that promotes the environmental, social and governance agenda for real assets through data and benchmarking, is working to provide the real estate industry with the tools it needs to measure sustainability performance. While its initial focus has been on the equity side of the market, the organisation also wants to provide debt originators with the capability to factor ESG performance into their activities.
GRESB’s head of EMEA, Josien Piek – herself a former banker and asset manager – explains how the ESG agenda can be applied to the lending market and why sustainability is becoming increasingly relevant to financiers.
Real Estate Capital: What has GRESB done to promote ESG benchmarking for the
wider real estate industry?
Josien Piek: GRESB was founded in 2009 by three large European pension funds which decided to combine their ESG-related questionnaires into one comprehensive list of questions and bring the answers together in one database. The real estate survey has since become the global sustainability standard, used by more than 75 investors, bringing together detailed ESG information on more than $3.6 trillion of real estate assets worldwide.
The questionnaire assesses the quality of ESG management and performance of real estate managers through questions relating to ESG objectives and policies, managerial attention and the available information to realise objectives, as well as the actual ESG performance of a portfolio, such as energy usage, the annual reduction of greenhouse gas emissions, plus the level of building certification.
At one end, investors need a clear way of assessing the sustainability of an underlying investment and how to engage with real estate companies. At the other end, real estate funds and companies get to see how they compare with their peer group, by sector and geography. This information gives them the ability to prioritise how they improve their score by knowing what investors want and how to achieve it, rather than just ‘fluffy’ sustainability thinking.
REC: How can sustainability benchmarking also apply to the debt space?
JP: Sustainability has a comparable impact on debt providers as it has on equity providers. On the debt side there is more focus on risk due to the asymmetric return profile of loans. There is also more focus on the due diligence phase as financiers typically have less influence on real estate managers than equity providers.
In 2018, six multinational banks along with 18 real estate debt funds and one mortgage REIT benchmarked their ESG programmes, procedures and policies through the GRESB Debt Assessment, which looks at how well debt providers are taking sustainability into account. The survey has been slow to attract new participants because it involves banks and real estate bond houses holding up a mirror to ask: ‘am I doing well enough on sustainability?’, rather than assessing the performance of the underlying real estate companies or enabling the scrutiny of an investor base looking through the database to see that everything is done well.
As a result, we have decided to discontinue the Debt Assessment and focus instead on encouraging lenders to use the existing GRESB Real Estate database for the sustainability-related risk analysis of the underlying loan portfolios. A couple of Dutch banks are currently using the GRESB Real Estate sustainability data, including ING Bank which structured a loan to the French listed real estate company Gecina based on its GRESB score. In this loan structure, the higher a company’s score the lower the interest rate on its loan.
The database offers lenders relevant data on risk assessment, energy efficiency and resilience, providing material data on the risk profile of the underlying assets that are being financed.
Risk is also the focus of a new GRESB Resilience Module which is currently in the testing phase, developed to measure companies’ capacity to assess, manage and adapt to social and environmental shocks. It looks at the level of managerial attention given to this strategic risk assessment and the steps taken to mitigate these risks.
It is being further aligned with the requirements developed by the Taskforce for Climate-related Financial Disclosure. After two more years of development, the most relevant questions will be integrated into the GRESB Real Estate Assessment and become mandatory for all managers filling out the annual GRESB questionnaire.
These data points will then be available for lenders using the GRESB database to inform their portfolio risk analysis.
REC: How can your property-level data benefit lenders?
JP: There are three tools to make the database available to lenders: the full benchmark report, which allows lenders to see how a company they are financing is doing in terms of sustainability metrics; the portfolio analysis tool which allows lenders to look at companies it is lending to and assess how its overall lending portfolio is performing on sustainability criteria; and the excel ‘data dump’ which helps lenders conduct their own due diligence by extracting data concerning aspects they consider important such as those relating to the carbon footprint of a portfolio, building certification and the level of stakeholder engagement.
REC: What methods can lenders use to genuinely adopt ESG practices into their lending?
JP: For sustainability to be a genuine aspect of a lender-borrower relationship, transparency and relevance of data is the first requirement. A good way to make sure that the lender has all the information needed to make a good assessment of the sustainability risk of a real estate portfolio or manager is to ask borrowers if they already report to GRESB on these issues.
If so, the lender can ask for access to these reports. They can then go one step further by linking certain sustainability ratings or metrics to the loan documentation, either through ESG-related loan covenants such as a minimum requirement for the Energy Performance Coefficient of buildings, or through linking the spread of the loan to certain sustainability requirements.
REC: While the green agenda has been grasped by some, how can the social and governance parts of ESG be addressed?
JP: True, the environmental agenda is more quantifiable, especially when it comes to emissions, and the financial mindset can more easily be applied; the book-keeping of financial data is based on the premise that more money is better than less the same way the book-keeping of greenhouse gases is based on the fact that less greenhouse gases are better than more. This differs from more qualitative sustainability metrics such as stakeholder engagement. Social aspects are often more qualitative but GRESB’s institutional investor base has helped us to define standards, based on best practice.
On the stakeholder engagement side, knowing what tenants, shareholders and the local community want from you as a company ensures you make better decisions and fosters better relationships. The finance industry has always taken quality of governance seriously because if management and policy is not well tended to, significant financial loss can result.
REC: Is there regulatory pressure on lenders to undertake sustainable financing?
JP: Increasingly so. The European Commission has set up a task force to look at how the financial sector can be made more sustainable, making sure money flows towards ‘green’ and away from ‘brown’ investments. It is currently in the taxonomy phase, meaning the EC is using sustainability metrics to define key terminology surrounding sustainability in finance, though there seems to be a sense of urgency to make big strides before the European election in May 2019.
One idea in the works is a potential broadening of the definition of investors’ fiduciary responsibility, to include sustainability rather than pension funds just focusing on meeting liabilities. This broadened definition of fiduciary duty could be extended to banks and other lenders.
REC: Are there other areas of finance where ESG has been adopted that we can learn from?
JP: Yes: there have been strong improvements in the context of financing emerging markets driven by pressure from large institutional investors. There was a scare at one point that bonds were being bought from African governments that were involved in corruption. Investors therefore asked their bond managers to adopt screening of these metrics and to come up with risk analysis of these items.
This increased transparency has driven greater social awareness among investors and managers and thinking has shifted towards improving ESG. Countries that demonstrate sustainable social policies have better long-term financing in place than those that do not.
REC: Why has the property finance industry lagged the property investment industry in this regard?
JP: It is partly due to the nature of debt versus equity provision. As an equity provider, especially in the real assets sector, you are the owner but not the manager of property and you want to make sure the manager does what you deem important. As a lender you’re more focused on risk; you want to make sure a property is managed so there’s value there for your loan to be repaid. The level of engagement with the management of the company or real estate fund is less than that of the owner/investor so it makes sense that the finance industry has lagged. Now the database has been built, however, and in light of increased requirements facing banks regarding sustainable financing, the finance industry will use it more and more.
REC: What progress do you think is being made in bringing the ESG agenda into the real estate finance market?
JP: There is now widespread scrutiny from the debt side on sustainability issues, not only because of regulatory clouds on the horizon, but also because sustainability is seen as a risk factor itself. A further reason can be the need to communicate on the sustainability of the loan or bond portfolio to investors directly or indirectly invested in the portfolios. In this sense, the holding to account is similar to the way this engagement process has played out in the equity markets.
Sustainability from either a risk or return perspective is an important factor to focus on to limit risk and enhance returns. A company that has got a bad ESG standing has a higher risk profile than a company that has these things in order. Lenders’ primary aim is to get their money back and sustainability is a natural way to ensure their chances are greater.