More clarity around how sustainable investment and development programmes affect real estate companies’ credit quality is needed to encourage the continued growth of an environmental, social and governance-linked bond market in Europe’s property sector, argues a senior analyst at one European rating agency.
Philipp Wass, executive director at Berlin-based Scope Ratings, told Real Estate Capital that although the issuance of ‘green’ and ‘sustainable’ bonds by European real estate issuers has increased substantially in 2021, ESG-linked capital markets issuance is dominated by larger property companies, with fewer incentives for smaller organisations to explore the financing option.
According to Scope’s data, the issuance of bonds which adhere to aspects of the UN’s Sustainable Development Goals has spiked in 2021. During this year to 6 August, around €22 billion of SDG-linked notes were issued by European real estate companies, up from €12 billion in 2020. Such bonds accounted for 36 percent of 2021 issuance by that point, up from 19 percent in 2020.
But Wass argues that until the impact of ESG on the credit quality of a wide range of property companies is easier to assess, investor demand for sustainable bonds issued by all but the biggest real estate firms will be subdued. “Greater visibility on the impact of going green is key,” he said, noting: “Comparability of issuers is a prerequisite.”
Wass believes a flight to quality, as real estate owners improve their assets for the post-pandemic world, will encourage more sustainable investment and development programmes in the industry. However, he added that many European real estate companies lack the resources to invest in ESG programmes to the degree that they would be comfortable enough to issue bonds that were underpinned by their ESG performance.
Wass said there is currently limited, if any, pricing benefit to issuers of ESG-linked real estate bonds, compared with regular bonds. He added that the limited pricing benefit, coupled with the existence of financial penalties in some ESG bond structures if issuers fall short of their sustainability targets, means there is a lack of incentive for real estate companies with fewer resources to commit to such issues.
“We see limited ‘greenium’ so far for ESG bonds,” he explained. “It is also questionable whether any will emerge in the near term.”
Larger ESG bond issuers that have reported a pricing benefit for sustainable issuances are beneficiaries of rising investor demand for such notes from the highest rated organisations. “One reason is the oversubscription of green bond issues from blue-chip companies, reflecting the massive investor demand for sustainability-linked securities,” he said.
“Generally, pricing is a function of an issuer’s credit quality and market dynamics, especially as green bonds rank pari passu with bonds of the same payment rank and issuer,” Wass explained. “Going green has no immediate impact on credit quality, as this ultimately depends on many parameters such as the potential risks that can be avoided or mitigated.”
He added: “As such, we need greater visibility on the impact of going green for an issuer’s credit quality – something we can observe only in the medium to long-term.”
Looking forward, Wass said bond investors need greater clarity around how sustainability affects corporates’ performance, including real estate corporates, for them to better assess how it could impact their credit quality. “Within the real estate sector itself, this is exactly what is lacking. There are myriad different certificates for buildings and companies existing side-by-side, all with a different focus, methodology and coverage.”
Wass is hopeful that new EU regulation designed to standardise corporate reporting around sustainability will help create more transparency in the ESG real estate bonds market.
“The new EU Taxonomy and the associated EU Green Bond Standard, plus the potential definition of standards for bonds linked to the UN’s sustainable development goals, will all help define what constitutes sustainable business activity and help establish a level playfield. Even so, considering the fragmentation in the real estate industry, this will be a challenge,” he said.