With the climate crisis showing no signs of easing, investors in real estate are increasingly prioritising the future-proofing of their portfolios, incorporating greener, and therefore more resilient, assets.
Moreover, with a raft of green government policies unveiled in the run-up to and during COP26, the impetus behind sustainable finance is accelerating, particularly when it comes to real estate.
Europe is leading the way when it comes to green finance. As evidenced in our 2021 Active Capital report, in the first half of the year nearly half of global sustainable lending came out of the continent.
Burgeoning demand has been further spurred by recent regulatory and policy activity, with central banks introducing initiatives to facilitate the transition to net zero. The EU has generally been seen as a leader in developing policy on disclosure through its taxonomy regulation. The UK is also developing its own post-Brexit framework, creating The Green Technical Advisory Group to develop its own taxonomy.
Encouragingly, other regions are also catching up. In Asia-Pacific, there are now sustainability reporting requirements in place when it comes to the stock exchange, as well as green lending facilities to incentivise environmental, social and governance targets and encourage investment in greener technology.
But which are the real estate investment categories most driven by ESG, and are lenders able to meet the level of demand?
Green finance requirements are already encompassing a wide range of sectors and deals. We have seen an increase in the instances of ground-up built-to-rent and single-family housing developed to ensure they are future-proofed against changing sustainability requirements and expectations.
There is greater traction when it comes to asset repositioning too. Most recent refurbishments are placing sustainability front and centre, with efforts to improve energy efficiency and carbon footprint – particularly when it comes to assets such as offices.
Lenders are responding accordingly, applying margin discounts if ESG requirements are considered. In terms of borrowers, institutional funds are particularly active, but we also expect interest from overseas capital and private developers to intensify in the coming months and years.
Given this momentum, the pressure is on lenders to ensure they are effectively meeting demand. Although there has been criticism that they have not pivoted quickly enough, lender appetite is evident – particularly for transactions where sustainability is placed at the very heart of a project.
To encourage this shift, lenders are increasingly offering facilities with ESG incentives – such as reduced margins – for sponsors that demonstrate a commitment to achieving certain pre-agreed ESG requirements. These are proving effective in that they are incentivising sponsors to place ESG at the forefront of their minds, particularly when it comes to borrowing against real estate.
Accordingly, we have seen several deals in recent months, involving a range of terms for ground-up development and refurbishments, with clearing banks and debt funds all focusing on ESG.
Lenders are also ramping up the level of due diligence undertaken when it comes to qualifying sustainability claims – a trend that was particularly evident in the second half of 2021 and is only set to continue. Ultimately, lenders are asking questions about any refurbishments that have been carried out with net zero in mind. Without a global standardised metric for assessing green investments, the challenge of navigating different regional standards remains.
Nevertheless, elements such as energy efficiency standards, on-site renewable energy generation, the impact of construction methods and materials are all being scrutinised as part of transactions, and hopefully this will rapidly become the norm.
As with all investments, margin reductions on debt facilities are a significant consideration for developers, even for those that are the most forward-thinking when it comes to sustainability. As we look to the New Year, one trend is emerging very clearly: sustainable financing will prove an absolutely fundamental driver of asset resilience post-pandemic.
Lisa Attenborough is head of debt advisory at real estate consultancy Knight Frank. She is based in London