Commercial real estate's green lending revolution in the spotlight

By Paul Norman - Friday, April 21, 2017 8:00

The Better Buildings Partnership (BBP) has launched a call to action to commercial real estate lenders urging them to focus more on sustainability. The move has been backed by a wide-ranging report highlighting test case examples of pioneering work being carried out by leading lenders such as ING, Lloyds Bank, TH Real Estate, Hermes and ABN AMRO. CoStar News exclusively reviews a report that reveals rapidly changing attitudes towards sustainability among real estate lenders.

Based on the work of the BBP Commercial Real Estate Lending Working Group, which is made up of leading European banks, debt funds and industry bodies including CREFC Europe, BBP has published Beyond Risk Management, a paper which highlights ways in which lenders are incorporating sustainability into their core business activities.

The report can be found here.

It includes case studies from Lloyds Bank, ING Bank, ABN AMRO, TH Real Estate and Hermes Investment Management and covers initiatives such as green loans and new technology such as apps aimed at engaging with borrowers to identify energy saving opportunities to which banks can provide finance.

The studies are used as evidence for a call to action to real estate lenders urging them to share best practice and focus more on their sustainability strategies.

The BBP writes: “Historically, sustainability considerations for lenders have predominantly been a matter of managing regulatory risk as part of due diligence and underwriting at the loan origination or acquisition stage.

“However, there are clear reasons why banks, debt funds and others involved in commercial real estate lending should adopt sustainability strategies that extend beyond risk and benefit from the opportunities that create a pathway towards market transformation.”

The BBP reports that the commercial real estate lending sector has been slower than the real estate equity investment sector in incorporating sustainability into business strategy because lenders are “not as close to the buildings as their owners, cannot exert comparable influence and are a step removed from the economic consequences of improvement measures”.

But it argues all this is changing with a flurry of products and services being developed to reward and incentivise more sustainable commercial buildings, often providing new lending opportunities and allowing better market data to be captured.

Call to action

The BBP Commercial Real Estate Lending Working Group calls on lenders to:

• Recognise the huge opportunity for positive change – “Lenders have a very diverse customer base and can have significant impact and influence on the mid and smaller property owners and assets that are not necessarily at the forefront of best practice.”

• Explore the commercial and reputational prizes to be won – “Innovative action on sustainability within commercial real estate lending can help drive new business, strengthen customer relationships and greatly improve the quantity and quality of information lenders hold about the buildings in which they have an interest.”

• Collaborate – “There is a need for collaboration so that metrics, terminology and standards can be harmonised to the degree necessary for products and services to become mainstream.”

The report argues that real estate lenders have seen an increasing interest, and in some cases pressure, from existing shareholders or fund investors to demonstrate how they integrate sustainability practices into their real estate lending business.

It writes: “This has been driven, in part, by the Global Real Estate Sustainability Benchmark (GRESB), which since 2015 has issued a real estate debt assessment requiring detailed information from commercial real estate lending businesses on how they are integrating sustainability considerations under the headings of management, policies and disclosures, due diligence, monitoring and opportunities.”

BBP adds that there is a clear growth in interest amongst lenders to understand carbon exposure.

“Carbon or energy footprint data on buildings within a loan portfolio will not normally be collected based on actual energy use data obtained directly from borrowers and banks are developing methodologies to estimate this data using information they already possess such as building type, floor areas, age of construction, Energy Performance Certificate ratings, use and occupancy rates.”

David Short, chair of the BBP CRE Lending Working Group, said: “Real estate lenders provide the foundations for the creation and continued regeneration of our building stock. However, a lesser discussed point is the important role they can play in driving market transformation towards a sustainable built environment. This report underlines the opportune timing for lenders who wish to take a market leadership stance and recognise the benefits that exist from placing a greater focus sustainability.”

Peter Cosmetatos, CEO, CREFC Europe, said: “Starting from an appreciation of the risks of paying insufficient attention to sustainability, we’re now seeing a number of forward-thinking lenders going a step further and seizing the opportunities – a real transformation compared to just two or three years ago. This report highlights some of the innovative products and services being developed to promote and reward more sustainable buildings. It demonstrates that lenders can meaningfully support the climate change agenda while strengthening their own business.”

John Feeney, Managing Director and Global Head of Commercial Real Estate, Lloyds Bank Commercial Banking, said: “Debt finance is the lifeblood of the real estate sector and so, in our view, lenders have an opportunity to promote and reward sustainable best practice. Property makes a significant contribution to carbon emissions and so mitigating its impact is critical. One of the aims of our Green Lending Initiative is to broaden the market for secondary, sustainable-backed debt. We hope this report and the BBP’s influence, will act as a further catalyst for change.”

Teun van den Dries, CEO, GeoPhy, said: “Sustainability has been integral to investment decision-making of real estate investors for a decade, witnessed by their demand for objective, quantitative data on energy, carbon, certification and other metrics. Over the past year, lenders have followed suit, and are increasingly using our sustainability data. Applications vary from carbon footprinting of the lending portfolio to climate risk assessments for assets, and from understanding the exposure to green certificates to risk analysis of recent legislation regarding energy performance certificates (EPCs).”

Case studies

The report produces a number of test case studies focused on how leading banks are pioneering sustainable real estate lending. In summary the studies are:

ING’s sustainability app for borrowers

Dutch bank ING, which has a commercial real estate loan portfolio of around €30bn worldwide, has focused on how it can help its clients reduce their energy costs and carbon emissions. It has worked with partners to develop a tool to help its borrowers identify the energy improvement measures for their buildings that provided the most attractive financial returns and greatest carbon emission reductions.

The tool is an app which has been offered to all Dutch clients. The borrower enters information about their buildings such as type, age of construction and floor area. The app then analyses the portfolio and recommends the top 10 measures per building to lower energy costs and reduce CO2, showing indicative costs, financial returns and carbon reductions. If the app indicates energy savings greater than €15,000 per year for a building, the client is offered a free on-site BREEAM and energy audit.

In the first five months since its launch last year, the app had been used to scan 18,000 buildings measuring 10m sq m (65% of ING’s financed portfolio). ING’s goal is to enable 5,000 Dutch clients to ‘sustainabilise’ their portfolio, equating to a total of 28,000 buildings. In addition, to help stimulate the Dutch market ING has started providing discounts on ‘sustainable loans’, as well as providing subsidy advice and offering free Energy Performance Certificate assessments for its clients.

ABN AMRO

ABN AMRO has a stated ambition of becoming the most sustainable property bank in the Netherlands and aims “to accelerate the transition to sustainable commercial property”. It has a specific sustainability policy for commercial real estate, which applies to general loans to clients in the commercial real estate sector as well as loans for a specific real estate asset, development or portfolio. It provides details of the bank’s policy to closely manage sustainability aspects related to its commercial real estate clients and to integrate these in the bank’s appraisal and decision-making processes.

The policy states: “As a provider of financial services, ABN AMRO is strongly committed to being a value-adding partner to its clients in the commercial real estate sector. Within this sector, sustainability is regarded as a strategically important topic in terms of risk and opportunity management.”

ABN AMRO has sought to use the information it has about the properties within its loan portfolio to assess investment opportunities presented by energy efficiency upgrades. Therefore, ABN AMRO has developed a web application targeted at CFOs of borrower clients that assesses and analyses investment opportunities across its loan portfolio presented by efficiency upgrades. The borrower CFO can log in and see these investment opportunities at building or portfolio level. The tool also provides guidance on availability of finance, government subsidies and technical partners to implement solutions.

Lloyds Bank

Sustainability is an integral part of all Lloyds Bank’s business activities, articulated through its “Helping Britain Prosper” campaign. It has embedded sustainability into its core business offerings by developing a product that provides commercial real estate debt at advantageous rates to reward and incentivise better sustainability performance. Lloyds Bank’s Green Lending Initiative was launched in March 2016 with a pledge of £1bn of commercial mortgage lending incorporating a discount of up to 20 basis points available for eligible clients.

The process of applying for a green loan begins with an assessment using a bespoke scorecard developed with independent consultants, Trucost. It evaluates borrowers in two discrete areas: the sustainability performance of their assets and the sustainability strategies of their businesses. The borrower has to reach a minimum score to be eligible.

Ultimately the scorecard provides Lloyds Bank with an understanding of the trajectory of performance to help it set the covenants. The covenants are broad in scope and can be structured around specific interventions and actions that the borrower commits to undertaking to drive performance, or can be structured around outputs that the borrower is expecting to achieve. The margin discount is then linked to these covenants, so that while the borrower is compliant, it benefits from lower debt cost. The Initiative had at time of reporting made five loans totally £132m with “very positive feedback from borrowers”. BBP adds: “Though a 20-basis point discount may be a modest incentive in cash terms, it can have an important psychological effect.”

TH Real Estate

TH Real Estate has established and implemented sustainable investment principles across the direct investment side of the business. More recently it has been integrating sustainable investment into its real estate debt platform, focused mainly on due diligence, underwriting and transaction closing processes.

It utilises a combination of borrower information, third party surveyors and internal processes including a sustainability assessment of the borrower and the assets/ leases to develop a comprehensive risk profile for debt transactions. Two particularly material risks it focuses on are flood risk and compliance with the England and Wales Minimum Energy Efficiency Standards legislation.

Where material sustainability risks are identified, the Committee will ask the Fund team to carry out further investigations, resulting in either engagement with the borrower to mitigate those risks appropriately or rejecting the transaction if a solution cannot be agreed.

Hermes Investment Management

During its due diligence process Hermes requests the borrower to submit sustainability information alongside appraisal or valuation reports. Findings from the acquisition due diligence are integrated into the decision-making process through risk assessment and mitigation requests to be included in the asset business plan to be agreed with the borrower. As part of its asset debt portfolio management processes Hermes has a system in place to collect and manage the sustainability information held on the borrowers and the assets. Hermes provides capital for refurbishment to properties in its loan books in accordance with pre-agreed refurbishment agreements including sustainability requirements.

The Better Buildings Partnership (BBP) is a collaboration of the UK’s leading property owners who are working together to improve the sustainability of the UK’s existing commercial buildings. The organisation's aim is to deliver market transformation through sustainability leadership and knowledge sharing across the UK property industry. The BBP currently has 28 members who represent in excess of £180bn Assets Under Management (AUM). The Better Buildings Partnership is a not for profit collaboration of the UK’s leading commercial property owners who are working together to improve the sustainability performance of existing buildings.

The BBP Commercial Real Estate Lending Working Group provides a forum to share and develop best-practice around sustainability considerations for commercial real estate lending. It is comprised of major European banks and debt funds, as well as supporting industry bodies. These include ABN AMRO, Aviva Investors, CREFC Europe, Deutsche Asset & Wealth Management, Hermes Investment Management, ING Bank, LaSalle Investment Management, Legal & General Investment Management, Lloyds Bank, Loan Market Association, PGIM, Royal Bank of Scotland, RICS and TH Real Estate.

pnorman@costar.co.uk

Get in Touch
+44 203 205 4600