This article is the third in a four-part series about how commercial buildings find ways to finance sustainability projects through ‘green lending’ and other innovative green finance techniques. The first article focuses on ‘green banks’ and how they can help property owners obtain financing for clean energy projects with high upfront costs. The second part covers green bond offerings, which are becoming an increasing share of U.S. real estate investment trust’s (REIT’s) debt issuance. This third part looks at green loans, whose proceeds must apply specifically to sustainable purposes. The fourth and final part covers green tax incentives, which some say have been too weak, inconsistent, and outdated for years, but could soon get a significant boost from Congress and the Biden administration.
Environmental, Social, and Governance (ESG) in finance and the commercial real estate world is a hot topic right now. Still, the roots of socially responsible investing go back further than you may think. John Wesley, the English evangelist and one of the founders of Methodism, is one example of an early adopter of socially responsible investing. Many of the best-known applications of the practice were religiously motivated. Wesley’s sermon “The Use of Money” outlined the essentials of his theory, which were not to harm your neighbor through business practices or invest in industries that hurt workers, such as chemical production. “None can gain by swallowing up his neighbour’s substance, without gaining the damnation of hell!” Wesley wrote. Followers of Wesley in 18th century England would avoid doing business with ‘sinful’ companies associated with products like guns, liquor, tobacco, or gambling. Suppose you want to go even further back than Wesley’s passionate preaching. In that case, many argue the origins of ethical investing started with Judaism and the Jewish concept of Tzedek, which means righteousness, justice, and fairness, and the obligation to do what’s right.
Fast-forward to 2021, and many investors and commercial real estate owners are showing an increased interest in socially responsible investing, especially regarding impacts on climate change. While they may not label fossil-fuel reliant industries as ‘sinful,’ companies are nevertheless considering the costs of pollution and climate change in their financial calculations. In less than 20 years, the ESG movement has grown from an initiative launched by the United Nations into a massive global phenomenon accounting for about $30 trillion in worldwide assets under management. One piece of the global ESG puzzle that’s begun to gain steam in recent years is ‘green loans,’ a form of financing similar to green bonds in that it raises capital for environmentally-friendly projects.
The World Bank’s International Finance Corporation defines green loans as an exclusive type of financing that enables borrowers, such as property owners, to fund projects that significantly contribute to helping the environment. Unlike green bonds, a green loan is typically smaller and done in a private operation. Green loans and bonds follow their consistent principles, the Green Loan Principles, and the Green Bond Principles, developed by organizations like the Loan Market Association and the International Capital Market Association. Both green loans and bonds must use 100% of their proceeds for environmental benefit.
The Green Loan Principles (GLP) were issued in 2018 to promote consistency for financial markets. The GLP addresses how the proceeds of a green loan are supposed to be implemented, as well as guidelines for project evaluation and selection, management of proceeds, and reporting. While the GLP is a good start, some property industry finance experts think the principles aren’t robust enough. But this hasn’t necessarily slowed down the growth of the green loan market. The World Bank reports there’s currently an estimated $33 billion in outstanding green loans worldwide, and the demand is outpacing the growth of the green bond market. Green bonds come with higher transaction costs and a minimum bond size to be tradeable, so the World Bank says issuers with smaller green portfolios typically receive green loans instead of issuing a green bond.
Europe currently dominates the green loan market, but several other banks worldwide, including the U.S., have issued green loans since 2017. Like the entire world of green finance, the green loan market is in high demand and should continue to heat up, according to a JLL report. “A building that is deteriorating in terms of its sustainability is a risk for both borrower and lender,” said Karen Shea, Managing Director, Capital Markets Agency Lending at JLL. Lenders and borrowers, like property owners, want to do the right thing, which is why a building’s green credentials factor into borrowing terms more and more. Tenants are demanding greener buildings, so it makes sense to secure green loans to fund energy-efficiency projects. But earning LEED certifications, for instance, is no longer a nice thing to have. However, that’s the cost of doing business in a world where more people are aware of the threats of climate change.
It all started with the Dutch
ING Group, a Dutch multinational banking corporation, issued the world’s first sustainability-linked loan in 2017 to Phillips, another Dutch multinational firm focused on health tech. The €1bn ($1.2 billion) loan tied the interest rate to Phillips’ sustainability performance. By June 2018, ING Group had inked 15 similar deals where it lowered the cost of borrowing by up to 10 percent based on the borrower’s ESG rating provided by Sustainalytics, a firm that rates companies on sustainability metrics. The incentive of lowering borrowing terms for green performance is similar to health insurance companies that penalize smokers. The loan to Phillips extends until 2022, and if the company’s ESG rating goes up, the interest rate goes down (and vice-a-versa). Since that first green loan in 2017, Environmental Finance compiled a list of several other banks that have teamed up with ESG rating agencies to offer similar loans. Most of the loans have been issued in European countries like Spain, Belgium, and France, but the U.S. had two companies (CMS Energy and Avangrid) that received green loan financing in 2018. In Europe, ING also provided Hines with its first green loan in 2021, which will provide an office facility in Frankfurt and finance an urban logistics park near London’s Heathrow airport, according to JLL. Both assets were awarded sustainability certificates and have recorded above-average energy efficiency levels.
The adoption of Green Loan Principles (GLP) was a massive milestone for the market, and it’s helped fuel a period of sustained growth. The principles were adopted with the help of the International Capital Market Association and closely modeled based on the Green Bond Principles, which had been issued in 2014. The Green Loan Principles are voluntary guidelines. Not everyone in the commercial real estate industry thinks the GLPs go far enough, though, and since the principles are voluntary, they don’t have to follow them. Gregor Bamert, head of real estate at Aviva Investors, told Property Week his firm created its green loan evaluating framework because the GLPs didn’t do enough to address the need to retrofit older buildings. Bamert said the Green Loan Principles seem to be more about a borrower’s overall corporate objectives than the loan’s specific environmental impact on an asset.
The age of eco-consciousness
Without mandatory standards, it’s up to lenders and borrowers to set their own internal rules with green loans. Trowers & Hamlins, an international law firm, said, “lenders need to take responsibility for setting their internal standards or ‘eligibility criteria’ for determining what they classify as green projects in the real estate context.” Without doing so, they risk the accusation of ‘greenwashing,’ which refers to deceptively persuading the public the organization’s policies are environmentally friendly when they’re not. Borrowers can mitigate the greenwashing risk by documenting eligible projects for green loan proceeds. The projects should always result in a material improvement of energy efficiency or reduction in carbon emissions. Green loan lenders are advised to be wary of buildings classified as green at the beginning of the loan terms but gradually fail to meet requirements. Trowers & Hamlins suggest lenders and borrowers should agree on ways to assess the eligibility of a building project throughout the life of the loan term, building these assessments into the loan documentation. Lastly, in most green loans, the lender will require the property owner to annually report the use of proceeds until the loan is fully drawn.
Securing green loans comes with benefits similar to green bonds. The positive media attention of securing a big green loan helps bolster company reputation and build stronger relationships with stakeholders and investors, especially the growing interest in ESG. For property owners, a green loan that funds significant energy-efficient or renewable energy projects also helps attract employees and tenants who highly value sustainable commitments. Though lenders of green loans may use different standards, to qualify, you’ll likely have to meet something similar to the four core components of the Green Loan Principles. That includes how the loan proceeds will be credited to a dedicated account and reporting quantitative performance indicators like energy savings to show the impact of the loan. The green projects that a property chooses need to provide clear assessments, measurements, and reporting of environmental benefits.
European capital has been at the center of the green loan market, but momentum is gathering in the Americas and other international markets. With climate change splashed all over the headlines most days, there’s a growing recognition that real estate assets need to step up their game to become more energy-efficient and reduce carbon emissions. Green loans are several sustainable financial instruments that can help property owners do this. While there may be some flaws to the Green Loan Principles, they still serve as a good framework for assessing if you qualify for a green loan and how to manage and report on the use of proceeds over time. If you meet sustainability metrics, lenders will likely offer green loans at more favorable terms, helping property owners meet increasing environmental regulations, save money on energy spending, and build eco-friendly reputations at the same time. This breed of socially responsible investing that helps the planet would probably make religious forefathers like John Wesley proud. Contributing to climate change may not be ‘sinful,’ but it certainly won’t help your commercial real estate business today in an age where being eco-conscious is more crucial than ever.