In today’s topsy-turvy commercial real estate market, getting a loan with favorable terms seems like an impossible dream. Interest rates were not hiked in the most recent Fed meeting, but they remain at a 22-year high. Banks, keen to reduce their risk, have tightened up lending, enacting stricter standards for potential borrowers to meet. But despite this difficult landscape, lenders are increasingly taking a shine to properties with more green qualities and shifting away from buildings that lack energy efficiency and other sustainable features, or what many term brown assets.
Describing assets and lending as “brown” or “green” are descriptions typically used in European finance circles, but it’s something being discussed a lot in the U.S., too. Brown properties tend to be older structures that aren’t very energy efficient and may not meet mandates for greenhouse gas emissions and decarbonization. Properties that are termed green are those that address issues around sustainability and decarbonization. Owners of these buildings are typically striving to achieve a net zero footprint and/or are sharply reducing the property’s carbon footprint. Green lending is financing structured in a way that enables borrowers to use the loan exclusively for projects that make a substantial contribution to environmental and sustainable objectives.
Green finance has seen record growth in recent years. In 2021, the green finance market exceeded $720 billion in the U.S., according to Forrester Research. It’s a market that includes green bonds, green loans, venture capital and private equity funding for green tech, green IPOs, and green acquisitions, which use funds to buy companies that bring environmental benefits. Forrester estimates that green loans exceeded $135 billion, driven by increased consumer and business demand that enabled some financial services firms to post double-digit growth in those loans. Some of the world’s largest banks are committing to green finance, including HSBC, which said in 2020 that it was earmarking $1 trillion to help clients transition to net zero emissions as part of the bank’s goal of net zero emissions across its entire customer base by 2050. Despite the growth in green loans, many companies and investors say they are having a difficult time obtaining them. According to a recent HSBC survey, 40 percent of respondents said the top barrier to creating more sustainability in their portfolios is finding financing.
In the nation’s largest office market, New York City’s landmark greenhouse gas emissions legislation, Local Law 97, requires owners of buildings more than 50,000 square feet to sharply reduce their emissions and energy usage. “Overall, banks are more likely to take a more cautious approach when evaluating commercial real estate, especially in urban cities like New York City,” said Steve Schleider, New York Tri-State Leader of the Valuation and Risk Advisory platform at JLL, in a recent podcast. Because of the penalties owners can face if found to not be in compliance with the law, banks may have to adjust their underwriting criteria to account for those potential penalties and potentially reduced property values associated with non-compliance. These factors are something banks may consider when evaluating the collateral value of a property as well as borrowers’ ability to repay the loan if it calls for capital improvements in order to do retrofits to meet these thresholds. “It could potentially be a disruptor for the commercial real estate industry,” Schleider said. “Banks already have had so much stress with interest rate environments, layering in this type of long-term compliance issue may also be something they can’t afford to kick down the road any longer.”
What’s leading banks to care more about green assets, or collateral, comes from a few different directions. “It goes toward corporate citizenship,” said Schleider. “It makes sense from an ESG view.” Office building owners, who are fighting to get spaces leased amid ongoing remote work trends, want their buildings to be attractive to tenants and situated within a more competitive framework. Tenants themselves have ESG commitments and metrics that hinge on whether a building is green or has certain occupancy levels. If a bank wants to lend against a property, one of the underwriting criteria for the risk profile surrounds whether the property is in compliance with local laws. “That’s the way to make sure banks are shifting from brown to green and reinforces the necessity to move from a brown to a green profile,” Schleider said.
A growing number of local, state and even federal regulations regarding building performance standards and the popularity of green building certifications with developers are further pushing banks to look more favorably at green buildings. Upfront investment in green building makes properties more valuable, according to the United States Green Building Council, which found that a growing number of building owners are seeing a 10 percent or higher increase in asset value, and the percentage of owners reporting that uptick has nearly doubled over the last decade. Building without upgrades and retrofits to systems like HVAC and lighting, and other upgrades that could help lower operational costs, a property may be less attractive to a lender, and potential loans could carry higher interest rates due to the risk value they see. “Among the investment community trying to position green versus brown, you might see a green property that has already gone through retrofits and can meet the first line of mandates,” Schleider said. “So as an owner, you need to think very carefully if you’re going to comply today, tomorrow, or roll the dice and never have to comply, but that’s a false sense of security.”
Adding another wrinkle to the issue is the rise of anti-ESG laws. A number of states have passed or are looking to adopt laws that restrict the use of ESG factors in making investment and business decisions. Proponents of the laws say ESG threatens investment returns and uses economic power to implement business standards beyond those required by law. But whether or not states are passing these laws or what the perceived political bent of making green choices will have on a business, the mandates to reduce carbon footprints and building emissions are still there and still need to be met. “The social and political will to have the buildings come into line to reduce their carbon footprints, that’s the impetus for all of this,” Schleider said.
The value in greener, more sustainable buildings is becoming more clear not only to the commercial real estate market but to the lending community as well. As more cities and states adopt regulations aimed at decarbonizing the building sector through limiting greenhouse gas emissions, it will continue to put pressure on owners to more closely scrutinize their building’s performance and seek to upgrade and retrofit properties in order to bring them into compliance. Despite growing anti-ESG sentiment, office tenants, commercial real estate developers, and banks looking to deploy billions and trillions of dollars in sustainable and green finance are all looking to meet their ESG obligations. If the growth in green loans continues on the same path, it’s been on and banks continue to look more favorably at green assets over brown, the hurdles to obtaining green financing may start to disappear.
