In recent years, investors across a variety of industry sectors have increasingly focussed on Environmental, Social and Governance (ESG) criteria when investing and managing their investments. When it comes to investing in real estate, financial performance is of course the primary driver behind investment decisions. However, it is no longer the only focus.
Real estate investors are expected to ensure that their assets satisfy the ‘E’, the ‘S’ and the ‘G’, of ESG. Buildings are expected to be constructed and operated in a manner which meets certain environmental standards. They must have a positive social impact and those involved in buying, building or managing real estate assets are expected to be governed in a responsible manner.
When it comes to investing in bricks and mortar, it is possible, and in some cases relatively easy, to embed ESG standards within those investments. However, when it comes to lending on bricks and mortar, it is not quite so easy. Nevertheless, real estate lenders are fast altering their business models to ensure that their loans are compliant with ESG criteria.
Putting to one side the increasing array of legislation which is slowly introducing mandatory compliance with certain ESG principles, a failure to embrace sustainable lending will leave businesses operating in the real estate loan sector at a distinct competitive disadvantage.
Principles on Sustainable and Green loans
The Loan Market Association (LMA) is the industry body for the syndicated loan market in EMEA and seeks to establish accepted market practices across the loan market, including the real estate loan market. The LMA is fully engaged in promoting growth and innovation in the sustainable and green lending markets, including helping to standardise various documentation and clauses to support ESG lending.
In May this year, the LMA published the Sustainability Linked Loan Principles (SLLP) which are aimed at incentivising a borrower’s achievement of ambitious, predetermined sustainability performance targets, measured against categories including energy efficiency, water consumption and usage of recycled materials. This follows on the back on the LMA’s Green Loan Principles (GLP) published in 2018. The GLP comprised voluntary recommended guidelines, to be applied on a deal-by-deal basis that sought to promote integrity in the development of the green loan market by clarifying the instances in which a loan may be categorised as ‘green’. These principles set out a framework, enabling market participants to clearly understand the characteristics of a ‘green’ loan, based around four core components including the use of loan proceeds, the process for project evaluation and selection, the management of loan proceeds and reporting criteria.
The establishment and compliance with principles like SSLP and GLP, whilst not mandatory, is important in giving investors’ confidence that lenders are not participating in ‘greenwashing’ (i.e. conveying a false and misleading impression as to how ‘green’ its products are).
When it comes to the loan documents utilised in the real estate lending sector, there is not yet any standardised set of documents or clauses used on loans which seek to address the ‘E’, ‘S’ and ‘G parts of sustainability. However, some common features are now emerging which incorporate ESG into loan documents.
The most common feature is to introduce an interest rate reduction where the borrower hits certain environmental targets – for example 5 or 10 bps – with borrower donating any savings from the margin reduction or towards further sustainability objectives. Other features include undertakings imposed on borrowers to provide ESG-related reporting, conditions precedent introduced which impose requirements to satisfy certain standards of sustainability.
As the real estate industry becomes more attuned to issues around ESG and sustainability, those lending on real estate projects will inevitably have to adapt their business models to ensure that they can operate their own businesses alongside the objectives of their clients. Whilst these issues are unquestionably de rigueur, it is abundantly clear that a measurable focus on ESG in the context of real estate lending will soon become the norm rather than the exception.
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