Mother nature has been the most persuasive advocate in climate change awareness. Severe weather events are no longer exogenous as one in three Americans have experienced a weather disaster this summer. These include California’s forest fires ravaging communities and Category 5 hurricanes on the east coast containing sustained headwinds of 156 mph, displacing people and livestock alike. These drastic climates are not peculiar to just the United States either. Increased number of heatwaves and increasing frequency of hot days have resulted in sea level rising, impacting coastal regions globally. Morgan Stanley estimates it would cost $50 trillion to decarbonize the world.
The need for dire investment to combat climate change has influenced both private and credit markets alike, as staggering capital has mobilized across environmental matters widely. In 2020, $700billion of green, social and sustainable bonds were issued, nearly doubling 2019’s $358 billion, according to the Climate Bonds Initiative. JLL estimates that investment products tailored for ESG could grow to more than $53 trillion of assets by 2025. Green bonds are fixed-income instruments that raise capital to finance sustainable projects, thereby aligning both lenders and borrowers’ priorities on sustainability across industries.
When narrowing where to generate the greatest impact in deploying ESG financing, look no further than real property. The real estate industry is responsible for 13% of the U.S. GDP, while accounting for 40% of all CO2 emissions, according to Fifth Wall’s CEO, Brendan Wallace. Real estate’s outsized impact on climate change has led to a proliferation of green debt financing. Long term, severe climate change contains consequences for both borrowers and lenders as buildings deteriorate Karen Shea, Managing Director of U.S. Capital Markets Agency Lending at JLL, has deduced that we are now at a point when a building’s green credentials are increasingly being factored in when borrowing. According to National Australia Bank, borrowers who pay close attention to the sustainability of both existing and new buildings are regarded as less risky in the long-term and worthy of better pricing.
This consideration was significant when real estate conglomerate ISPT entered into Australia’s largest-ever sustainability linked loan (SLL) in May, a $2.8billion facility aimed to improve sustainable outcomes across its operations. Loan parameters require ISPT to improve the sustainability performance of its core property portfolio across four key metrics: greenhouse gas emissions intensity, water consumption, waste reduction and labor certification. ISPT is in alignment with its ESG Strategy and their “Flag on the Hill” 2025 targets, including “100 per cent renewable electricity consumption, zero organic waste to landfill and a 30per cent reduction in water usage.”
The challenge historically for green financing is the difficulty of commercial real estate developers and operators to deviate from their common practices to being environmentally conscious, chiefly because they have tended to operate from a purely financial vantage point. However, green financing may be an attractive enough incentive for operators to change. Green financing can often deliver favorable margins in the form of lower interest rates for sustainable outcomes whilst containing clauses to potentially pay higher interest if targets are not met (audited by an external third party). In practice, earlier this year LondonMetric refinanced with a debt placement that included a £50m green tranche. That 15-yeartranche had a coupon of 2.43%, two basis points lower than an equivalent non-green 15-year tranche.
However, attractive lending margins do come with strings attached. Green lending requirements may include energy performance targets akin to achieving a 60% reduction in carbon emissions within assets under its operational control. Assets failing to reduce carbon emissions to the necessary levels may face a 75 bp penalty before bond maturity. Despite the difficulty some operators may experience adopting to sustainable practice, cutting lending spreads is always top of mind for Sponsors with long investment durations. In addition to attractive rates, funds, listed companies and private equity investors alike have begun to adopt corporate net zero targets, so green financing also satisfies shareholder ESG pressure. Ultimately, green financing expands the general awareness of the basic importance of ESG and climate issues.
Transforming buildings is the biggest priority for green bond issuers, and by directly linking long-term financial incentives to measurable improvements in environmental performance for collateralized buildings, borrowers are forced to consider sustainability factors in a more meaningful way. Himanshu Raja, CFO at the multi-national U.K. development firm Hammerson, believes there will be “far fewer” debt issuances without a green framework moving forward. If nothing else, green financing is a continuation of integrating sustainability into everything we do.
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