ESG Bona Fides Paying Off As Lending Standards Tighten

ESG lending is gaining momentum in the real estate lending community – and perhaps at no better time.

CRE lending standards are tightening even further because of ongoing global banking troubles. Borrowers supporting their applications by substantiating their ESG metrics could find it easier to get a loan across the finish line in a tightening market.

Borrowers should make a strong effort to demonstrate their ESG bona fides, according to a new report from CBRE.

CBRE said that the most advanced ‘ESG-aware’ lenders are those with institutional parentages, such as pension funds whose parent companies have strong ESG policies which they want to implement across all activities.

It’s been driven from the top down in recent years, according to the report.

“This in turn is often because of pressure on the parent companies from their own equity investors. These firms can’t now credibly commit to (for example) a net zero target without including the lending part of their business in it.”

CBRE said lenders are increasingly integrating ESG into lending decision-making, with lending eligibility criteria becoming more commonplace.

“Borrowers should be mindful of this when capital raising to obtain finance at the best terms from the widest pool of potential lenders,” according to the report.

Clearly Defined ESG Commitments Ideal

Sara Neff, Lendlease’s Head of Sustainability, US, tells GlobeSt.com that in today’s constrained lending environment, experienced sponsors with clearly defined ESG commitments are best positioned to obtain debt financing.

“While ESG has not historically played a significant role in lender underwriting, more banks are evaluating the ESG performance of not just the underlying asset but also the borrower to ensure their practices comply with the expectations and requirements of shareholders and other stakeholders,” Neff said. “They also view lending to ESG-focused sponsors as a means of risk mitigation, as they recognize that investments in this area support the long-term value of the projects they are financing.”

Lendlease recently secured $360 million in construction financing from a four-bank syndicate for 1 Java Street, a mixed-use multifamily development along the Greenpoint waterfront in Brooklyn.

“These lenders were drawn to Lendlease’s industry-leading corporate ESG initiatives – as part of its Mission Zero campaign, the company has committed to achieving absolute zero carbon across scopes 1, 2, and 3 globally by 2040 – as well as the sustainable fundamentals of the project itself, which will be the largest geothermal residential building in New York State, if not the country, when complete in 2025.”

Demand from Tenants and Owners

Reid Thomas, chief revenue officer and managing director at JTC Americas, responsible for overseeing the day-to-day operations of the Specialty Financial Administration business unit tells GlobeSt.com that for borrowers, the benefits of factoring in ESG go beyond obtaining better financing terms.

“Increasingly, real estate developers are recognizing that there is demand from tenants and owners for green buildings, offices, or homes – and studies show that there is a willingness to pay a premium for such spaces,” Thomas said.

“This means developers who embrace the incremental reporting requirements for green loans will also benefit from being able to charge higher rent and/or sales premiums and will have a more valuable asset upon disposition.”

Lenders Are Quantifying Risks

Tony Liou, president of Partner Energy, tells GlobeSt.com that ESG provides a broader view of risk, and this is about banks evaluating risks, including risks on the asset and borrower.

“We agree and are seeing more organizations, such as CMBS and pensions funds, adopting more ESG policies,” Liou said. “CREFC and organizations in the US are also working on ESG questionnaires for lenders, including pension funds with lending programs.

“To me, this is about quantifying risk. A common question asked in these questionnaires is whether the property sits in a regulatory environment that requires energy disclosures.”

Liou said an example is NYC Local Law 97, where most buildings over 25,000 square feet will be required to meet energy efficiency and greenhouse gas emissions limits by 2024, and those properties not in compliance will be subject to penalties, which can also affect the value of the assets.

“So, regulations cannot be ignored,” he said.

Another common question is about climate hazards and property resilience.

“Understanding how resilient the property is to climate hazards is about understanding physical risks, and lenders can’t turn a blind eye to that,” Liou said.

Other items to address include whether there are high energy-efficiency items or renewable energy on-site.

“These are best practices that can increase the value of the property,” according to Liou. “Understanding this information is not only beneficial to the bank, but also to understand their fiduciary responsibilities.

“Aside from green loan programs supported by agencies like Fannie, Freddie, and HUD, there aren’t any other programs that provide discounts on the interest rates. There are opportunities here to help borrowers improve property resiliency and reduce operating costs.”

Pressure from Local & National Regulatory Bodies

Anne Hill, SVP, Bayview PACE tells GlobeSt.com that borrowers are actively seeking alternative financing amid the tightening capital markets and there is still significant pressure from local/national regulatory bodies as well as institutional investors to employ green-building upgrades to reduce carbon footprints and meet climate change objectives, including New York City’s Local Law 97.

“Developers and investors seeking ESG-friendly financing are increasingly adding Commercial Property-Assessed Clean Energy financing (C-PACE) in their capital stack,” Hill said.

“C-PACE in commercial real estate is not only popular for new construction but owner/operators are also utilizing it for property redevelopment that addresses deferred maintenance or performs upgrades to attract tenants.”

Hill said that as C-PACE financing continues greater adoption, having passed a milestone of over $4 billion in total financings according to PACENation, commercial real estate owners and developers as well as their traditional lending sources are putting this green finance alternative to use to build new, refinance or make needed improvements.

ESG Momentum Building Among REITs

Uma Moriarity, Global ESG Lead & Senior Investment Strategist at CenterSquare Investment Management, tells GlobeSt.com the ESG momentum has been building and from a real estate perspective, she has seen it appear for the REITs in these ways:

• Increasing number of green bonds being issued to help fund green building efforts. It’s difficult to quantify the impact this is having today from a pricing perspective, but before the debt markets went into chaos, folks were claiming that green bonds were pricing better than non-green bonds. Part of this is likely due to green bonds increasing the investor base, so you’re seeing more demand – you’re able to not just reach traditional real estate lenders, but also ESG lenders.
• Lines of credit increasingly include green addendums that allow for spreads to decrease (typically around 1bp) on their spreads based on reaching certain sustainability outcomes (can be based on ratings improvements from GRESB, increasing the number of green certifications in their portfolio, etc.)
• Credit ratings agencies are increasingly looking at physical climate-related risks as part of their credit quality analysis – for example, Moody’s acquired Four Twenty Seven to assess this for real estate.

‘Climate Change Is Not Going Away’

Breana Wheeler, director of operations at BREEAM USA, tells GlobeSt.com that in the context of today’s market, a focus on ESG is imperative not only because the need to act is clear from the science, but also from a financial and operational risk management perspective.

“In tandem with the overall business case for deploying stronger ESG strategies, momentum for ESG-linked finance has also picked up in recent years as stakeholders gain a better understanding around the role ESG plays in an asset and portfolio’s larger risk management strategy and approach to opportunity capture,” Wheeler said.

“The reality is that climate change is not going away — and the risk it poses on the commercial real estate sector is not only present but growing. To ensure business continuity through difficult times, owners and operators should leverage strategic ESG initiatives as tools to foster the short- and long-term health of a development, and to consistently increase asset value.”