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Insight

Green Buildings and Real Estate Finance implications

Sustainability and efficiency of real estate assets is increasingly important for occupiers and investors. European lenders are taking an active interest in 'green' buildings and increasingly committing to more sustainable practices.

Sustainability and efficiency of real estate assets is increasingly important for occupiers and investors. European lenders are taking an active interest in 'green' buildings and increasingly committing to more sustainable practices. Real estate services firm JLL has stated, in its most recent sustainability report that it has now transitioned 30% of the buildings it manages for clients to a renewable electricity contract and been working with the UK Green Building Council's Advancing Net Zero programme aims to help the industry hit zero emissions by 2050, and ensure that all new buildings meet net zero standards by 2030.

The green building movement within the real estate sector has been bolstered by the recent report published by M&G (Green buildings: what are the financial benefits for investors?) which publishes the results of a study reviewing the financial benefit to investors of owning certified green buildings relative to non-certified buildings.

So, what are certified green buildings?

According to the World Green Building Council, a 'green' building is a building that, in its design, construction or operation, reduces or eliminates negative impacts, and can create positive impacts, on our climate and natural environment. The UK Green Building Council's mission is to radically improve the sustainability of the built environment, by transforming the way it is planned, designed, constructed, maintained and operated.

There are several different green building ratings used internationally. The Leadership in Energy and Environmental Design (LEED) is a rating system developed by the US Green Building Council. The rating system developed in the UK is known as BREEAM (Building Research Establishment Environmental Assessment Method).
 

And, how does the UK measure up internationally?

Internationally, Canada is the frontrunner for green buildings with over 50% of office stock in Vancouver and Toronto being certified as 'green'. In Europe, Stockholm has been leading the way. Stockholm has one of the most aggressive commitments to transforming its real estate with a government issued goal of increasing the energy efficiency of buildings by 20% in 2020 and 50% by 2050.

The London real estate market lags somewhat behind its international counterparts having only 9% of its buildings as LEED or BREEAM certified in 2016, though some of this must be down to London's plethora of older buildings.  The UK does, however, have some green buildings to be proud of – One Angel Square, The Co-operative Group's new head office in Manchester has been billed as the world's most environmentally friendly building. It is the only commercial building in the UK to achieve maximum ratings in energy and sustainability performance by the three main rating systems. It has an A rated Energy Performance Certificate and Display Energy Certificate and BREEAM outstanding accreditation, making it one of the largest buildings in the world to have an outstanding BREEAM rating. The newly unveiled Bloomberg HQ in London has also achieved the highest-ever BREEAM rating for office buildings – the most eye-catching energy-saving feature being the half a million LED lights embedded into its bespoke ceiling panels – using 40% less energy than a typical fluorescent office lighting system.

But, why should the real estate market be interested?

The findings of the M&G study have shown the economic benefits of investing in green buildings. According to the study, the certified share of M&G European assets achieve a higher rental income (+53bps) and although, certified buildings experience higher operating costs (+31bps), on balance, the rental revenue premium compensates for the increase in operating expenses, resulting in a high distributable income to investors (+19bps). The M&G report also concluded that if certified buildings are typically associated with higher rental values and lower tenant incentives, this also lends itself to a more stable income profile that is less sensitive to changes in economic conditions.

How has the UK real estate market embraced green initiatives to date?

As cities commit to greener initiatives, real estate lenders have sort to benefit from this activity and seize a share of the growing green investment market. Notably, Lloyds Banking Group launched a major new £1bn Clean Growth Finance initiative in 2018 . This initiative provides businesses with discounted lending for green projects. Borrowers will be incentivised through a margin discount of 20bps on purchases over £10 million with the borrower required to deliver on a number of green commitments. Other UK banks have also followed suit with Barclays announcing plans to launch a green mortgage where buyers of new-build energy efficient homes can access lower interest rates.

What about the Loans Market Trade Bodies?

The LMA (UK) published (jointly with the LSTA (US), and APLMA in Asia-Pacific), the Sustainability Linked Loan Principles on 20 March 2019. This joins the LMA's previous publication of the Green Loan Principles.
The SLLP are voluntary guidelines that enable lenders to incentivise improvements in the borrower's sustainability profile by aligning loan terms (for example, margins) to the borrower's performance against pre-determined sustainability performance targets (SPTs). For example, sustainability linked loans will align the borrower’s performance to margin over the life of the loan. In some instances, a loan may be structured to allow for its categorisation as both a green loan, aligned with the Green Loan Principles, and a sustainability linked loan. Common categories of SPTs include: energy efficiency (e.g. improvements in the energy efficiency rating of buildings owned by the borrower), sustainable sourcing of raw materials and supplies, increases in recycling rates or use of recycled raw materials and supplies, water consumption and use of renewable energy.

Conclusions

The M&G report shows that green buildings are not just for the environmentally conscious but also have proven financial benefits for real estate investors. We think that green building ratings will become increasingly relevant for the credit analysis of real estate lenders with financial models and rental income assumptions being tweaked to take into account the financial benefits of green buildings demonstrated by the M&G study.

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