Lenders hold back CRE sustainability, ULI and PwC say

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Lenders and regulators are not doing enough to push the real estate sector to decarbonise, according to a major new report released this week. This is a missed opportunity that could have serious consequences for the planet.

The Urban Land Institute and PwC’s Emerging Trends in Real Estate Global report said that as a group, property lenders are too passive, in many cases taking the position that it is their duty to follow where customers lead in sustainability, rather by using the leverage they have to push customers to change.

Regulators could do more to make it more profitable for banks, in particular, to lend to the greenest real estate or make loans that make existing properties greener.

And there’s another problem the industry as a whole needs to address, according to ULI and PwC — right now, even if your building isn’t green, there’s so much money lying around in real estate that you you can probably always find someone to lend against it or buy it. That will change, but this abundance of cash is slowing the pace of change.

But the report says the first signs are emerging of a world where if your building is a big carbon emitter, you won’t be able to borrow at all.

The real estate industry’s eyes are on how the pandemic will influence the environmental, social and governance movement.

“The pandemic has already reinforced the importance of ESG for everyone in real estate,” ULI Europe Managing Director Lisette van Doorn said in the report. “In fact, interviews for Global Emerging Trends indicate even greater concerns this year about capital and operating expenses and the risks associated with real estate being fit for purpose.”

The Organization for Economic Co-operation and Development calls for $7 billion to be invested each year by 2030 to ensure the world meets climate and development goals. “It will mean a historic reallocation of capital into real estate,” said one of the people interviewed anonymously for the report.

Some interviewees for the report said banks have the ability to catalyze their borrowers towards adopting greener practices, while others believe they can only follow, especially in times of abundant liquidity.

“The glut of cash looking for home loans is making it more difficult,” one said. “To be frank, borrowers who aren’t so green can still get financing. So until liquidity dries up over time, you can’t really force borrowers to adopt green practices. Quantitative easing has gone on for too long.

In a world where debt financing is less abundant, lenders will have the ability to make borrowers adhere to certain criteria, playing an active role in promoting sustainability. “We feel that as lenders we have a responsibility to lead customers towards this goal,” said one interviewee. But some respondents said this was not the appropriate role for lenders.

“We’re not saying we’ll stop funding buildings that aren’t green,” one said. “We’ll never do that just because it’s not the reality of our client universe, and it doesn’t actually help the transition. It just takes liquidity out of the market.

Most respondents said they believe lenders, particularly banks, are one step behind owners, investors and developers in understanding that financing renovations and improvements to existing stock would have the greatest impact on reducing carbon emissions in real estate.

“We finally realized the fact that, quite simply, if you tell customers, you will only finance [existing] green buildings, you’re not really contributing, are you? said one lender. “If a customer comes to you and says, okay, we’re going from brown to green, you have to put your money where your mouth is. And so that’s what we’re going to do more of. But we’ve been burnt out by development before.

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The discussion of environmental sustainability in lending needs to go beyond labels, and figuring out how and where to put funds can be complicated. For example, debt funds often finance value-added renovation programs. These unregulated funds are considered less likely than banks to have a defined sustainability strategy or framework. But by financing such renovations, they participate in the green transition, even if the debt they grant is not qualified as a green loan.

At the same time, many lenders will provide “green development finance” to projects that will have a high energy efficiency rating when completed, regardless of the embodied carbon created by a project. In this sense, they are financing a project that creates a significant amount of carbon but is still considered green.

“It’s so difficult to measure embodied carbon, and there’s no standard definition or measurement of it, and that makes it difficult for lenders,” one interviewee said.

Not all lenders in the industry are passive. An interviewee for the report spoke of the establishment of a green lending framework specifically designed to help small and medium enterprises access green finance, to encourage them to decarbonise their portfolios. These companies typically don’t have the resources to develop their own green lending strategy or employ an ESG specialist, so the lender has to do the heavy lifting for them, according to ULI and PwC.

These small businesses will be vital if the broader real estate sector is to reduce its emissions. Real estate is a long-tail industry, where even the biggest players own only a tiny fraction of the global real estate stock.

“We developed a framework with SMEs in mind because we know they are the ones that have the most difficulty refinancing themselves,” the interviewee said. “And the costs of getting a green loan, hiring a specialist consultant, for these borrowers is prohibitive. We have certain parameters. If the client is able to meet those parameters, they can get a green loan. on our side. ”

Some interviewees said regulators have leverage that could be used to incentivize banks, in particular, to take on more green loans.

When banks make a loan, they must hold a certain amount of capital on their balance sheet to protect against losses in the event of default on the loan. The less risky the loan, the less capital they need to hold and the cost of capital to make that loan goes down.

If banking regulators designated more sustainable housing loans as less risky, the cost of capital for these loans would be reduced and they would become more profitable for banks, encouraging them to take out more of these loans.

If loans to refurbish existing assets are designated as less risky than loans for new developments, then banks would have an incentive to make more of these loans, rather than finance new developments which may not be needed and could be clearly harmful to the environment.

“The banking community has spoken to the European Central Bank asking, can you link capital consumption to sustainability in any way? And the answer has always been good, no, sustainable assets aren’t necessarily less risky. So no, we can’t,” said one interviewee. “The mechanism exists in the infrastructure world, where social infrastructure loans need to have less capital held against them. sustainable properties were considered less risky, you could invest more or finance more competitively.

Some interviewees raised the prospect of a world where banks only finance green properties, and where borrowers who are suddenly unable to refinance resort to legal action due to a lack of agreement on what constitutes a green building.

One lender said it aims to grow its loan portfolio to 25% green loans, a target that will increase over the next few years. To achieve this goal, at least 50% of their new loans must be for green properties – your chances of getting financing from this lender drops by 50% overnight if your property is not green.

“Banks are starting to say, right now we’re giving you a quarter point incentive, in the next 10 years we’re going to say we’re not renewing your loan unless we see certain types of green improvement,” one interviewee told ULI and PwC. “It’s quite controversial, because borrowers say, if we can’t even agree on what the baseline is, how are we going to agree on what the improvement is and if you arbitrarily cancel my loan, that’s cause for litigation.

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