Greening finance or financing green in the real estate industry

24 February 2020

The City Property Association (CPA) brought together a knowledgeable panel to discuss the evolution of green finance over the last 12 months and looking to the next stage in light of the increasing desire in the London market to implement effective strategies to combat climate change.

Greening finance

Banks are now seeing their clients approaching them directly in respect of green finance mechanisms within their revolving credit facilities.

Key performance indicators (KPIs) linked to green targets set by the borrower are becoming a popular choice. The borrower’s performance against the KPIs will affect its margin percentage under its financing arrangement. If the borrower performs well against its KPIs it will save money by having less margin to provide to the bank which creates a powerful incentive for borrowers to comply with their environmental and sustainability responsibilities.

Often any money made by the borrower from succeeding at its KPIs or failing (thereby benefitting the bank) are donated to third party environmental charities. This way no party benefits from the other's failure or success in its environmental initiatives and also assists borrowers in satisfying their CSR obligations.

The banks are keen to ensure that the KPIs are suitably challenging for the borrower and are not just a way for a business to “green wash” its financing arrangements for appearances only. Borrowers need to be prepared for the bank’s due diligence of the proposed KPIs. KPIs for property companies include:

  • a target to reduce carbon impact in development programmes;
  • targets around biodiversity in development; and
  • energy usage of portfolio properties.

It was acknowledged that for property companies to meet such KPIs they not only need to change their own internal practices, but influence and drive change for their supply chains and occupiers. This could mean considering the drafting in construction contracts which reflect the KPIs and including stringent green lease clauses for compliance by tenants to support an energy usage KPI.

Financing green

Across the industry and within the climate discussion more generally, a particular area of concern is de-carbonising existing building stock, rather than constructing “net zero carbon” new builds which is often the more appealing focus area.

Residential buildings and older commercial buildings will most likely require financial support to encourage property owners to undertake the necessary environmental changes (retrofitting) to their existing properties. At present, there are few such financial incentives in the UK.

The Green Finance Institute has established the “Coalition for the Energy Efficiency of Buildings”, which has an ambitious target to produce and bring to market a portfolio of finance products that enable greater retrofitting of existing building stock in time for COP26 (the next UN climate conference in Glasgow in December 2020). For example, a potential innovative mechanism is for debt to be linked to the property itself so that the financial burden of repaying a fit-out loan can be shared between the owner and any new occupiers. The publication of their initial review and findings is expected in Spring 2020.

We expect retrofitting to become more common and the associated costs may be addressed in green lease provisions for commercial buildings sharing the burden between tenant and landlord. For residential properties drafting will be required for legal charges relating to loans for retrofitting work. The charges will apply to the property over a number of years binding several owners of a property until the original loan is paid off, thereby enabling the initial cost of the retrofit to be shared with the future owners of the property that benefit from the changes.

It is undoubtable that green finance is an innovative aspect of the market that will become increasingly appealing for many of our clients and eventually the norm.