Given the built environment’s contribution both to greenhouse gas emissions and climate change, lenders that fund real estate projects have found themselves under pressure from governing bodies to show evidence that they are paving the way to a sustainable way of living.
The UK government publishing its Greening Finance roadmap back in October 2021, coupled with the COP27 United Nations Climate Change Conference, illustrated the pressures that lenders face to ensure they are tackling climate change through their lending.
Lenders such as Barclays and HSBC have created sophisticated sustainable debt funds to prove they are aligning themselves with the UK’s world-leading net zero commitment.
In the hotels sector, this in turn creates pressure on borrowers and developers to reduce their carbon emissions, as lenders are now scrutinising sustainable aspects of a hotel real estate project.
As published by the Loan Market Association, green loans exclusively finance green projects whereas sustainability-linked loans (SLLs) do not require the use of proceeds for green projects and instead focus on incentivising improvements to the borrower’s sustainability performance by aligning the loan terms with predefined sustainability performance targets.
If a hotel developer or borrower can illustrate that its hotel asset satisfies the ‘green building’ components, then they are entitled to apply for a green loan to finance a new green hotel concept or refinance a green hotel. Green financing can attract preferential interest rates which, ultimately, offer a commercial incentive for any borrower.
“If a hotel developer or borrower can illustrate that its hotel asset satisfies the ‘green building’ components, then they are entitled to apply for a green loan to finance a new green hotel concept or refinance a green hotel.”
On the other hand, green loans increase the administrative burdens on the borrower and, therefore, developers should assess whether the borrower has the corporate ability to comply with its obligations. Nevertheless, a green hotel will have reduced carbon emissions, thereby creating a positive public image. This is appealing for future investors and lenders when refinanced or sold.
In contrast, SLLs are any type of loan instrument and/or contingent facility that incentivises borrowers’ achievement of sustainability performance targets. A borrower’s sustainability performance is measured by predefined key performance indicators that measure improvements in the borrower’s sustainability profile.
In the context of hotels, the borrower may apply for an SLL to finance a new property. If it is able to meet predetermined energy-efficiency targets, then the interest margin on the loan given by the lender is reduced. SLLs carry a higher reporting burden with which the borrower must comply, as set out in the loan documentation.
Agreeing the correct level of sustainability criteria that the borrower must meet is crucial. It should not be so high that the borrower cannot meet the standards, resulting in a potentially increased margin on the loan and possibly an event of default under the loan facility.
Jack Mitchell is a solicitor at Burges Salmon
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