In recent years, investors across sectors have increasingly focused on environmental, social and governance (ESG) criteria.
Real estate investors are expected to ensure their assets satisfy the ‘E’, ‘S’ and ‘G’ of ESG. Buildings are expected to be constructed and operated in a manner that meets certain environmental standards; they must have a positive social impact and those involved in buying, building or managing real estate assets are expected to be governed in a responsible manner.
Real estate lenders are also altering their business models to ensure their loans are ESG compliant. In May this year, the Loan Market Association (LMA) published the Sustainability Linked Loan Principles, which are aimed at incentivising a borrower’s achievement of predetermined sustainability performance targets, measured against categories including energy efficiency, water consumption and use of recycled materials.
This follows on the back of the LMA’s Green Loan Principles published in 2018, which set out guidelines to clarify when a loan may be categorised as ‘green’.
When it comes to the loan documents utilised in the real estate lending sector, there is not yet any standardised set of documents or clauses, but some common features are now emerging that incorporate ESG into loan documents.
The most common feature is for the lender to agree an interest rate reduction where the borrower hits certain environmental targets, with borrowers donating any savings from the margin reduction to charity or towards their own further sustainability objectives.
Other features include the lender imposing undertakings on borrowers to report on KPIs, which are linked to ESG criteria, or the lender demanding that the property satisfies certain standards of sustainability as a condition to loan drawdown.
While these issues are unquestionably de rigueur, as investors continue to become more attuned to issues around ESG and sustainability, it is clear that a measurable focus on ESG in the context of real estate lending will soon become the norm rather than the exception.
James Walton is banking and finance partner at Edwin Coe