TEN TRENDS FOR A ZERO CARBON WORLD
07. The colour of money
If the current growth trajectory in sustainable finance continues – and we expect an acceleration – it will have major implications for how real estate development and investment is funded. Indeed, this could be a driver that reshapes the entire property industry, with ESG principles becoming an essential component of financial viability.
Global issuance of ESG bonds increased from around $150 billion per annum just four years ago to over $400 billion in the twelve months to mid-20211 – a clear illustration of the momentum behind the green finance market. The UK government’s September 2021 ESG Gilt auction saw $13.5 billion of bonds receive $135 billion worth of bids, whilst logistics-focussed UK REIT SEGRO recently issued a $580 million green bond which was eight times oversubscribed2. This growth is a global phenomenon. Net new money flowing into US ESG investment funds in 2020 is estimated to have more than doubled to over $50 billion, up from $21 billion the year before – and ten times the annual $5 billion level seen in previous years.
GREEN BOND ISSUANCE
The growth in Socially Responsible Investing (SRI) and financing has direct implications for real estate, in several ways. From an equity perspective, a 2020 survey of over 800 institutional investors4 found that 44% of funds following ESG strategies were investing in property – meaning they have sustainability targets hard wired into their investment decisions. In making ESG an explicit focus, these funds are at one end of the spectrum and are set to grow rapidly given that green buildings could represent a $25 trillion investment opportunity by 20305. But as we discuss in Risk and returns6, all investors are under increasing pressure to build sustainability into their investment activity. Things are changing on the debt side of the equation as well, with many banks now setting ambitious ESG lending targets. In April 2021, Bank of America more than trebled its goal for sustainable loans and financings to $1 trillion by 20307 – on top of an existing pledge of $500 billion to support socially inclusive lending to sectors like affordable housing; whilst Goldman Sachs is committed to a target of $750 billion of sustainable lending.
All investors are under increasing pressure to build sustainability into their investment activity.
INCORPORATION OF ESG FACTORS INTO REAL ESTATE PORTFOLIO MANAGEMENT PROCESS
The volume of capital for investment or lending that will be deployed according to ESG principles is set to grow exponentially because, in addition to market demand for ESG products, we are at the thin end of a global wedge of regulatory pressure. The Taskforce on Climate-related Financial Disclosure (TCFD) guidelines requiring firms to disclose their exposure to climate risks will become law for most companies in the UK and Canada in the coming years8. With compulsory reporting backed in principle by the G7, levels of disclosure are likely to rise in most market economies.
In the EU, the Sustainable Finance Disclosure Regulation (SFDR) requires financial sector firms (including pension funds, insurance funds, asset managers and banks) to fully disclose the ESG impacts of their investment decisions along with their exposure to all ESG risks9. Perhaps more important, it also sets out rigorous rules on how these are measured and reported. This will drive a material increase in genuine transparency, which will in turn accelerate market pressures on the financial sector to genuinely address ESG issues throughout their business activities.
In Europe at least, every lending or investment decision will have to be made with at least some reference to ESG or SRI criteria.
In future, companies that are sincerely committed to driving forward the ESG agenda will find it easier to prove their credentials. This will enable them to tap into the growing pool of SRI capital, much of it coming from retail investors, where a key challenge is differentiating true ESG performance from the “greenwash” of carefully crafted PR messaging. Anything that drives rigorous, comprehensive, standardized reporting will provide confidence to investors and boost growth in ESG funds – who will have to be increasingly discriminatory in where they place their money. Those who may be less inclined to place ESG at the heart of their activities will still be impacted. Lenders who are required to identify, price, and disclose their ESG risk will be forced to discriminate against borrowers who are not actively working to mitigate those risks.
The ESG investment landscape therefore offers both opportunity and threat. In the US, Greenworks Lending (an affiliate of global asset manager Nuveen) provides long-term financing for energy efficiency, water conservation and renewable energy projects including new construction and retrofitting. Public sector authorities are developing opportunities for city wide energy, building and infrastructure solutions, which offers up opportunities at scale for private sector investment through various vehicles, funds, and financing models.
Anything that drives rigorous, comprehensive, standardised reporting will provide confidence to investors and boost growth in ESG funds.
In the UK, the government has mandated that commercial buildings that are leased to a tenant must meet certain energy performance criteria by 2023, with even greater restrictions coming into force over time. It is estimated that 85% of existing commercial buildings in the UK will require retrofitting to meet the minimum performance level in 2030, requiring significant investment by landlords which will drive demand for new capital or loans. Establishing funds specifically targeting this market represents a clear opportunity; for example, UK financial group Aviva Investors has committed to originating nearly $1.4 billion in real estate climate transition loans by 202510.
On the other hand, while many organisations now offer mortgage financing which includes some support for retrofitting, few organisations will be willing to lend on a UK property that will be legally un-lettable by 2030 without some form of guarantee that remedial action will be taken. Driven by a rising tide of regulation, a growing pool of capital seeking sustainable investment opportunities and demand for investment to reposition assets for an era shaped by ESG considerations, green finance will be one of the fastest growth opportunities in real estate.
1Climate Bonds Initiative https://www.climatebonds.net/files/reports/cbi_pricing_h1_2021_03b.pdf 2https://www.segro.com/media/press-releases/2021/16-09-2021?sc_lang=en 3https://www.cnbc.com/2021/02/11/sustainable-investment-funds-more-than-doubled-in-2020-.html 4RBC Global Asset Management: https://www.rbcgam.com/en/ca/about-us/responsible-investment/our-latest-independent-research 5https://globalabc.org/sites/default/files/inline-files/2020%20Buildings%20GSR_FULL%20REPORT.pdf 6See Risk and returns 7https://www.businesswire.com/news/home/20210408005484/en/Bank-of-America-Increases-Environmental-Business-Initiative-Target-to-1-Trillion-by-2030 8https://www.spglobal.com/esg/insights/companies-investors-face-new-pressure-from-compulsory-disclosure-of-climate-risk 9https://internationalbanker.com/finance/what-is-the-sustainable-finance-disclosure-regulation/ 10https://www.avivainvestors.com/en-gb/about/company-news/2020/12/aviva-investors-1bn-climate-transition-loans/