The greening of finance

Anyone regularly reading the news from the real estate market on the pages of (for example) Eurobuild CEE may have noticed that recently investors have been increasingly turning to ‘green loans’ and ‘green bonds’ in order to finance or refinance their acquisitions, developments and the existing assets in their portfolios. But why has ‘green financing’ become such a current buzzword? What forms does it take? And is the impulse behind this trend due to genuine concerns about the environmental impact of real estate investment activity – or is it being forced upon the market by legal obligations?

The environmental impact of real estate simply cannot be underestimated. According to the International Energy Agency, in global terms, the operations of buildings account for 30 pct of energy consumption and 26 pct of global energy-related emissions. Added to this is the fact that the expectation is that the global floor area will increase significantly in the future, having been projected by the IEA to grow by around another 20 pct by 2030, with more than 80 pct of this likely to be in developing and emerging economies. In the CEE region, however, the situation is even more extreme. According to the European Bank for Reconstruction and Development (EBRD), the real estate sector in the CEE region is responsible for possibly up to 50 pct of total energy consumption, while in the EU as a whole, buildings are responsible for an estimated 40 pct of total energy consumption and 36 pct of carbon dioxide emissions.

The forces driving the change

Little wonder, then, that politicians and the people who vote for them have become more concerned about the issue – while the same goes for those who use buildings, and hopefully also for those who build and own them. And since there would be no real estate sector without a reliable source of financing, an increasing onus is being put upon lenders to ensure that real estate finance is linked to pro-environmental activity, while market players are also keen to display their green credentials by taking out such loans. That this is the case is confirmed by Maciej Tarnawski, the managing director and head of global debt financing of Santander Bank Polska. “The use of green financing is being driven by both the EU and market forces. EU regulations and directives aimed at achieving climate neutrality by 2050 are playing a significant role, mandating sustainable practices and investments. Market forces, including consumer preferences, investor demands, and the perceived long-term value of sustainable assets, are also contributing to this significantly. The importance of green financing is growing, as it aligns financial investments with environmental sustainability goals,” he claims.

These new EU regulations include ESG reporting, one prime example of which is the Corporate Sustainability Reporting Directive (CSRD), which, according to Bartosz Ordon, an associate of Baker McKenzie Polska, is certainly providing an impulse for the transition to a sustainable and environmentally-friendly economy: “The increasingly strong preference for green debt on the part of financial institutions, such as when it comes to the development banks, is also of great importance because it may already actually constitute a barrier to obtaining financing for entities from high-emission sectors.” He also goes on to mention that for green bonds (more on which in a moment), “the entry into force of the EU green bond standard will certainly be a breakthrough, as it will standardise a market that is currently quite fragmented.”

Another impulse for borrowing parties to take out such loans is that they are issued on more favourable terms than standard financing – as long as certain green requirements are fulfilled, as Bartosz Nojek, a partner and the co-head of the banking and finance practice at Dentons in Poland, tells us: “Green real estate financing remains available in Poland and the CEE region as financial institutions are being forced to accept this by non-financial reporting obligations, the scope of which has expanded over recent years to provide more environmentally-friendly financing. Since green real estate financing should generally be less expensive, it is becoming more and more popular for investors.” He also goes on to add that while green real estate loans are becoming the market standard, there are also other types of financing available, “such as sustainability-linked loans (SLLs). We are currently observing a slowdown on the commercial real estate market in general, which has resulted in reduced number of financing transactions and we believe that bounce back will be associated with increased volume of green / SLL financing, as this is the future,” he explains.

The Ts and Cs

The terms and conditions for green loans and bonds typically include the requirement for projects to meet specific environmental criteria or standards, such as energy efficiency benchmarks or sustainability certifications. As Maciej Tarnawski of Santander Bank puts it: “Investors need to demonstrate that their projects will have a positive environmental impact, which can involve obtaining certifications like LEED or BREEAM, or showing reductions in energy consumption or carbon emissions.” However, according to Bartosz Nojek: “Different banks have different standards in regard to which project can benefit from green financing and there can still be slight differences in their lending requirements. On top of that, there are the internal policies of different banking groups. Banks may have their own internal criteria for the requirements for fulfilling a ‘green loan’ and for the projects that wouldn’t meet these.”

One recent example of green financing in our part of the world was Santander and Erste Bank’s loan for Cornerstone’s acquisition of the Warta Tower office building in Warsaw from Globalworth last summer. These funds are being invested in the building’s subsequent rebranding (it will now be called V Tower) and renovation to upgrade to make it attractive to the market by bringing it in line with ESG and user-friendly standards. In the opinion of Bartosz Nojek, the ability to demonstrate the green credentials of portfolios is becoming a significant advantage when it comes to access to finance on favourable terms: “The PR aspect that is constantly being put out by real estate investors is that their projects are fully in line with ESG standards, and so this is becoming the market norm. And if they can demonstrate the green qualities of their projects, they can obtain better conditions in terms of the financing and its pricing. On the real estate market, this is particularly true for the office and logistics segments, but also increasingly applies to all the other sectors. The tendency is to meet ESG standards and to be able to demonstrate this.”

Added definition

Bartosz Nojek goes into further details about what actually constitutes a green loan, citing the definitions provided by the London-based Loan Market Association (LMA): “Based on the LMA’s Green Loan Principles (GLP) and Guidance on Green Loan Principle, to qualify as a green loan, the loan must comply with the following four components of the GLP: the use of the proceeds, the process for the project’s evaluation and selection, the management of the proceeds, and the reporting. This also includes applying the loan’s proceeds to an eligible green project including a green building that meets regional, national or internationally recognised standards or certifications. Such types of financing might be summarised as loans that must contribute to sustainable development and can be given to projects and investments in buildings with specific green credentials that satisfy the bank’s requirements.” Bartosz Ordon, meanwhile, characterises green loans and bonds in this way: “They oblige the issuer or the borrower to use the entire financing obtained only for environmentally-friendly projects – and it is also possible to refinance expenses already incurred on them. This is the basic difference between green and traditional financing, where in the case of standard bonds, the issuer can, in principle, use the funds obtained from their issue for any purpose.”

Sustainability-linked loans differ from standard green loans in that they include an option to decrease the margin upon the fulfilment of certain key performance indicators. “Templates have also been drawn up by the LMA for SLLs. Their recommendation is for these to contain riders that impose certain obligations that need to be met, such as specific documentation verifying the green qualities of the buildings. Sustainable linked loans (bonds) provide for an option to decrease the margin upon the fulfilment of certain KPIs. Also, they necessitate the financing party to appoint an SLL coordinator, whose main role is to monitor the fulfilment of KPIs and other conditions that determine the possibility of granting such a loan. The underlying documentation also contains a number of environment-related provisions, including obligations and representations,” explains Bartosz Nojek. Bartosz Ordon of Baker McKenzie adds to this that: “By issuing sustainability-linked bonds, the issuer undertakes to achieve certain KPIs that are related to the implementation of specific pro-ecological goals (e.g., increasing the share of renewable energy in the production process). Obtaining a specific result means that the issuer will receive financing on more favourable terms, that is, the margin will either be reduced or not increased.” One of the differences between a standard green loan and an SLL is the way the pricing is determined. “For a green loan, at the very beginning the pricing is fixed and continues throughout the progress of the project. But for an SLL, KPIs and other targets need to be met during the project; so, if these are not met the pricing of the loan is increased,” reveals Bartosz Nojek. But whereas a green loan has to be used for environmentally-friendly investment, the situation is different in the case of sustainability-linked bonds, where there is no such limitation: “The financing can also be used for other purposes. However, the issuer must demonstrate that it is achieving its sustainability goals, which can be done in various ways (changes in supply chains, modernising technological processes, etc.),” adds Bartosz Ordon.

Green bonds currently happen to be the most popular form of debt financing for sustainable development projects. “This category also includes more targeted instruments, such as climate bonds aimed at achieving goals related to reducing carbon dioxide emissions into the atmosphere. Examples of this include the financing of net zero or nearly-zero emission buildings (ZEB, NZEB),” points out Bartosz Ordon. On the Polish real estate market, Ghelamco Group has issued green bonds worth almost PLN 1 bln since the beginning of 2023, while in 2022, CPI Property Group issued sustainability-linked bonds worth EUR 700 mln, and fellow Czech developer CTP successfully placed a EUR 750 mln green bond earlier this year. Warsaw-based GTC is another notable real estate company that has issued such bonds.

Could your building even qualify?

But when it comes to projects, is it the case that every building could be eligible for a green loan? And if not, then what? “From time-to-time, we are asked by our clients whether a property built several years ago would be an interesting proposition for the banks,” relates Bartosz Nojek of Dentons. “In that case, you have to look into whether the building has a future and if it can be upgraded to ESG standards. If not, then it can be very difficult to obtain financing for it, as the banks look at the whole life-cycle of each project, that is, the risk of a lack of potential refinancing in the future. Therefore, you need to have a refurbishment plan in place or to radically transform the project in some way.” And for those that fail the requirements of the lenders: “The financing of projects that don’t or will not (in the future) meet ESG requirements might be a niche for some alternative debt providers, such as mezzanine and/or opportunistic funds or private investors,” he adds.

The stark fact is that the EU legislation connected to sustainable real estate and financing is already substantial and is set to intensify further. Market players, whether they are genuinely enthusiastic about ensuring the green qualities of their real estate portfolios or not, will have to embrace this change one way or another – or soon they won’t be able to secure financing at all. “All the forces and trends are pushing in this direction, and not only in the EU, but in the US, the UK and around the world. And so, the same approach is being adopted by both lenders and borrowers. If a project meets ESG standards, then banks and investors are going to be more willing to add them to their portfolios. But in the end, when all these new regulations become binding, it will be the case that banks won’t even be allowed to provide financing for projects that don’t meet these standards,” concludes Bartosz Nojek.