What is Green Financing in Commercial Real Estate?

Lenders and investors are becoming more worried about the impact of their lending and investment choices on the environment due to increasing concern over climate change. They’re searching for methods to decrease their carbon footprint to obtain positive environmental results while still fulfilling their investment goals and achieving financial returns.

Green loans were created as a result of these concerns. These loans are specifically designed to fund or refinance new and/or existing eligible ‘green projects’ and can take the form of term loans, revolving credit facilities, or working capital facilities.

How big is the green financing market?

More and more CRE lenders are providing green loans as the demand for environmentally-friendly financing increases. This is part of a larger trend in the financial sector, with over USD $700 billion in sustainable and eco-friendly debt issued globally in 2020—a significant increase from USD $250 million in 2018.

Investment products that focus on addressing environmental, social, and governance (ESG) issues are predicted to expand to more than USD $53 trillion in assets by 2025.

‍Fannie Mae has incorporated BREEAM Residential Plus as an acceptable evaluation method for loans under its Multifamily Green Initiative, which granted USD $13 billion in green loans last year.

Green bonds are also gaining significant interest from investors in capital markets, creating high demand that lenders could benefit from. Companies with ESG strategies are now viewed as more creditworthy borrowers.

ESG values are becoming increasingly important to US real estate investment trusts (REITs), with more of them investing in green properties in response to investor pressure. In 2021, proceeds from green bonds issued by US REITs accounted for 15.5% of all REIT bond proceeds—the highest percentage to date.

While green bonds still represent a small percentage of capital-raising activity, they have become increasingly popular over the past four years, expanding the potential buyer pool for REIT securities and enabling REITs to attract sustainability-minded investors.

What are the current guidelines for issuing green loans?

In March 2018, the Loan Market Association collaborated with the Asia Pacific Loan Market Association and the Loan Syndications and Trading Association to release the Green Loan Principles (GLP) and Guidance on Green Loan Principles (GLP Guidance).

The GLP and GLP Guidance were later updated in February 2021.To qualify as a green loan, a loan product must meet the four essential components of the GLP:

• Use of proceeds - The loan's proceeds must be utilized for an environmentally friendly purpose, with environmental benefits that are assessed and quantified where possible. These funds can be used to finance a new green project or refinance existing debt.

• Evaluation and selection process - The borrower must clearly communicate their environmental sustainability objectives, how their project fits within an eligible green project, and the criteria used to identify and manage environmental and social risks associated with the proposed project. This is crucial for lenders to assess the environmental attributes of the green loan.

• Management of proceeds - The proceeds of a green loan must be credited to a dedicated account or tracked by the borrower to promote transparency and maintain the integrity of the loan product. If the loan consists of different portions or divisions within a loan agreement, each of these green tranches must be unambiguously identified or labeled.

• Reporting - The borrower must provide an annual report that includes information on the use of proceeds, a list of green projects to which the funds were allocated, a brief description of each project, the amount allocated to each project, and the expected impact of each project. This report should be updated until the loan is fully drawn, and as needed thereafter.

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In addition, green financing should be utilized to fund environmentally sustainable projects, which may include, but are not limited to:

• Green buildings that conform to regional, national, or globally recognized standards or certifications
• Pollution prevention and control (such as reducing air emissions, controlling greenhouse gasses, soil remediation, waste reduction, and waste recycling)
• Renewable energy transmission and production, appliances, and products
• Climate change adaptation, such as information support systems like climate observation and early warning systems
• Sustainable land use and management of natural resources

It’s important to note that a loan can only be labeled and marketed as a green loan if it meets the requirements of the GLP. Loans that don't comply with the four fundamental components of the GLP should not be treated as green loans.

Therefore, it’s necessary for the loan party to confirm that the loan complies with the GLP criteria. Simply financing an environmentally sustainable project does not automatically qualify the loan as a green loan.

How do you qualify for green financing in CRE?

To secure and maintain a green real estate loan, the borrower must either construct eco-friendly buildings or renovate existing ones with minimal environmental impact. The ultimate objective of green architecture is to attain a zero-emissions or "net-zero" building standard.

A net-zero building uses only renewable energy sources that don't emit carbon dioxide to power lighting, heating, cooling, and vehicle charging.

Achieving the net-zero standard requires more than just utilizing high-efficiency energy sources. It also necessitates supplementary renewable energy generation. In heavily populated and densely constructed cities, where there is limited space for renewable energy generation, energy can be produced from off-site renewable sources located nearby.

To achieve a net-zero building standard, CRE owners can replace technologies that use fossil fuels with carbon pollution-free electricity (CFE). The General Services Administration recommends several sources of CFE, including solar, wind, geothermal, and marine energy.

Solar energy is harnessed by reflecting sunlight onto solar panels, which converts it into heat that can be stored or used to generate electricity. Wind energy is generated by wind turbines connected to a generator, while geothermal energy is obtained by drilling wells into underground water reservoirs to extract steam or hot water for power generation.

Marine energy, produced by waves, currents, tides, and temperature changes, requires large-scale infrastructure, making it suitable for coastal communities.

Using available marine energy alone could potentially satisfy nearly 60% of America's annual electricity demand, according to the National Renewable Energy Laboratory.

Wind turbines and geothermal heat pumps can be installed after assessing the ideal location and complying with local zoning ordinances. Solar panels perform best when placed on south- and west-facing roofs sloped at 15 to 40 degrees.

Can you renovate existing CRE to become green?

Green loans are an option for new and existing buildings. In fact, green architects agree that retrofitting existing buildings is the most environmentally friendly approach. It not only reduces energy consumption but also minimizes emissions that arise from constructing new buildings.

Green renovation likewise offers several other advantages, such as preserving historic architecture and promoting public health by improving indoor air quality and reducing exposure to harmful substances.

Although the initial costs of green renovation are typically higher than non-sustainable renovations, green properties save more on energy costs in the long term and have higher values. Additionally, heritage preservation and a historic ambiance can attract tourism, which in turn can support local businesses.Here are some options for owners of existing CRE buildings to reduce their environmental impact:

• Install a metal roof made of recycled materials with a reflective surface to reduce energy costs
• Use LED lighting instead of traditional incandescent lighting
• Install "smart" high-efficiency lighting with automatic dimmers and sensor-activated lights
• Use low-flow plumbing fixtures like dual-flush toilets and motion-activated, touch-free faucets
• Utilize ‘intelligent’ electric sockets with automated shutdown capabilities, which rely on either sensors or timers to cut off the electricity supply to empty rooms or sockets that are linked to inactive appliances
• Use natural, heat-retaining flooring like concrete or brick to cool rooms and reduce the need for air conditioning in the summer
• Use sustainable flooring made of bamboo or reclaimed wood
• Install insulation in walls and roofs to prevent air leaks and heat loss
• Install energy-efficient windows to prevent the escape of heated or cooled air
• Plan landscaping to shade and cool the building, reducing energy bills
• Use no-VOC paint to reduce air pollution.

Conclusion

As a CRE investor or property owner, it’s important for you to stay updated on recent trends affecting the industry, including green loans. Green financing can significantly reduce greenhouse gas emissions, which are the primary cause of global warming. Overcoming obstacles and raising awareness about sustainable growth can create the necessary infrastructure for this type of CRE financing.

Environmental change and pollution become increasingly concerning not just for the US but for nations around the world. However, while there has been a gradual increase in the number of green real estate buildings, they still represent a minority. The biggest challenge to decarbonizing the environment is that approximately 70% of many global cities' building stocks will still be standing in 2050.

Now more than ever, potential green projects need to be identified and evaluated for eligibility for green finance. It’s essential to establish and encourage green initiatives and promote green buildings. Funding renewable energy resources is also crucial.

CRE property owners themselves have to understand how to use greener practices and technologies in their buildings to generate energy and preserve resources.

Institutional investors also need to get involved to speed up the adoption of environmentally friendly CRE construction methods. They can provide liquidity to the green real estate sector, allowing primary lenders to offer better green lending programs. They can expand their product offerings and client base, build portfolios with lower risks and higher values, and access new funding opportunities by investing in green bonds, securities, and green lending institutions.

Green finance has the power to drive the shift towards a more environmentally sustainable economy by providing financial support for global environmental initiatives, including green CRE. Governments, businesses, and investors need to collaborate more closely to raise awareness, establish green entities, enact legislation, and provide funding for energy and resource conservation.