Financing the transition to net zero: the who, how and when

In the run-up to COP26 there was a flurry of announcements from the real estate sector around green financing. ESG-linked bonds were launched, green revolving credit facilities, a smorgasbord of sustainable funding options. These mechanisms all made the headlines, but how long will it be until green financing options are the only options available? And does green financing need to become “business as usual” if the sector really is to reduce its contribution to carbon emissions? For John Davies head of sustainability at Derwent London, green as BAU is just five years away. The REIT has already raised a sizeable volume of capital through sustainability-linked financing, most recently a £350m green bond, which will be used to repay part of its revolving credit lines and finance some of its green projects. The experts John Davies, head of sustainability, Derwent London Louise Ellison, chief commercial officer, Longevity Partners Sarah Ratcliffe, chief executive, Better Buildings Partnership Nina Reid, head of responsible property investing (global), M&G Real Estate David Willock, head of ESG finance and structuring, Lloyds Banking Group “All of the finance is going to end up being sustainability-linked somehow because businesses are going to have to demonstrate how they are actually challenging business as usual and delivering against the climate emergency that we are facing,” adds Louise Ellison, chief commercial officer at Longevity Partners. “And I think that will really start to drive things.” Shades of green “There are probably different shades of green across equity and debt, and we are starting to see that play out in some of the regulation that is coming forward,” says David Willock, head of ESG financing and strategy at Lloyds Banking Group. “Something done a year ago can age very quickly and we work in a really high-velocity regulatory and standards environment. I think it’s fair to say the trend has been a huge acceleration in ESG-labelled bonds this year. I think we will start to see continued differentiation of shades of greenness.” Nina Reid, M&G Real Estate’s head of responsible investing, agrees. Sort of. She believes that financing as it is today will be changed within five years, but that innovation will mean that green financing will never really become the norm. “You would hope that the agenda is constantly moving,” says Reid. “So maybe what we are talking about green financing today becomes market norm, but then you would hope that it moves on to the next level of sustainability or biodiversity, the issues that we are not even talking about at the moment or tackling.” One issue the market is talking about a lot but not yet tackling head-on is the issue of stranded assets. Raising green finance for new net-zero buildings may well be popular today, but how is the sector going to pay for the many existing buildings that will not be up to scratch when it comes to environmental standards? The stranded challenge “The biggest challenge that we have is our existing buildings,” says Better Buildings Partnership chief executive Sarah Ratcliffe. “When we talk about how you can use funds, let’s think about some different mechanisms where we can actually channel some of that sustainable finance into upgrading existing buildings. “One of the really interesting conversations that is evolving around sustainable investment and finance is the whole concept of stranded assets, and that really worries me. A lot of the Better Buildings Partnership members have large portfolios of existing buildings and are beginning to talk about methodologies to look at value at risk. “What those methodologies spit out at the other end is actually quite frightening, in terms of how much value could potentially be at risk.” And for real estate, it is not as easy as just getting rid of something because it is not up to standard. “We don’t want to get to the position as a sector where we are simply disposing of these assets, because these buildings still exist,” adds Ratcliffe. “Someone has to own them and they sit in communities that are hugely reliant on the economic activity that these buildings generate. So in terms of a fair transition, that gives us a really big challenge.” Ratcliffe wants to see more financing mechanisms focused on the “less sexy” side of real estate. Financing that focuses on impactful investment that delivers real value, not just for the owners of buildings but for the communities in which those buildings sit too. Lloyds’ Willock says this type of financing is coming, with lenders starting to ask a lot more questions about what is happening at an asset level, and that financing stranded assets could become much more stick, rather than carrot, focused. Hidden opportunities For Derwent’s Davies, that change in attitude is where the opportunity lies. “For me, I can’t help but think rather than looking at it negatively and saying ‘What are we going to do?’, actually is it a little bit about skill set? Perhaps some of these assets which are stranded or potentially stranded we could do something with? That’s the really interesting thing. And as soon as our sector starts to get that whiff of commercialisation, that will be all it takes.” But to get there will require collaboration and commonality of language. All five panellists at EG’s Sustainability Live agreed that investment in real estate would be green as business as usual within the not too distant future, but all said there were hurdles to overcome, with language and understanding being chief among them. “I think, at the moment, there’s a really big opportunity, particularly for ourselves,” says M&G’s Reid. “We have a massive global portfolio and a lot of our buildings are on long leases to occupiers where they are ultimately responsible for the consumption. But the net-zero agenda actually allows us a really great in on the environmental side to have aligned discussions with them about how we are going to finance it. “We will probably find across the industry a variety of models about how this financing is going to work. Some of it will be directed by the landlord and in some of it we will probably see a degree of hybridisation where we might finance it in exchange for rentalising that over time; we might see third-party financing coming in.” She adds: “Real estate is not known for its innovation, but there are really great opportunities to disrupt how we think about financing and ownership of buildings. I think we are probably on the cusp of starting to see some quite interesting discussions with occupiers yielding different ways of thinking about what that relationship is and how we might go about financing that.” Common language Collaboration with occupiers over who pays for the green transition is only one part of the equation. For Ratcliffe, the language between financiers and the built environment needs to have more commonality too. “We all need to take responsibility to learn another language that we are not familiar with,” she says. “Financiers need to understand the language of the built environment because in order to develop innovative finance mechanisms, they need to understand the practical challenges that the built environment sector faces. And in order for the built environment to be able to attract the right finance and have that integrity, we need to talk the language of the finance sector.” But real estate has the opportunity to work together to bring about the change to green financing as BAU – and to do it in a way that is mutually beneficial for all, says Reid. “What we need to have is a shared voice about what can be improved and not expect the regulators in the EU to make the taxonomy better for us,” she says. “We have to say, ‘Look here are all the issues with it’ and collectively, ‘Here is what we think the solution is’ and suggest that and start using it. It’s going to need both sides. I don’t think the regulators are ever going to sort it out on their own, they need to be influenced by the users of it.”   To send feedback, e-mail samantha.mcclary@eg.co.uk or tweet @samanthamcclary or @EGPropertyNews Image © Shutterstock