Portfolios now being judged by how ESG-compliant they are

Portfolios are being judged by how ESG-compliant they are, delegates heard at Real Asset Media’s European Debt Finance & Investment Briefing, which was held online recently.

“ESG is the next big topic after Covid,” said Norbert Kellner, head of syndication, Berlin Hyp. “It’s become a substantial part of our business. Financing vehicles are being used to steer the process, so that the way the project is being financed ensures the outcome. In Berlin the authorities are laser-focused on that before they grant building permits.”

Norbert Kellner, head of syndication, Berlin Hyp

What used to be a marketing ploy or a box-ticking exercise has become an integral part of the investment and financing process.

“We’re very focused on ESG because our investors care and because, as real estate debt investors, we focus on underwriting positive credit migration,” said James Mathias, portfolio manager, real estate debt, PGIM Real Estate. “That applies whether we focus on core senior debt strategies looking for premiums to fixed income, or whether we’re looking at value-add real estate.”

Research has demonstrated that over time green buildings see more yield compression and higher rental growth. Mathias said: “It’s become a critical theme across our industry as we underwrite investment performance too. We’re also looking at ESG covenants in lending documentation.”

Lenders are becoming active participants in the shift to sustainability.

“We’ve seen lenders incentivise borrowers by reducing margins if they have solar panels and so on,” said Deepak Drubhra, co-founder, Westfort Advisors. “ESG is definitely on the radar”.

Berlin Hyp, which issued the first green bond seven years ago, is now working on transformation loans.

“It’s another word for capex,” said Kellner. “It’s a great story and an interesting opportunity for us on the lending side to drive that change towards ESG conformity by financing the switch from brown to green assets.”

The focus is shifting to where the real problem is: existing buildings and the need to improve them.

‘Embedded carbon’ makes renovation greener than redevelopment

“The big concern from an ESG perspective is embedded carbon, so it is way more green to improve an older building than to knock it down and build a shiny new one,” said Ali Imraan, director of debt and special situations, LaSalle Investment Management.

ESG is the general theme, but there are many nuances.

“As we start to measure ESG more effectively across the real estate industry we’ll get a clearer idea of what fulfils the criteria beyond the simplistic definitions that we started with,” said Mathias.

The drive towards sustainability is driven by regulators, investors, landlords and lenders but also, crucially, by tenants who want to be in a healthy space.

“We want to do more refurbs of well-located offices in cities, because we see a real opportunity,” said Imraan. “There are good risk-adjusted returns there, because you are making changes that tenants want.”