Alternative lenders gear up to bridge green debt finance gap

A huge opportunity lies ahead for alternative debt providers to help real estate investors green their properties as traditional lenders continue to reduce their exposure to property, speakers agreed during a panel discussion on European debt finance and investment at EXPO Real earlier this month.

Green lending in today’s environment is ‘incredibly important’, said David White, head of real estate debt strategies at LaSalle Investment Management. “There’s a place for it and it’s very prevalent in terms of what we do.” Who will pay for the transition cost of making assets sustainable and how that will affect asset pricing is still in discovery mode, he added. “First and foremost is where are assets priced today and where they will be priced in the future. There’s still a bit of arbitration throughout the capital structure from debt to equity, but in terms of funding gap, that’s where we see a tremendous opportunity in today’s world.”

An estimated $1.6 trillion in real estate loans will require refinancing in the next five years, White said. “Based on where we estimate banks will continue to lend – which will be on a reduced basis – we see the debt gap at about $250-360 billion on a conservative basis in the next three to five years.”

A large portion of that figure will come up for refinancing in the near term, and alternative lenders are well-placed to fill the gap, he said. “It’s no secret that alternative lenders are becoming more prevalent in the market. The first half of 2022 was the first extended period that alternative lenders were outpacing banks in terms of lending volume. That was not a cyclical component of the market.”

A great deal of uncertainty exists regarding the actual size of the current funding gap based on loan-to-value (LTV) and interest-rate-cover (ICR) ‘pinch points’ for investment grade lenders, said Kristina Foster, fund manager at Schroders Capital.

“Nobody has got a handle on that yet or how Basel 4 [new capital requirements for banks] will impact lenders in terms of cost of capital going forward. We don’t think it will necessarily trigger a flow of LTV and ICR breaches but what it will do is take up future capital which means future liquidity will reduce further again.”

This will give alternative lenders more opportunities, particularly in the senior loan space, she added. “Traditionally, alternative lenders have tended to dominate the high yield, high leverage and development space. On the green aspect, people have been saying that sustainability has gone on the back burner in the current crisis but I don’t think that’s the case.”

Lenders are required under EU regulations to start thinking about sustainability and have a moral duty to do so, Foster pointed out. “In the alternative lending space, it’s what our investors want to see so you can’t ignore it. This is exactly the first question they’re asking – how are you delivering ESG or sustainability on debt strategies? We say investors can get ESG and deliver impact through lending.”

ESG considerations are also a major priority for Vienna-based Erste Group Bank AG, said Hannes Wimmer, managing director, loan capital markets. “Every initiative nowadays is focused on the sustainable operation of the building and a huge chunk of the financing is still missing.”

Real estate investors will increasingly be required to take embedded carbon emissions into account, under the EU Taxonomy – the cornerstone of the EU’s sustainable finance framework, he pointed out. “Based on this calculation, it makes much more sense to take a look at transitional investments than starting greenfield projects from scratch.”