Lenders and borrowers grapple with benchmarking impact

Real Estate Capital explores how lenders and borrowers are accounting for ESG.

CO2 green carbon footprint

Commercial real estate lenders and borrowers are looking at ways to benchmark their loans and investments as institutional investor interest in and regulatory guidelines around green and sustainable strategies move up the industry’s agenda.

The Securities and Exchange Commission in March published proposed governance that would compel public companies to report climate-related risks stemming from their businesses, while a joint venture between the National Council of Real Estate Investment Fiduciaries and the Pension Real Estate Association this month published a list of the key ESG performance metrics for the private real estate industry, according to affiliate title PERE.

Meanwhile, CBRE’s 2021 Global Investor Intentions Survey, released earlier this year, found that 60 percent of respondents said they’d already implemented ESG criteria into their investment strategies. The report also projected greater regulatory pressure to enhance sustainability in the US, the UK, Europe and parts of the Asia-Pacific region, including tightening codes around green buildings, using more sustainable materials, and reducing carbon outputs.

Fannie Mae and Freddie Mac were pioneers in the US green lending space, offering borrowers incentives for meeting specific KPIs around factors that included energy usage.

“We saw an opportunity to become innovative and bring that into our discussion with our clients, who are already interested in it,” says Jeffrey Schwartz, a director at New York-based ING Real Estate Finance. “Our private equity fund clients have investors pushing them to acquire a property that is green or to take it to the next level. We’ve structured loans with green incentives where the borrower is committing to go out and achieve a green building certification under LEED or the National Green Building Standard.”

Opportunity knocks

Investments in opportunity zones have the potential to check a number of these boxes for borrowers and lenders, according to Reid Thomas, a managing director at San Jose, California-based JTC Americas. The specialty fund administrator believes its practice in the OZ sector is helping lenders and investors to benchmark their investments and track where the money is going.

“Opportunity zones were invented to help communities in need, and we believe they could be transformative, but this kind of transformation will take decades to achieve. We want to get everyone focused on the bigger picture related to these investments and if they are doing what they’re supposed to be doing for investor motivations and other factors,” Thomas says. “To try to tie opportunity zones closer to impact investing and ESG, which is a global phenomenon, is a really important thing; they are 100 percent aligned.”

Interestingly, there is not always a great understanding of the connection between opportunity zones and impact investing. JTC completed a survey of 145 investors, developers, brokers, fund managers, bankers, advisers and other relevant participants from December 2021 to February 2022 and found that, while four out of five respondents viewed OZ investing in a favorable way, only about half said they understood the relationship between opportunity zones and impact investing, Thomas says.

Lenders should be aware of the opportunity zone initiative because the vast majority of these projects will have associated lending opportunities, Thomas says. “Within the OZ space, lenders will be able to identify opportunities that meet the target of virtually all focus areas in terms of asset class, term, risk profile, size, geography, borrower and credit level. Lenders are also able to receive [Community Reinvestment Act] credits for loans in these sectors,” he adds.

The firm does the financial accounting for OZ investors, extending it to account for the impact of these projects, and Thomas believes it is possible to quantify and report these statistics.

“We know how much money is being spent and what it is being spent on, what the labor income in the community is going to be – there are things you can derive using normal economic tools to figure that out,” Thomas says. “It doesn’t have to be a massive burden to do this kind of reporting and tracking if you set it up right at the beginning.

“Our company started with the idea that there are well-intended investment opportunities that get set up and then fail. We approach the market with the standpoint of: can we develop technology to really track the investment monies to make sure there is no fraud, abuse or other issues?”

Looking ahead

At this point, there is not yet software available that does standardized reporting on ESG or impact reporting. But this could be coming. JTC America’s approach includes using businessman and philanthropist Howard Buffett’s impact rate of return to break down disparate projects and investments, and comes up with common, understandable scores. Thomas believes this ability to accurately report on ESG metrics will become more important in the coming years.

“Regulators are increasingly concerned about greenwashing. Lenders who claim to be enabling positive ESG outcomes are likely to face increased reporting and compliance mandates going forward,” Thomas says. “The OZ Transparency, Extension and Improvement Act calls for the OZ fund managers to monitor and track the impact of the investments, which helps remove the burden solely from the lender. Fund managers need to tell their story and the investors want to ask questions or get information about what they really care about. You always have to have the ability to have this customized – it can’t be automated.”