The US commercial real estate debt markets, which largely lag behind their peers in the UK and Europe in creating and implementing green principles into their lending processes, are starting to chart a more verdant path forward.

The shift comes from a confluence of factors, including internal changes within companies that emphasize ESG principles, and institutional clients increasing their focus on these same issues. Additionally, the Securities and Exchange Commission’s April proposal around new governance that would mandate public companies report the climate-related risks of their businesses is making the push toward green lending more urgent, market participants tell Real Estate Capital USA.

“The commercial real estate market is starting to see real interest from limited partners in ESG strategies,” says one New York-based real estate manager. “These investors want to see how serious you are about ESG, and this is affecting the lending side of the business as much as it is affecting the equity side. This is something that will stand a better chance of succeeding if the whole lending community is a part of it.”

“We are able to get very attractive terms for what we have been doing that is energy focused. We feel as if we are helping to educate the lenders as we work on deals
with them”

Peter Merrigan

While most lenders are still working to formulate their lending policies around green loans, borrowers are already starting to see an impact. A case in point is Taurus Investment Management, which in March launched a roughly $500 million joint venture with Aegon USA Realty Investors to acquire value-added multifamily properties.

The partners have a bigger-picture plan to renovate and reduce the energy consumption of those assets and will work with Taurus subsidiary RENU Communities to improve energy efficiency, increase onsite energy production via solar panels and provide better air quality for tenants.

Peter Merrigan, chief executive officer and managing partner of Taurus, said the Aegon venture stems from a meeting of the minds of two investors with a similar focus on Sun Belt markets. The partnership has so far seeded one asset in Orlando, Florida. It is working to build out the portfolio, working through RENU as it does on projects like this because of the complexity of these renovations.

“The interest is evolving week by week, month by month on the lending side. We just closed on a couple of assets that are also falling under this retrofit bucket, and we are finding lenders are very attracted to it,” Merrigan tells Real Estate Capital USA. “I can’t put a number on it, whether it is 20 basis points better, for example, but we are able to get very attractive terms for what we have been doing that is energy focused. We feel as if we are helping to educate the lenders as we work on deals with them.”

Taurus found from the start that its energy initiatives benefited the profitability of its projects. “When we did our initial project, we didn’t believe it would have a net drag on returns – we were looking to increase the returns and we have been successfully able to prove that thesis in a few cases,” Merrigan says.

The C-PACE story

The consensus is that C-PACE, or Commercial Property-Assessed Clean Energy, will be a key part of financing green real estate deals going forward. The program has evolved beyond its roots of financing small-scale solar power, resiliency and other projects related to energy efficiency. Market players believe the state-specific legislation will present one of the more compelling means of tapping into new green lending opportunities.

A test case could be the New York City market, where property owners are racing to implement Local Law 97, legislation passed in 2019 that aims to put into place carbon caps on buildings of more than 25,000 square feet. The legislation, which will affect about 50,000 commercial and residential properties in the city, goes into effect in 2024. New York adopted a C-PACE framework last year, joining California, Washington and more than 30 other states that use the program.

“It’s such a massive market opportunity and we haven’t even scratched on the door yet,” Chris Robbins, managing principal and co-founder of C-PACE lender GreenRock Capital, tells Real Estate Capital USA.

“We are seeing a huge uptick in the number of building owners, investors and developers who are exploring C-PACE as part of their capital strategy for new construction, adaptive reuse and recapitalization of projects mid/post construction, all while meeting their ESG goals – a true win-win.”

Climate risk = investment risk 

According to Nuveen’s second annual EQuilibrium Global Institutional Investor Study, released in March, select institutional players have started to turn their focus and money toward everything related to innovation; for instance reducing energy consumption or transforming old industries and assets – both areas that C-PACE financing can typically play a role in facilitating.

In the New York-based manager’s study, 71 percent of institutional investors surveyed said climate risk is investment risk, while 79 percent said the transition toward a low-carbon economy is inevitable. Across all institutional respondents, 86 percent said the transition to a low-carbon economy will present new investing opportunities.

This transition has been largely collaborative, with market participants often sharing best practices.

Abigail Dean, the global head of strategic insights for Nuveen Real Estate, notes that the firm has had a strong ESG program for more than 10 years and a net-zero carbon goal in 2040 for its real estate portfolio.

Dean tells Real Estate Capital USA the firm has found the push toward a greener commercial real estate market has been a collaborative effort. “It is one of those parts of the market that is more open to collaboration and the sharing of best practices,” Dean says. “We recognize as an industry that we are all together, that we are buying and selling buildings together. It’s something that is happening as an industry effort.”

The process of greening a portfolio over the longer term is not easy. “There are the easy wins, the LED lighting, the optimization of HVAC systems and technology to monitor where energy has been used,” Dean says. “But after that you’re looking at more fundamental changes to buildings, like moving to full electrification or upgrading facades or glazing.”

Fundamentally, there will need to be a redevelopment of real estate to at least achieve the net-zero carbon goal, she continues: “That work is becoming more expensive, and it makes us focus more on adapting what we already have. There is a lot of embedded carbon in ground-up development, and redevelopment is a sign that we will be using fewer materials. There are other concepts that are out there, like renting office furniture instead of buying it to reduce the end-of-life waste.”

For CBRE Investment Management, the impact of ESG-related issues on the future of a property is a constant and critical consideration. “We think focusing on high-quality, future-proof assets is the right thing for our investors and for the future valuation of these assets,” says Sabina Reeves, CBRE’s chief economist.

“One of the conversations we have about properties is what are the capex assumptions for today’s standards versus what tomorrow’s standards will be.”


The Big (green) Apple

According to data from JLL, 90 percent of the roughly 150 million square feet of Class B office space in New York City is more than 50 years old.

Sandeep Srinath, a member of the structured solutions group at ING Real Estate, tells Real Estate Capital USA that the huge stock of slightly older, large buildings in the city would fit the bill for larger C-PACE revitalization projects under the new mobilization act.

“The value of real estate in New York is obviously one of the highest anywhere, so the LTV numbers work pretty well,” Srinath says. “We think there will be a growing demand for very large C-PACE deals in markets like New York.” San Francisco is another market where the same thesis could apply, he adds.

Srinath notes that agencies, lenders and investors need to buy more into larger, single-asset financing – in the same manner as single-asset single-borrower deals – to further fuel the C-PACE revolution. Part of the challenge with picking up momentum is the overall volume of C-PACE originations. Still, there are more opportunities now to bring the financing in on larger ground-up projects, especially in New York City.

“It could very easily be possible there’s a $1 billion building in New York with a very large C-PACE project on it and financing that large asset will be different than pooling assets into a warehouse and doing a securitization,” Srinath says. “It will have to be done differently.”

Thomas O’Connor, co-chair of the real estate finance group and a member of the real estate practice group at Duval & Stachenfeld, tells Real Estate Capital USA that the New York City C-PACE rollout has been bumpy, but he thinks the city’s Climate Mobilization Act will spur more action.

O’Connor notes C-PACE financing presents an avenue to make building improvements for a better value compared to rescue capital or other options available to finance compliancy with New York City codes. He cites co-ops and condominiums in the multifamily realm as being ripe for C-PACE opportunities in particular, with the next two years set to be fruitful for lenders deciding to work with the worst climate non-compliant offenders in the niche.