US lenders are leaning into ESG

It is still early days for sustainable lending in the US, but the growth of C-PACE and green lending indicates the direction of travel.

While the US private real estate credit market still lags behind Europe in its embrace of the ESG agenda, a decisive shift in outlook is underway.

“As part of a global business we can see how sustainable finance, which has been widely adopted across Europe, has spread to the US,” says Jeffrey Schwartz, director at ING Real Estate Finance, the Dutch bank’s US arm, which is an active participant in the US real estate lending market. “The dialogue continues to expand. At every conference it is now part of the discussion, whether among sponsors, senior lenders, or the debt funds we partner with.”

It is still “early days in terms of the ESG and sustainability journey,” admits Josh Green, co-founder of ESG data platform Novata. However, he notes: “The cost of capital is increasingly in play as a variable that is influenced by sustainability.”

That has prompted lenders to consider their approach to the issue, he says. They can respond defensively by preparing themselves for tighter regulation and increased due diligence from multinational institutions demanding compliance with their ESG policies, or seize the opportunity to go on the offensive by taking advantage of a lower cost of capital for sustainable assets. Another option would be tapping into investment allocations available only to sustainable lenders.

However, ESG’s foothold within many US lenders’ businesses is still relatively shallow, says Lee Hodgkinson, head of ESG at debt fund manager Avrio Real Estate Credit. “There is still a bit of a disconnect between what investors in debt and credit want to see in terms of ESG, and what many lenders are doing.

“Some of them have ESG teams, but it may not yet be integrated into their lending practices. If the ESG and lending teams don’t communicate properly, they are in danger of missing risks that may impact their investments.”

Building alignment

The lack of an established framework for sustainable lending in the US has held back progress, says Hodgkinson. That is starting to change, however, following the creation of the Integrated Disclosure Project in 2022, to which Avrio has aligned its ESG questionnaire for potential borrowers.

“That is one of the few programs out there trying to standardize ESG data collection and reporting within the lending space,” says Hodgkinson. “It is championed by the Alternative Credit Council, the Loan Syndications and Trading Association, the Loan Market Association and the UN-supported Principles for Responsible Investment, so it has good backers.”

“There is still a bit of a disconnect between what investors in debt and credit want to see in terms of ESG, and what many lenders are doing”

Lee Hodgkinson
Avrio Real Estate Credit

Some lenders, including Fannie Mae and Freddie Mac, have introduced products offering pricing incentives for borrowers that achieve sustainability targets. ING also offers incentivized pricing green loans to owners of buildings that achieve top LEED and NGBS Energy Star ratings.

So far, only a handful of balance sheet lenders have a special bucket for green financing, says Schwartz. But where ING has been the lead lender in a syndicated green financing structure, it has found willing partners. “So there is evidence that other lenders are willing to accept it.”

Another indication of the increased interest in sustainable finance has been the greater use of Commercial Property-Assessed Clean Energy (C-PACE) loans, a state-led partnership mechanism that provides long-term finance, repayable through the property tax system, for real estate owners that develop or renovate energy-efficient buildings. Total C-PACE investment has grown from less than $1 billion as of 2018 to $5.2 billion by 2022, the latest year for which data is available.

Growing appetite

“The size of the market and the scale of deals has changed drastically,” says Laura Rapaport, founder and chief executive officer at specialist C-PACE lender North Bridge. “In the first 12 years after the program’s inception in 2008, there was only $2.25 billion of C-PACE lending across 2,600 transactions.”

Rapaport explains that higher interest rates have made the cost of capital of C-PACE loans more competitive in a period when the crisis affecting US regional banks, and the state of capital markets, have limited liquidity. “That has led to a renewed focus, especially by the institutional space, on trying to understand what C-PACE is, and how they can use it.”

Figures from PACENation show that over half of C-PACE investment is for energy efficiency projects. A further 17 percent is for renewable energy projects, with 15 percent for mixed projects and 3 percent for resiliency.

There is a ready market for C-PACE loans packaged up and sold on the asset-backed securities (ABS) market, says Sandeep Srinath, managing director of asset securitization at ING, which provides a revolving warehouse debt facility to C-PACE providers.

“Green loan or bond designation is a key value driver for investors that have pockets of money allocated for green projects and deals. And high tenant demand for newly renovated commercial real estate that meets green building standards bodes well for a product like C-PACE,” says Srinath.

While green finance products are more widely available and popular, the development of social impact-related lending has made less distinct headway.

Like other ESG-focused lenders, Ares Management Corporation’s ESG questionnaire for real estate credit sponsors includes a range of social indicators. Nonetheless, social impact is still more difficult to measure, says co-head of US real estate Bryan Donohoe.

Moreover, Donohoe argues that building a diverse and inclusive business is a long-term project. “You need to take a ground-up approach, bringing in younger people from more diverse backgrounds. It is not something that happens overnight.”

Schwartz says ING endeavors to execute on social initiatives and is evaluating the scope for financing developments that exceed mandated levels of affordable housing provision. But he admits that implementing such a strategy has so far proved challenging. “It is difficult to make the economics work for an investor when structuring something more restrictive than is required by government.”

ESG policies have met with some pushback from right-wing politicians in the US, with the term becoming divisive in some circles. Investors will find consensus around the underwriting of risk, argues Donohoe. He cites the example of rising insurance premiums in the face of more frequent severe weather events.

“Over the past two years some areas of the US have seen a massive spike in insurance costs. Those costs will be reflected in asset values, and in returns for investors,” he says.
“That is expected to be a catalyst for more adoption of what we term ESG, regardless of whether everyone characterizes it the same or not. The identification and proper pricing of risk is going to be the greatest driver of this moving forward.”