Green Commercial Loans - insights from Master's Thesis

Anna-Mari Jalo: Green Commercial Real Estate Debt Financing and Market Practices

When discussing sustainability and financing, significance is emphasized. Still, there is a lack of awareness of how sustainability will affect the real estate industry from a financing perspective and its associated risks. Master thesis aboutgreen commercial real estate debt financing and market practices aimed to deepen knowledge by focusing on influencing drivers and barriers of green real estate debt financing and market practices of green real estate loans. The purpose was to increase understanding of current market practices and the influencing factors affecting green real estate financing and thereby help investors and the whole real estate industry understand the change in green financing. The empirical part of the study was conducted by interviewing the major banks that provide loans for professional real estate investors and operate in Finland. According to the interviews, many factors affect green real estate financing demand, supply, and pricing. The most significant ones are presented below.

Firstly, the greenium (green premium) of commercial green real estate loans somewhat varies. Greenium can be seen as resulting from the capital market's demand-supply dynamics. Some loan providers forward greenium directly to the borrower. Loan providers who do not specify a greenium, still require sustainability aspects even to provide funding. The study shows that the availability of financing and refinancing, in general, is more meaningful than the significance of greenium. The risk related to refinancing can already be seen in affecting loan market practices by the cost of funding.

Secondly, the development of criteria is seen as a driver for green real estate financing. Most of the interviewees highlighted the certifications, especially LEED and BREEAM. According to the interviewees, the increased development in criteria has made it easier to verify greenness. In addition, there are many benefits associated with green building certifications and greenness in general. The development of regulation is also observed affecting green real estate financing. Regulation accelerates the way financial operators move towards a more sustainable way of doing business. Regulation drives modernisation needs and increases credibility, for example, related to misleading marketing or other greenwashing aspects. Emission reduction targets for different countries and cities also come through regulation. In particular, the effect of EU Taxonomy as a driver was highlighted. In addition, the Energy Performance Certificates (EPC) scale of a building's energy efficiency from the Energy Performance of Building Directive (EPBD) was mentioned, as well as the Sustainable Finance Disclosure Regulation (SFDR). With the tightening of regulation, sustainability aspects will have an even more significant impact on the value of real estate.

Despite the development of criteria and regulation, there is a lack of criteria concerning commercial green real estate loans. The requirements should be better considered for smaller sustainability investments. The criteria also need to consider the benefits of the social aspects broadly enough. Several interviewees also mentioned that the challenge is the differences in criteria between banks, even though they emphasised that the differences are not significant. Interviewees stated especially the EU Taxonomy and the possibility of its interpretation by the regulation entity. Several interviewees also mentioned the differences in local regulation between different countries. Local regulations and the fast development of regulations create friction in the product development of banks. The differences in loan market practices are not necessarily very significant, but there are differences in the strictness of the criteria. Such a considerable variation in criteria may confuse borrowers and stakeholders and decrease the credibility of green real estate loans.

The table below shows the summary of criteria for green real estate loans, based on interviews and supplemented with the banks' green finance frameworks or similar, which the interviewees mentioned and are publicly available. To summarise, green commercial real estate debt financing and market practices are transforming, especially regarding the significance of regulation, which will grow and change market practices in the future. 

Reference:
Jalo, A.-M. (2024). Green Commercial Real Estate Debt Financing and Market Practices [Master’s Thesis, Aalto University]. https://aaltodoc.aalto.fi/handle/123456789/126411

For further information on the findings of the Master Thesis, please reach out to Anna-Mari Jalo ([email protected] / +358403522670).