In particular, investors with ESG goals are moving away from equities, which to date have been a core area of focus for ESG investors and are instead shifting their attention on alternative asset classes to make an impact.
Whilst data availability, however questionable, has previously allowed ESG in public markets to be more easily measured and understood, there is growing awareness of the positive environmental and social impact that ESG integration can generate within private asset classes.
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One such asset class is private real estate debt, which is experiencing heightened interest from investors due to less availability from more traditional sources of credit financing.
With the spotlight now on private real estate lending, combined with increased demand from investors for ESG-focused strategies, the ability of this asset class to adequately address ESG considerations is under scrutiny.
Historically, real estate lending has been slower than the real estate equity investment sector with regards to ESG integration, with data accessibility, as well as lack of control and influence over a building in comparison to its owner, being cited as the primary reasons for this being the case.
Nonetheless, the real estate lending space plays a critical role in the built environment’s decarbonisation, nature restoration and social impact efforts.
Lenders provide the foundations for the creation, preservation, and regeneration of our building stock and as such have a responsibility to support the sustainable transformation of the real estate sector.
Increased recognition of this responsibility, continued investor pressure, improved ESG maturity from borrowers – and not to mention regulatory pressures like the EU’s Sustainable Finance Disclosures Regulations – have all led to the industry seeing a marked shift in action from many private real estate lenders.
In addition to the number of managers waking up to the growing level of expectation being placed on them by investors, we are also seeing a shift in terms of what lenders are focusing their attention on.
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Rewind five to ten years ago, and the main sustainability focus for any real estate debt manager was the consideration of asbestos, invasive species, flood risk, land contamination and Minimum Energy Efficiency Standards (MEES) risk within due diligence and underwriting at the loan origination or acquisition stage.
Fast forward to today and the level of detail being asked for by lenders of their borrowers has changed significantly, particularly for an ESG-focused fund under SFDR.
Going one step further, many lenders are starting to include loan covenants that address data sharing and other ESG-linked targets, as well as looking at preferential lending for those with stronger sustainability ambitions.
It is clear that real estate lenders have a real opportunity to drive market transformation, but there are also clear risks and benefits associated with the integration, or lack thereof, of ESG considerations.
There is mounting evidence that transition risk, regulation and investor pressures may expose a significant number of real estate assets to the risk of becoming stranded.
This has a direct impact on lenders, who need to be monitoring their existing and future loan book against a set of rigorous ESG criteria, the extent of which extends well beyond what has previously been looked at in the past.
In addition to improved risk management, there is also a great deal of value to be found in engaging with borrowers on the topic of ESG.
This is particularly true in the real estate equity investment sector, where these considerations have acted as a real catalyst for improved tenant relationships.
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Yet the same concept applies to lending, where managers have an opportunity to create positive touchpoints with borrowers to foster better relationships, which could lead to further financing opportunities in the future, as well as to support borrowers in achieving their own ESG ambitions and goals.
This idea is further supported when lenders are able to provide their borrowers with incentives that encourage the operation or development of more sustainable buildings, such as preferential lending rates to meet specific ESG requirements or capex opportunities to upgrade and improve buildings.
ESG is constantly evolving and dynamic in nature. Its sheer complexity and magnitude have at times left even experts on the subject in a state of confusion.
Yet, despite this, it remains one of the most truly collaborative workstreams; solely because its purpose is universal and impacts us all.
As such, there is a significant amount of knowledge and experience to be shared across geographies and private market sectors.
Those asset classes, like private real estate debt, which due to their nature have been slower to embrace the concept of ESG, can and should look at what they can learn from other private alternatives, as well as to the wider industry for further collaboration and market best practice.
Whilst tremendous progress has been made, real estate debt managers must re-evaluate the role they can play in the drive to transform the built environment; for time is of the essence.
Jessica Pilz is head of sustainable investing at Fiera Capital
