Sustainability-Linked Lending Series, Part 5 – Applying Sustainability-Linked Lending Principles to Real Estate Finance Transactions


In our August issue of REF News & Viewswe continued our in-depth analysis of the core components of the Sustainability-Related Lending Principles (“SLLP”) (“Core Components”) and reviewed loan characteristics, reported progress against sustainability performance targets, and sustainability and verification.

As a reminder, the SLLP has defined a framework, allowing all market players to properly understand the characteristics of an SLL. The framework is based on the five main components, namely:

  • selection of key performance indicators (“KPIs”);
  • calibration of sustainability performance goals (“SPT”);
  • loan characteristics;
  • reporting on progress against SPTs; and
  • verification

In this article in our series on sustainability-linked lending, we will discuss the application of SLLPs to real estate finance (“REF”) transactions and examine some associated issues.

SLLPs in a real estate financing context

In March 2022, the Loan Market Association (“LMA”) published a Guide to Applying the SLLP to Real Estate Finance and Real Estate Development Finance Transactions (the “REF guidance”).

In response to growing demand from the property finance and property development finance industry to integrate sustainability into their financing solutions, the LMA has launched this initiative. Following the launch of SLLPs by the LMA in 2019, SLLPs have become increasingly popular in the syndicated loan market. The volume of SLLs began to outpace that of green loans. However, the real estate finance industry has yet to take advantage of this rise in popularity of SLL. In the REF market, green loans are significantly more prevalent than SLLs.

This REF guide sets out what borrowers, financial parties and their advisers should consider when seeking to align their transactions with the SLLP. It adds REF guidance to existing SLLPs and accompanying guidance and includes sections on:

    • the roles of the parties involved in an SLL to ensure the transparency and integrity of the SLL product;
    • selection and disclosure of KPIs (with relevant examples applicable to REF transactions – which we will discuss in more detail below);
    • calibration of SPTs;
    • declaration and verification; and
    • documentary considerations.

The LMA has previously published similar guides for applying green lending principles to REF transactions. The CROR Directive does not apply to residential mortgages or any other form of retail lending.

Problems with using SLLs in REF

To date, the use of SLLs in the context of REF and real estate development finance has largely focused on the financing of real estate investment trusts (“REITs”) and in relation to social housing projects, but the LMA recognized that in general there are some practical challenges that can arise when applying SLLPs in the context of REF and real estate development finance.

These challenges are defined in the REF Guide:

    • REF loans are generally made available to a borrower who is a special purpose vehicle (“SPV”) with no trading history. Such an SPV borrower is unlikely to have a pre-existing sustainability strategy and/or have access to historical environmental, social and governance data. Since there is no data available, this can cause problems with an SLL in the selection of KPIs and the calibration of SPTs. As the REF Guide recognizes, this may be easier when (i) a portfolio of properties is being financed, (ii) capital expenditure is needed to finance renovations or (iii) when the property being financed is an asset operating.
    • Generally, in REF investment financing transactions, the borrower does not occupy the property financed and in fact may not have direct control over the development or day-to-day operation of the property. The borrower may have some ability to require its tenants to adhere to SLLPs or green lending principles through provisions in the underlying leases. However, as the borrower cannot in practice control the actual activities of the tenant occupying the property, he may be reluctant to commit to objectives which are beyond his day-to-day control.
    • There are still divergences in the market as to what is considered to be ‘doing enough’ in terms of improving sustainability performance in the contexts of REF and real estate development finance. This can lead to concerns about greenwashing (that’s to saythe practice of gaining an unfair competitive advantage by marketing a financial product as environmentally friendly, when in fact it does not meet basic environmental standards) which can damage the reputation of borrowers and lenders.

Notwithstanding the above issues, there have still been various SLL transactions in the contexts of REF financing and real estate development. The REF Guide notes that there is still significant potential for further growth of SLLs in the contexts of REF financing and real estate development due to a number of factors, such as: (i) the need to decarbonise the fleet existing real estate to achieve global climate goals, (ii) improve the sustainability of construction methods and materials, and (iii) address the shortage of affordable housing worldwide.

REF-focused KPIs

The REF Guide defines some common categories of KPIs observed in the contexts of REF funding and real estate development, as well as an example of the improvements that a KPI in this category might seek to measure. Examples include:

    • Energetic efficiency: Improvements in the energy efficiency rating of the building(s) owned or leased by the borrower (often demonstrated using a green building rating, standard or certification). Energy efficiency improvements can be related to the in-use performance and/or the fabric of the building(s).
    • Sustainable Sourcing: Increased use of verified sustainable raw materials/supplies in the construction or renovation of building(s) or funded development.
    • Embodied carbon: Embodied carbon reductions associated with funded development.
    • Clean transportation: Improvements in the use of low-carbon transport and related infrastructure, including electric vehicle charging stations and dedicated spaces for bicycles.
    • affordable housing: Increase in the number of affordable housing units developed by the borrower.

For more examples, please see the REF guidance. We note that the examples contained in the REF Guide are not exhaustive and are intended to be indicative only.


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