Sustainability-Linked Loans Series, Part 5 – Application Of Sustainability-Linked Loans Principles To Real Estate Finance Transactions – Real Estate

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In our August edition of REF News and Views, we
continued our deep dive into the Sustainability-Linked Loan
Principles (“SLLP”) core components (“Core
Components”) and looked at loan characteristics, reporting
progress against sustainability performance targets, and

As a reminder, the SLLP set out a framework, enabling all market
participants to clearly understand the characteristics of a SLL.
The framework is based around the five Core Components, namely:

  • selection of key performance indicators

  • calibration of sustainability performance targets

  • loan characteristics;

  • reporting progress against SPTs; and

  • verification

In this installment in our Sustainability-Linked Loans Series,
we will discuss the application of the SLLPs to real estate finance
(“REF”) transactions and consider some associated

SLLPs in a Real Estate Finance Context

In March 2022, the Loan Market Association (“LMA”)
published a guide on the application of the SLLP to real estate
finance and real estate development finance transactions (the
“REF Guidance”).

In response to the rising demand in the real estate finance and
real estate development finance industry to integrate
sustainability in their financing solutions, the LMA launched this
initiative. Following the LMA’s launch of the SLLPs in 2019,
SLLPs became increasingly popular in the syndicated loans market.
SLL volume began to surpass that of green loans. However, the real
estate finance industry has not yet benefited from this rise in SLL
popularity. In the REF market, green loans are significantly more
prevalent than SLLs.

This REF Guidance sets out what borrowers, finance parties and
their advisers should consider when looking to align their
transactions to the SLLP. It adds a REF focus to the existing SLLPs
and accompanying guidance and includes sections on:

  • the roles of the parties involved in a SLL in ensuring the
    transparency and integrity of the SLL product;

  • selection and disclosure of KPIs (with examples tailored and
    applicable to REF deals – which we will discuss further

  • calibration of SPTs;

  • reporting and verification; and

  • documentation considerations.

The LMA has previously published similar guides for the
application of the Green Loan Principles to REF transactions. The
REF Guidance does not apply to residential mortgages or any other
form of retail lending.

Issues with the Use of SLLs in REF

The use of SLLs to date in the REF and real estate development
finance context has largely been focused on financing real estate
investment trusts (“REITs”) and in relation to social
housing projects, but the LMA has acknowledged that in general
there are certain practical challenges that may arise in applying
the SLLPs to the REF and real estate development finance

These challenges are set out in the REF Guidance:

  • REF lending is typically made available to a borrower that 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 access to historical environmental,
    social and governance data. To the extent that there is no
    available data, then this may cause challenges with a SLL in
    selecting KPIs and calibrating SPTs. As the REF Guidance
    acknowledges, this may be easier where (i) there is a portfolio of
    properties being financed, (ii) capex is required to finance
    retrofit works or (iii) where the property being financed is an
    operating asset.

  • Generally, on REF investment finance transactions, the borrower
    does not itself occupy the property being financed and in fact may
    not have direct control over the fit-out or day-to-day operation of
    the property. The borrower may have some ability to require its
    tenants to adhere to the SLLPs or green loan principles via
    provisions in the underlying leases. However, as the borrower
    cannot in practice control the actual activities of the tenant
    occupying the property, it may be reluctant to commit to targets
    that are outside of its day-to-day control.

  • There are still divergences in the market as to what is
    considered “doing enough” in terms of improving
    sustainability performance in the REF and real estate development
    finance contexts. This can lead to concerns over greenwashing
    (i.e., the 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) that can cause reputational damage to both borrowers and

Notwithstanding the above issues, there have still been various
SLL deals in the REF and real estate development finance contexts.
The REF Guidance notes that there is still significant potential
for further growth of SLLs in the REF and real estate development
finance contexts due to a number of factors, such as: (i) the need
to decarbonise existing building stock to meet global climate
targets, (ii) to improve the sustainability of construction methods
and materials, and (iii) to tackle the shortage of affordable
housing globally.

REF-focused KPIs

The REF Guidance sets out some common categories of KPIs seen in
the REF and real estate development finance contexts, together with
an example of the improvements which a KPI in this category might
seek to measure. Examples include:

  • Energy efficiency: Improvements in the energy
    efficiency rating of building(s) owned or leased by the borrower
    (often demonstrated using a sustainable building rating, standard
    or certification). Improvements in energy efficiency can relate to
    in-use performance and/or the fabric of the building(s).

  • Sustainable sourcing: Increase in the use of
    verified sustainable raw materials/supplies in the construction or
    refurbishment of building(s) or development being financed.

  • Embodied carbon: Reductions in embodied carbon
    associated with the development being financed.

  • Clean transportation: Improvements in the use
    of low carbon transport and related infrastructure, including
    electric vehicle charging points and dedicated bicycle spaces.

  • Affordable housing: Increases 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 Guidance are not exhaustive and are intended
to be indicative only.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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