I recently gave a talk for the Environmental Bankers Association (EBA), and ex-ante, I was excited about the prospect of fierce debates with bankers about "green" financing. After all, if energy efficiency and/or sustainability factors affect the investment performance of real estate, then lenders should take these factors into account in their underwriting of assets. There might be an upside to green building, which will benefit the equity investors, but long-term lenders will be more concerned about the risk of "stranded assets," (to use the language of Al Gore and David Blood) following changes in building regulation (think about the UK, that wants to make it unlawful to lease out space rated with energy label F or G in 2018), carbon pricing, or even the fat tail risk of climate change events. Alas. I certainly did my part of the fierce debate, but the response was a little muted. For (mortgage) lenders, pricing risks related to energy efficiency seems to be a big challenge, which leaves the most important part of the capital market with a neutral stance towards energy efficiency projects. Oh sure, Wells Fargo will make big claims related to financing of "green" real estate projects ($6.4bln in 2012 alon), but ask them whether factors such as LEED or Energy Star play a role in the underwriting, and the sound of silence will fill the room/phoneline.
There is much more focus on stand-alone financing of energy efficiency/sustainability retrofits. Whether it is PACE for Commercial in the US, the Environmental Upgrade Agreement in Australia, or the Green Deal in the UK. Providing stand-alone financing to households is challenging though, as the UK government has learned (see this BBC News article: 'Only 200 homes' signed up for Green Deal energy loans'), certainly at interest rates required to actually pay for the overhead. Why borrow at 7% when current interest rates are a fraction of that? And commercial owners often finance capital improvements on their balance sheet. (Sure, Prologis made nice headlines when taking out the first PACE financing for their SF headquarters, but was that lien really necessary...).
Why not start at the beginning, with the integration of environmental factors in the underwriting process? We know how to price in flood risk. We know how to deal with asbestos. So, let's price in that EU energy label, that US Energy Star score, or that Australian NABERS rating. Here's a simple example from Triodos, a small Dutch bank:
You don't have to speak Dutch to understand this: a label step corresponds to 0.1% increase or decrease in the interest rate. Very simple. Yes, the effects are small, but that seems appropriate for the risks related to energy efficiency (although a recent IMT/UNC study found large effects of energy efficiency on default risk).
In an attempt to map the opportunities for integration of sustainability requirements into financing of new developments, redevelopments, or refinancing of commercial real estate, I recently did a (quick and dirty) survey of tools that are globally available for "greening the building stock." (Disclaimer: this research was commissioned by the Dutch Green Building Council.) The good news is that all major Dutch banks are involved in this project (ABN Amro Real Estate, ING Real Estate Financel, FGH Bank, NIBC, Syntrus Achmea Real Estate & Finance):
Especially the German program is interesting (but well, let's leave the discussion on trade-offs between input and output for another blogpost...). And of course, this overview may miss certain financial instruments, so please send me a note with your views (or leave a comment).
