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New Shoots Emerging in Green Bond Market for Real Estate

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New Shoots Emerging in Green Bond Market for Real Estate

T he emergence of the market for green bonds--conventional bonds whose proceeds must be used for sustainable investments--is supporting environmentally beneficial strategies in the real estate sector. This new source of financing allows for an alignment of interests between tenants, commercial real estate companies (CREs), and investors: tenants aspire to rent office space and buildings that are energy-efficient and neutral to their environment; real estate companies are getting the funds to develop or acquire these new assets; and investors are showing a growing appetite for green bonds as ethical and socially responsible debt instruments.

A number of industry studies, such as that by Global Real Estate Sustainability Benchmark (GRESB), have even found that the financial performance of CREs is generally stronger when environmental, social, and corporate governance (ESG) factors are incorporated into their strategy. We believe the current low interest rates prevailing in Europe have also played a part in this development, encouraging issuers to pay the incremental cost of documenting and reporting a green bond.

However, real estate green bond issuance has been limited so far, maybe because of the lack of standardization in the market. The first green bond was issued in 2013 by property company Vasakronan, and two CREs, Foncière des Régions and Fabege, have issued green bonds in recent months. Foncière des Régions and Fabege will use the proceeds to finance existing or in-development assets that have, or will obtain, green building certifications, such as BREAAM (Building Research Establishment Environmental Assessment Method) or its French equivalent HQE (Haute Qualité Environnementale).


  • Investors' demand for corporate green bonds is building, but issuance by Real Estate Investment Trusts (REITs) is currently limited.
  • Each instrument is ad hoc currently. Further growth in the green bond market should allow greater standardization that would preserve CREs' operational flexibility.
  • Large international tenants are increasingly demanding in terms of the environmental performance of the buildings they rent. Properties with green credentials support tenants' cost-saving programs and their efforts to demonstrate better sustainability performance.
  • This is pushing CREs to improve this aspect of their portfolios, notably through green building certifications.
  • Investors view such certifications as reliable and trustworthy, which eases REITs' access to the green bond market.

Investor Appetite For Green Bonds Is Growing

Government pledges to support the transition to a lower-carbon economy have led major financial institutions and supranational agencies to promote the growth of the green bond market. Governor of the Bank of England Mark Carney showed support for green bonds in a speech to the United Nations General Assembly on the "Sustainable Development Goals" in April 2016, suggesting that "green bonds have the potential to align the interests of issuers and investors."

Investor appetite for buying green financing is not only driven by their commitment to contribute to the development of a greener economy, but also by green bonds' reduced exposure to regulatory and climate change risk. Investors view green bond issuers as better attuned to the risk of climate change and better able to adapt and contribute to tackle it. Moreover, corporate green bonds can deliver higher yields and offer diversification away from supranationals' and banks' green bonds, which still represent the larger portion of green bond issuance.

Consequently, significant demand for corporate green bonds is building and investors are ready to buy up green bonds if they meet certain requirements. There is still some debate over the definition of "green" and how to ensure proper reporting of the projects to be financed through green bonds, as well as how to establish the link between the proceeds raised and the actual green project (see our report "The Corporate Green Bond Market Fizzes As The Global Economy Decarbonizes," published April 15, 2016). For a green bond to attract a large pool of investors, a reliable assessment of the "greenness" of the use of proceeds and efficient reporting appear to be key.

Access Is Currently Limited To A Closed Group Of Large, High-Quality Issuers

The issuance of green financing by REITs has so far been limited, totaling about €2 billion in Europe. Green bonds offer two advantages to real estate issuers we rate. First, green financing promotes their efforts to improve the sustainability of their portfolios. Second, it enables them to reach larger pools of investors and to tap the significant investor demand for green instruments. Nevertheless, we understand some of our issuers remain skeptical about the benefits of the green bond market.

Outstanding Green Bonds In The EMEA REIT Sector
Issuer Rating Segment Date of issuance Maturity Amount Coupon
Fonciere des Regions BBB Office May 2016 2026 €500 million 1.88%
Fabege AB NR Office May 2016 2018 SEK600 million 1.30% + three-month STIBOR
Vasakronan NR Office - Retail April 2016 2018 SEK550 million 0.78% + three-month STIBOR
Vasakronan NR Office - Retail October 2015 2020 SEK267 million 1.50%
Vasakronan NR Office - Retail October 2015 2020 SEK330 million 1.05% + three-month STIBOR
Vasakronan NR Office - Retail August 2015 2018 SEK156 million 0.75% + three-month STIBOR
Unibail Rodamco A Retail April 2015 2025 €500 million 1.00%
Vasakronan NR Office - Retail February 2015 2018 SEK650 million 0.37%
Vasakronan NR Office - Retail November 2014 2019 SEK500 million 0.53% + three-month STIBOR
Vasakronan NR Office - Retail March 2014 2019 SEK750 million 0.67% + three-month STIBOR
Vasakronan NR Office - Retail March 2014 2019 SEK500 million 2.47%
Vasakronan NR Office - Retail April 2014 2016 SEK1 billion 0.35% + three-month STIBOR
Unibail Rodamco A Retail February 2014 2024 €750 million 2.50%
EMEA--Europe, Middle East, and Africa. REIT--Real Estate Investment Trust. NR--Not rated. STIBOR--Stockholm Interbank Offered Rate.

Documenting and reporting the "greenness" of a bond has a cost, on top of fees for external bodies performing secondary opinions or third-party certifications. So far, it doesn't seem like green bonds benefit from favorable pricing, with similar spreads observed on the primary market on otherwise similar green and traditional bonds. The issuer bears the extra cost of issuing a green bond, which could be a barrier to the expansion of the market in the long run. Current issuance is taking place in an environment of extremely low interest rates. The average cost of debt of rated issuers has significantly decreased over the past year.

Green bonds could conceivably be less attractive to issuers if interest rates went up and financing became more expensive. The extra costs associated with issuing a green bond could also discourage an issuer paying a higher funding cost than peers, for example, because of its weaker credit quality.

Green bond documentation typically includes selection criteria on funded assets and issuers' clear commitments around use of proceeds. This can restrict the flexibility of the issuer in terms of asset rotation or tenant management. For example, the issuer might be unable to sell an asset because it has been developed through green bond financing and this has to be reinvested in another project that satisfies the outstanding green bond criteria. Or, the issuer could have to vacate tenants to refurbish rented space in order to avoid a time lag between receiving proceeds and making green investments. We take a positive view of long lease durations because they reduce cash flow volatility. Green strategies could theoretically weaken our assessment of the risk on the rental income generation if they were to result in shorter leases, higher vacancies, and reduced flexibility of lease management and development activities. We believe that an issuer with a large portfolio would be less concerned by these factors than a smaller player, as its size would provide enough of a pipeline of refurbishment and development to allow it to meet the green bond criteria without reducing its flexibility in terms of portfolio management. For these reasons, green bonds could be a more natural financing tool for larger issuers with stronger credit quality.

The green bond market for REITs is still nascent and a greater degree of standardization will probably be needed for further growth. A welcome step in this direction would be a sector-specific framework that limits extra costs and unifies green bond criteria and commitments for the use of proceeds, while preserving flexibility for issuers in terms of asset rotation and lease management. The framework developed by the Swedish bank Skandinaviska Enskilda Banken has supported the expansion of the green bond market in Sweden. Other characteristics of the Swedish bond market have helped the development of green bonds, such as issuers being able to place issues as small as SEK100 million (about €11 million), as well as the long-dated commitment by major investors to support the transition to a low-carbon economy.

Tenants Increasingly Want Environmentally Sustainable Buildings

Tenants, mostly large international companies, are increasing their efforts to develop a strong and consistent strategy for the management of the buildings they occupy. Reducing operating expenses is a pressing strategic goal, putting emphasis on buildings' sustainability and energy consumption. According to the United Nations Environment Program, buildings use about 40% of global energy, 25% of global water, 40% of global resources, and they emit approximately one-third of greenhouse gas emissions. Tenants particularly want high-performance, sustainable buildings to help them reduce their energy bill. The positive image is an extra side benefit.

Beyond tenants' focus on cost reduction and the importance of energy management as a cost-saving opportunity, sustainability also appears to be a growing concern in corporations' global strategies.

All big corporations now include large sections of their annual reports and regular reporting devoted to their green track record. This captures all measures being adopted at plant and product level to save energy and resources, but it also extends to the office space they rent. A recent survey among 120 European global corporations shows that sustainability and environmental concerns represent 17% of the greatest challenges for organizations' future operations, ranking equally with geopolitical issues, and higher than other challenges such as energy prices, currency fluctuations, or competition from emerging markets (see the CBRE European Occupier Survey 2015/16).

To meet the expectations of their tenants, real estate issuers that we rate are investing more to achieve much stronger sustainability measures for the larger buildings in their portfolio. As of year-end 2015, most CREs we rate already publicly report that a majority of their office portfolio is "green" certified. They all target certifying more of their assets over the next two-to-three years.

Green Building Strategies Strengthen CREs' Competitive Positions On The Office Market

High sustainability attracts stronger tenants and, consequently, helps CREs to collect adequate rents and reduce vacancies. The "greenness" of assets can be a distinguishing factor in oversupplied markets where tenants care about sustainability, such as Paris. We view high occupancy and creditworthy tenants as strong positives in our assessment of an issuer's competitive advantage as they support predictable cash flows from operations. The age and location of the buildings in the portfolio and the percentage of certified space are important factors in our analysis as indicators of asset quality. Green strategies have delivered on limiting vacancy and maximizing occupancy but there is no consensus on whether a rent premium exists for green real estate. However, a 2010 study by Wiley, Benefield, and Johnson of 46 markets and 7,308 properties found that buildings with a LEED (Leadership in Energy & Environmental Design) certification had a rent premium of 15.2%-17.3% over conventional buildings, after controlling for region and lease type.

The green real estate strategy of rated European commercial CREs correlates with their market positioning; CREs whose portfolios comprise only a few assets of prime quality in central business district locations view sustainability and certifications as necessary to demonstrate the superior quality of their assets. Société Foncière Lyonnaise's portfolio in the Paris office market fits this profile. It has a relatively small number of assets, but they are of the highest quality in terms of energy efficiency and location. The company has already obtained green certifications for all its assets. In markets largely undersupplied with high-quality assets, such as Madrid, improving the greenness of buildings through certifications is a way for CREs to affirm market leadership. Merlin Properties, whose portfolio is about one-third office buildings in Madrid and Barcelona, plans to obtain green certifications for most of its assets to preserve its leading positions on the office market in Spain.

Issuers with a focus on medium-rent levels invest in green buildings for current refurbishments and developments. However, sustainability is not a core priority in their operating strategy because they do not need to offer the most prime assets. This seems to be Derwent London's approach, as it focuses more on future assets than its existing portfolio for improving sustainability. In the heated London office market, the focus on certification has been somewhat lower than in continental Europe. Until recently, reducing vacancy and attracting new tenants has proved less difficult in London than in some other European cities. Post-Brexit, however, the rental environment may turn more sluggish, and buildings' green characteristics may come to play a bigger part in the differentiating strategies of large U.K. REITs.

Green Building Certifications Can Be Used To Demonstrate The Greenness Of A REIT Green Bond

BREEAM, HQE, and LEED are independent certifications assessing the sustainability of buildings--their "greenness"--through indicators such as carbon emissions, materials, water efficiency, waste management, occupant wellbeing, and comfort. These indicators are combined to derive a final rating. For BREAAM, for example, the ratings range from acceptable to outstanding. BREEAM is the most widely used certification, followed by HQE, which is mostly used by French issuers, and then LEED, which is the second most used international certification among office players that we rate.

Comparison Of Green Building Certifications
Type of certification for office buildings New Construction; Refurbishment And Fit-Out; In-Use International Building Design + Construction; Interior Design + Construction; Building Operations + Maintenance Building - Newly built or refurbished; Building - In use
Subscores Energy; health and wellbeing; innovation; land use; materials; management; pollution; transport; waste; water Integrative process; location and transportation; sustainable sites; water efficiency; energy and atmosphere; materials and resources; indoor environmental quality; innovation; regional priority Energy use; environmental impact; comfort and health; management
Assessment Scoring on different issues for each of the subscores, scores are compiled to get the final rating Projects earn points in each subscores and final rating derived from the total number of points Each subscore receive a number of stars depending on performance
Possible outcome Acceptable - Pass - Good - Very Good - Excellent - Outstanding Certified - Silver - Gold - Platinium Pass - Good - Very Good - Excellent - Exceptional
Provider Building Research Establishment (BRE) U.S. Green Building Council Certivea in France Cerway outside of France
BREEAM--Building Research Establishment Environmental Assessment Method. LEED--Leadership in Energy & Environmental Design. HQE--Haute Qualité Environnementale.

To take one example, the Carre Vert building located in Paris, which is rented by EDF from Wereldhave, has obtained a BREEAM rating of "outstanding". That building displays many sustainable technologies, including: a cooling system supported by geothermal heat pumps distributing the air through cooled water loop; photovoltaic panels, urban wind turbines, and solar thermal panels for electricity and hot water production; green roofing with sedum to help rainwater runoff and thermal isolation; a rainwater recycling system for irrigation and toilets; on-site sustainable water treatment; a leak detection system; and sanitary supply shut off valves implemented on all toilet blocks.

Investors view green building certifications such as BREEAM, LEED, and HQE as credible measures of environmental sustainability. Unibail Rodamco and Fabege use BREAAM in their Green Bond criteria and Green Bond Framework, respectively, and Vasakronan uses both BREEAM and LEED in its Green Bond Framework. These certifications are important in a market where there is no standardized assessment of the "greenness" of the use of bond proceeds.

The extent of the success of green bonds in the real estate sector will likely depend on whether the clear, broad appeal of this form of financing generates enough momentum to tackle the lack of standardization in the market. If this barrier can be removed, these environmentally friendly, higher-yield, and asset-enhancing instruments could start to see much wider use over the next few years.

We would like to thank Liz Hypes of Greenleaf Advisors LLC for her contribution to this report.