Planting the seeds of sustainability

Planting the seeds of sustainability

The pros (and cons) of green finance in real estate

Sustainable or “green” finance is gaining significant traction in the real estate market in the UK. Green finance in real estate refers to financial products and transactions designed to promote environmentally sustainable projects. As the UK moves towards meeting its 2050 net-zero emissions target, green finance has become a critical tool in transforming the built environment. In this article we will explore some of the distinct benefits and challenges presented by sustainable finance for both lenders and borrowers in adopting green finance products.

Meeting regulatory targets and enhancing reputation

The UK government has set stringent environmental standards, including the net-zero emissions target by 2050. Lenders engaging in green finance transactions are better positioned to meet these regulatory expectations. As authorities increasingly scrutinise the environmental impact of financing, adopting green finance not only helps lenders comply but also enhances their reputation for sustainability, which may be of particular importance to institutional lenders.

Similarly, as businesses and individuals become more environmentally conscious, borrowers investing in sustainable properties gain credibility and enhance their corporate social responsibility (CSR) profile. Green finance transactions can boost a borrower’s brand reputation and appeal to consumers who prioritise sustainability.

Attracting ESG-conscious investors

Investors, particularly those with an interest in Environmental, Social, and Governance (ESG) criteria, are increasingly looking for green finance options. By offering green loans or financing, lenders can attract a growing pool of investors seeking to align their investments with sustainable practices. This helps lenders expand their investor base and appeal to ethically-driven capital.

In the same way, with the growing demand for ESG-compliant investments, borrowers can also tap into a more extensive network of institutional and private investors. Many investors are now prioritising sustainability in their portfolios, providing borrowers with better access to funds. For borrowers, securing green finance can open doors to a wide range of financing options, including green bonds, green mortgages, and other ESG-focused products.

Improved asset value and demand

Buildings that meet sustainability criteria, such as those with high energy efficiency, are more attractive to tenants and buyers, especially as public awareness of climate change increases. As a result, properties financed through green loans often enjoy higher demand and retain value better than conventional properties. Lenders benefit from this stability, as properties with higher demand are less likely to default.

Properties with green certifications or sustainability features also tend to have higher operational efficiency, lower running costs, and greater appeal to tenants. This results in improved tenant retention rates, potentially higher rental income, and a stronger asset value. Borrowers can, therefore, expect higher returns on their investments in green real estate.

Lower borrowing costs (but higher up-front costs)

One of the most compelling advantages of green finance for borrowers is the potential for reduced borrowing costs. Lenders are often willing to offer lower interest rates on green loans due to the reduced risk and increased appeal of sustainable properties. Additionally, borrowers may benefit from green financing incentives, such as lower upfront costs or discounts on interest rates for meeting sustainability criteria. 

However, one of the main barriers to green finance is the initial cost of making properties environmentally sustainable. Whether it’s installing energy-efficient technologies, achieving certification standards (such as BREEAM or LEED), or retrofitting existing properties, these upfront costs can be significant. Although borrowers may save money in the long term through energy savings and lower operational costs, the initial investment may be a hurdle, especially for small developers or landlords.

Relative unknowns and market immaturity

While green finance is growing, it remains a niche sector within the broader real estate market. The market for green building certifications, green loans, and sustainable development projects is still maturing, and many lenders and borrowers may be unfamiliar with the full range of green financing options available. There is also a lack of uniform standards across the industry, making it harder for participants to navigate the green finance landscape confidently.

In addition, green buildings are still relatively new in the real estate market, and the valuation process can be complicated. Lenders may find it difficult to assess the long-term value of a green property, especially if market comparables are limited. The lack of standardized green metrics or universally accepted valuation frameworks adds to the uncertainty. As a result, lenders may be hesitant to offer favourable terms to borrowers if they cannot easily appraise the risk and reward of green investments.

Conclusion

Sustainable or green finance offers significant advantages for both lenders and borrowers in the UK real estate market. Lenders can benefit from reduced risk, regulatory compliance, and enhanced appeal to ESG-conscious investors, while borrowers can enjoy lower costs, access to capital, and improved property value. However, green finance is not without its challenges. Initial costs, valuation complexities, and the relative immaturity of the market can pose difficulties for both parties. Despite these hurdles, the growing emphasis on sustainability in the UK’s real estate market suggests that green finance will play an increasingly important role in shaping the future of property investment and development. 

As both the regulatory landscape and market demand for green properties evolve, it is expected that these challenges will diminish over time, making green finance a cornerstone of the real estate sector in the years to come.

As they head to MIPIM next week, the Hill Dickinson team is looking forward to discussing sustainable finance and the future of real estate finance with new and existing contacts.