Green bonds have already proved to be a good fit for commercial real estate and, along with other emergent sustainable finance products, are expected to increasingly come into play as owners/managers pursue decarbonization and look to bolster the climate resiliency of their properties. Beyond spurring reductions in greenhouse gas (GHG) emissions through the $2-billion building retrofits initiative, the Canada Infrastructure Bank (CIB) also aims to foster that trend and attract more private capital to the possibilities of low-carbon investment.
“Our primary mandate is to catalyze and help transform the market for building upgrades and decarbonization retrofits. We don’t intend, nor will we be allowed to stay in the market in perpetuity,” Aaron Berg, CIB’s director of energy efficiency investments, observed during a recent webinar sponsored by REALPAC. “As we accelerate the volume of decarbonization and retrofits, we hope the broader awareness of the dynamics for doing retrofits increases, and that increased awareness and knowledge enables the market to function better. Then we will begin to exit the market in terms of our level of participation.”
Also joining the conversation, two well-versed financiers charted the momentum of the labelled sustainable finance market and underscored its relatively strong performance in the current economic volatility. Fanny Doucet, managing director and head of sustainable finance with Scotiabank, and Susan Thompson, director of ESG solutions with TD Securities, sketched out the two broad instruments available to investors and seekers of capital, both of which are tied to rigorous environmental and/or social criteria.
The most common of these is categorized as use-of-proceeds, in which funds raised through the instrument would be directed to specified types of eligible projects. In a real estate application that could be green building development or acquisitions, energy efficiency upgrades or improvements related to climate change adaptation.
Sustainability-linked products are a newer arrival in the market, allowing for funds to be raised for general corporate purposes. However, borrowers are tied to a sustainability target with the loan rate or payout to investors adjusted upward if they fail to meet that target. For commercial real estate, those targets might be tied to energy performance or reductions in GHG emissions.
“Broadly, the sustainable finance market in Canada has been about $50 billion of issuance annually so it is quite a large market,” Doucet reported. “The use-of-proceeds part of that — whether it’s bonds or loans or other instruments — makes up a large portion of that market, about 80 per cent of it.”
Real estate has been a prominent component of that activity. For example, use-of-proceed bonds are well matched to the now waning development boom, which ushered a spate of buildings with top-level green certifications onto the office/retail/mixed-use market.
“In terms of issuance, especially on the bond side, the real estate sector was out in front of the pack doing green buildings with the proceeds,” Thompson said.
There was also an increase in year-over-year uptake of sustainability-linked loans within the commercial real estate sector in 2022 despite what she typifies as “horrible” market conditions. Declining bond volume across the overall market has eroded what she terms the “greenium” on bonds — a savings to the issuer of up to 5 or 6 basis points attributable to the bond’s ESG credentials — while sustainability-linked products currently seem to come with more certainty.
“The 5 basis point adjustment, up or down, is fairly standard in the sustainability-linked loan side. If you hit your target, then you receive a pricing adjustment that benefits you. If you miss your target, then it’s a pricing penalty.” Thompson advised. “The bond side is really hit or miss these days. It’s very market dependent.”
Labelled sustainable finance market fortifies ESG credibility
What is clear is that the commercial real estate sector has much work to do if it is to line up with Canada’s interim target for a 35 to 40 per cent reduction in GHG emissions relative to 2005 levels by 2030 and reach the ultimate goal of net-zero carbon output by 2050. Berg characterized it as an opportunity for owners/managers to both modernize and boost the value of their assets, making them more operationally efficient, more resilient, more in demand for tenants and more attractive to investors.
“The risk, to just be quite frank, is that you get left behind,” he cautioned. “If you wait too long and don’t act then you end up behind the wave and have a hard time catching up because the supply side would be busy modernizing buildings for the early actors.”
Doucet tallied a number of potential advantages to seeking required capital in the labelled sustainable finance market, suggesting that it signals intent in a way that can enhance valuation and open up a larger pool of potential investors at a time when institutional investors and lenders have ESG targets of their own.
“It’s a way to tell your ESG stories. It’s very, very valuable in highlighting how the assets that you have may have stronger valuation than your peers because you are so focused on best-in-class buildings,” she said. “We’ve seen that transactions that have a label — if it’s a green bond; if it’s a sustainable bond — will get better market execution even through market volatility.”
“If you’re able to issue a labelled instrument, you might tap investors that you would normally not be able to in conventional financing,” Doucet maintained. “On the lending side, the same applies. At Scotiabank, for example, we have a $350 billion climate commitment for financing climate-related activities. We are looking to partner with our clients, including in the real estate space, to find opportunities.”
Looking to CIB’s gameplan, Berg reports that about $900 million of the building retrofits fund has now been committed. That includes: about $300 million in direct loans to large players that can bring the required 20 per cent equity to attain a minimum $25 million in CIB funds; about $400 million to the aggregators tasked with coordinating groupings of smaller projects; and the remainder in bank participation agreements.
Representing one of the aggregators, Stuart Galloway, executive vice president with SOFIAC, outlined his company’s approach with its smaller contractees, in which it covers all project costs and takes its payment from their resulting savings. Notably, it has recently partnered with the Building Owners and Managers Association (BOMA) of British Columbia, targeting members with current annual energy costs of at least $500,000.
“If there are no savings, then the client pays nothing. If the savings are $100, they’d pay us $80 and keep $20,” Galloway explained. “Where the CIB backing came in was to help us de-risk it for our other investors and make it more accessible so that we could then pass that risk avoidance over to the client.”
“We can take certain risks, offer certain concessionalities and help make projects happen. There will be lots of choice in the market, capitalized by CIB,” Berg reiterated. “In current market conditions where we’re seeing tightening — there’s a battle against inflation, rising rates — there are a lot of things we can do that the private sector regulated financial institutions simply cannot do at the moment. However, we have a very important mandate to work with private capital.”
Barbara Carss is editor-in-chief of Canadian Property Management.
