Green Bonds: Driving Sustainability in Real Estate

Introduction

Green bonds continue to attract significant interest from both investors and issuers. With evolving ESG priorities, heightened regulatory attention and innovative applications, Green bonds remain a critical tool for achieving sustainability goals within the real estate sector. This article reviews the key characteristics of Green bonds, their application in real estate and recent trends shaping their relevance. Indeed, Green bonds could be the key to raising and directing investments toward technologies and projects that contribute to emission reductions and climate solutions in the real estate industry.

What Are Green Bonds?

Green bonds are a fixed income financing instrument issued by companies, the proceeds of which have been specifically earmarked to raise funds for projects that have a stated climate and/or environmental impact. Green bonds are backed by the issuing entity’s balance sheet and will usually carry the same credit rating as their issuers’ other public debt obligations.

As real estate needs to achieve both net zero operational carbon by 2030 and net zero embodied carbon by 2050, Green bonds are seen as a powerful facilitator in achieving these targets. For example, the proceeds of Green bonds may be used by companies for:

• Refurbishment of existing real estate assets in order to improve their BREEAM or equivalent sustainability rating,
• Investing in Net Zero Carbon and decarbonisation projects,
• Installing renewable energy sources, such as solar panels, on existing buildings,
• Enhance biodiversity or adopt circular economy principles in property development.

Since 2022, there has been a notable increase in Green bond issuance by real estate companies, reflecting the growing urgency to align with global climate goals and meet investor demand for sustainable finance.

• Global issuance of green bonds in 2023 amounted to $587.6 billion, 15.3% up from $509.5 billion in 2022.
• The UK issued $32.7 billion of green bonds in 2023, 5.6% of the global issuance volume. UK green bond issuance is up 77.7% from $18.4 billion in 2022, significantly outpacing the global average green bond issuance growth rate.

Issuers of Green bonds

The process of issuing Green bonds largely mirrors that followed in conventional bond issuance and will include:

• Ratings analysis
• Marketing and ‘investor roadshows’
• Placement
• Allocation and pricing

However, the key defining feature of all Green bond issuances is in setting out the ‘green’ credentials of the bond and in ensuring that these mesh with the expectations of potential investors and other stakeholders. Green bonds have a certification process, governed by Climate Bond Initiative or the International Capital Markets Association.

Defining ‘green’

The definition on what constitutes a Green Bond is evolving clarity. There are a number of internationally recognised organisations which are working hard to ensure uniform definitions what constitutes a ‘green bond'.  The Green Bond Principles published by the International Capital Markets Association (ICMA) continue to serve as widely adopted voluntary framework. Recent updates to these principles in 2023 have further emphasized transparency, impact reporting, and alignment with global climate targets.  The Climate Bond Initiative also has widely accepted criterion for green bonds as does the EU Green Bond Principles.

Challenges continue to arise regarding the aspect of ‘additionality’ of green bonds and their impact in effectively addressing climate challenges. For the real estate industry, the examples of ‘good’ use of green finance has been effective. The real estate sector has been very transparent in the use of proceeds allocation.

The benefits of issuing Green bonds

Treasurers have seen the benefits of issuing Green bonds, most notably:

• Broaden the investment base and offer new engagement opportunities
• Compensation of effort with gain, they are seeing some savings in borrowing costs
• Contribute to transition, risk management, and future-proofing the business
• Enhancement of reputation and visibility
• Strengthening internal integration

Investors in Green bonds

From an investment perspective, the community of investors in Green bonds has been increasing significantly, driven by:

• Institutional Allocations: Pension funds, sovereign wealth funds, and other institutional investors are increasing their allocations to sustainable finance.
• Greenium: Investors are increasingly willing to accept slightly lower returns in exchange for the environmental benefits of Green bonds, a phenomenon known as the "greenium."
• ESG Commitments: A stronger focus on ESG factors, including regulatory pressure, is driving demand for Green bonds across sectors.

Investors now demand greater accountability from issuers. Robust impact reporting, including lifecycle analyses and alignment with net-zero pathways, has become a prerequisite for maintaining investor trust.

Tax Treatment and Pricing of Green Bonds

From a taxation perspective, Green bonds are treated as conventional loan relationships. Accordingly, all income, gains, profits and losses made by companies on Green bonds are treated as income items and taxed under the loan relationships legislation without any specific allowance for the ‘green nature’ of the financing instrument.

Loan relationship debits and credits are based on the profits and losses that are reflected in the issuer’s accounts in respect of its loan relationships as items of profit or loss where its accounts are prepared in accordance with UK generally accepted accounting practice or international accounting standards.

Pricing of green bonds

The pricing of Green bonds is comparable to that of traditional bonds. In general, the issuer bears the extra cost of issuing a Green bond and in monitoring the use of the proceeds so raised.

It will be interesting to see how the pricing of Green bonds changes in an environment where interest rates are rising and there is increased investor demand for green investment product.

Broader ESG Integration in Real Estate

Green bonds play a vital role in real estate’s transition to a sustainable future. Notably, they complement broader strategies, including:

• Aligning with updated EPC (Energy Performance Certificate) requirements.
• Supporting biodiversity enhancement and renewable energy projects.
• Financing circular economy initiatives to reduce embodied carbon.

Conclusion

As the demand for ESG-centric investment products continues to grow, Green bonds are playing an increasingly pivotal role in real estate’s journey towards sustainability.

In this dynamic landscape, it is more critical than ever for real estate companies to engage advisors who specialize in sustainable finance and can help navigate regulatory complexities, investor expectations, and the evolving market for Green bonds.