It has been a golden period to issue green bonds, for those real estate investors able to access the public debt capital markets (DCM). According to Morgan Stanley, last year was both the strongest for all types of real estate bonds, with approximately €70 bn of euro issuance, and also for green bonds which made up almost 30%, or €20 bn of the total.

But then in February, it all went pear-shaped as pricing for borrowers became more expensive. According to Bayes Business School at London University, February 2022 total real estate issuance slumped, to 10 new bonds (January 2022: 35) and €3.2 bn in issuance volume (January: €13.8 bn). Only one was a green bond. Average credit spreads to 10-year Bunds were up by 40 bps-50 bps.

Roundtable participant Dr Nicole Lux, head of debt at Bayes’ Real Estate Research Centre, said that since mid-March, CRE bond market issuance continued to be subdued over March. Eurobond debt issuance was 17 new bonds and €4.6 bn in total issuance volume of which €2.3 bn (5 bonds) were green bonds. The rated universe was 5 new bonds (€3.3 bn) with an average rating of A3-Baa2. Issuance was concentrated on short-term bonds (2-3 years) with an average coupon of 1.9% for A3-Baa2 credit.

There was only £68 mln of new GBP bond issuance as the UK bond market struggled with increasing credit spreads and interest rates.

Considering that the three investors taking part in PropertyEU’s discussion – P3 Logistic Parks, CBRE Investment Management and CTP – had alone issued €4.5 bn of green bonds in the 13 months between January 2021 and January 2022 at very competitive pricing, how is the change in the DCM going to affect the industry’s future requirement for green finance?

Richard Wilkinson, CTP’s deputy CEO and CFO, said the upward move in credit spreads in February was driven primarily by high inflation and the prospect of interest rate rises: ‘Markets are cyclical. The bond market has been fantastic for everyone in the last years, particularly with the European Central Bank buying lots of bonds...and the banks really suffered. Now, if we or P3 could issue the bonds that we did at the start of January again, they are somewhere between 100 bps and 150 bps more expensive – and that is without Russia and Ukraine.’

Under-estimating inflation
He said CTP had believed last year that markets were under-estimating inflation. ‘Our view is that inflation is much more real than central banks are thinking. That is also what our tenants were telling us and we were listening to them last year. So we think that means interest rates will only do one thing. It’s very clear that central banks are going to stop quantitative easing (QE) and that will raise interest rates and borrowing costs.’

CTP had already produced a green finance framework back in 2020 and cracked on with raising debt in the DCM while pricing was still low. He believes the company is unique in that it has said it will only issue green bonds. Front loading its funding in that way means the company currently holds a lot of cash yet to be invested or allocated.

‘We are sitting on a lot of cash which is quite expensive at the moment because it means I’m paying the banks to have the money. But it also means that we don’t have to worry about raising debt at the moment,’ Wilkinson said.

P3 issued its first green bond in January 2022 just before pricing started to move significantly. CFO Thilo Kusch explained that the group is still working on its ESG strategy. ‘All our new buildings are at least Very Good certification and most are getting to Excellent or Outstanding. We haven’t announced a target of net zero or negative yet, but we want to establish one, establish how we get to it and then get on with pursuing it.’

After GIC acquired P3 in late 2016, ‘financing initially came from our main shareholder, basically recourse financing’, Kusch said. ‘Last year we decided to become independent in financing, with a green bond programme launched in January. We would like to continue that, if markets open, and that will probably remain the strategy going forward. But obviously at the moment it is getting very expensive!’.

For CBRE IM, accessing the public debt markets is slightly different. P3 and CTP are both large corporate entities in long-term ownership operating in one market – logistics.

‘We have different ownership structures so we cannot co-mingle,’ pointed out Duco Mook, the investment manager’s treasury and debt team head. ‘Every fund needs to be financed on its own: sometimes that’s at SPV level, sometimes at fund level, or somewhere in between, for example a portfolio. If the size needed for DCM is not there, that points us to mortgage secured debt. ‘If the size is there, if the strategy is there, then we go toward the DCM and we would also target 100% green debt.’ The two green bonds it issued last year totalling €1 bn were for its flagship evergreen European core fund.

QE and interest rates
Mook also believes that the ECB’s main priority is to stop QE, hence interest rates are only going one way. He doesn’t see the bond markets shutting down – unless geopolitical events spread ‘and there’s a bigger upheaval than the current one. Then multiple markets would be closed’.

He explained: ‘Debt capital markets will be less liquid, and prices will drive up. But there won’t be no liquidity which is what shuts down a market. That is first of all because issuers need to refinance, but foremost because investors have their balance sheets to invest. Of course, if they allocate 20% they might lower that to 15%, but they won’t lower it further.’

Wilkinson summed up the shifting backdrop as ‘moving back to a market where it is better for the banks than it is for bonds’.

Many borrowers may already be narrowly better off sourcing private debt. Mook observed that in the bond market: ‘The issuer gets the full benefit of any negative swap rates, whereas on the banking side, that is debatable and negotiable and you don’t always get it. For example, the 7-year swap used to be at minus 50 bps. If you get 50 bps benefit, the banking market can’t compete. That’s liquidity-driven, by the ECB. The pricing for secured debt has been quite stable in terms of tenors. 10-years is slightly more expensive than 5Y, but it’s a flatter curve compared to the bond market. There, 10Y is now far more expensive.’

The exception now in 2022 are real estate companies with a very high rating. ‘If you are single A, you will probably continue to issue at size,’ Mook added. ‘If you’re a notch or a couple of notches down? We have seen -BBB issuing bonds and they probably saved 20 bps or so. But next year or the year after, these parties will probably be better off going to the private debt market.’

Wilkinson’s advice ‘to every borrower is to keep both avenues open’. But how ready is the private debt market to meet borrower requirements for green finance?

According to Mook, the availability of green finance in the private market is harder to monitor and it can be difficult to access because it is patchy, both by lender type and market. Just over 50% of CBRE IM’s loans arranged last year are green, but he says that in some markets it is impossible to achieve a green loan. ‘There is a difference within the lenders’ market,’ he continued. ‘In my view, the international corporate banks are ahead of the game if you compare them to insurance companies or pfandbriefbanks.’

Lux said she had recently heard a lot of real estate debt funds saying they want to concentrate on green lending ‘because, as in the bond market, their investors are also green and are demanding it’. But other alternative lenders and real estate banks may not have the same pressure from investors. Mook suggested the pressure may come from elsewhere: ‘If it’s secured debt, it’s an agreement between the lender and the borrower and the green governance will not be disclosed – it is confidential. So the only party that can push that are central banks and regulators.’

What is green?
He said that ESG is ‘topic number one, two and three’ throughout real estate now and ‘that is also true for lenders who are a bit conservative and who aren’t frontrunners. The German central bank is literally knocking on the doors of the German banks who are behind saying: you need to do more green’.

Lux said the banks’ defence is that they finance what their borrowers bring them; they don’t steer the market. ‘They are telling me that if they are already working with prime borrowers and new buildings, they automatically have green...if the requirement of the latest build is green anyway then (over time the proportion of green on their books will rise) and the banks don’t need (their own) green label.’

Mook’s riposte was that it’s a given that banks look at the product out there. ‘But the regulator, the borrowers and the market are demanding those lenders change their view and allocate a proportion – whether it’s 20% or 50% – to green loans, and it needs to have a label otherwise there is no benchmark.’

Wilkinson said: ‘We have a green bond framework which is audited by an external party, Sustainalytics. The banks would have the opportunity, if they wanted, to do the same.

‘The interesting thing for the whole industry, not just the banks, is not so much financing the new assets – which is all green – but what do you do with the brown assets? Because knocking down an existing building and building a new one is much worse in terms of the CO2 you produce. Which is the greener lending?’

And that’s where the banks are a bit lost, Lux said, ‘because they feel they have no way to assess what they should now consider first and what last. They are not quite there yet’.

The other argument from the high street banks, she concluded, is: ‘We need to be there to support the general economy and there’s so much old stock out there. What if the guy can’t immediately have the perfect refurbishment? Obviously, nowadays it is all about capex and refurbishment and they want to support that. But you’ll find very few lenders who have a mindset about what needs to be in place for a proper refurb and to what level.’ 

The hard graft behind issuing green bonds
Developing a green framework to issue green bonds is about more than assembling sufficient newly-built, BREEAM certified (or similar) buildings in a green asset pool.

The roundtable participants said that not only are more and more bond investors wanting green product – with some ‘dark green’ investors only buying green bonds – they ask a lot of penetrating questions. ‘If you say: “I will issue a bond, with a green stamp from Sustainalytics”, it is not enough. You need to have a certain level of ambition about your green targets,’ said P3’s Thilo Kusch.

Duco Mook of CBRE IM concurred: ‘During the roadshows for our two green bonds last year, more than 50% of all the questions were about our ESG targets and our ambition. ‘Our green ambitions were very well received but our advisor said: “If your green ambitions are not high enough, you will be challenged and it will work against you”.’

Kusch pointed out that while a property company’s carbon footprint ‘is somewhat determined by us, who build the warehouses, it is also the tenant in terms of how he uses the energy...A role we can play is that we provide the energy. And we’re doing green leases now because we need to get more co-operation and to agree the targets’.

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Pictured: clockwise from top: dr Nicole Lux (Bayes’ Real Estate Research Centre), Jane Roberts (PropertyEU), Richard Wilkinson (CTP), Thilo Kusch (P3), Duco Mook (CBRE IM), Charles Truijen (PropertyEU)