Green Bonds in Real Estate

Introduction

Green bonds have been attracting a great deal of interest from both investors and issuers in recent years.  This article reviews the key characteristics of Green bonds and their relevance to real estate.

Green bonds are a type of fixed income financing instrument issued by companies the proceeds of which have been specifically earmarked to raise funds for projects that have a climate and/or environmental link. 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.

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 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 rating,
• Investing in Net Zero Carbon projects,
• Installing renewable energy sources on existing buildings

Whilst issuance of Green bonds by real estate companies has, to date, been relatively limited it is expected that Green bond issuance will increase substantially in the short to medium term.

Issuers of Green bonds

The process to be followed by issuers of 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.

In this regard, a significant challenge for issuers of Green bonds is that there is no uniform definition of what is a "green bond" and, as such, there is a spectrum of views amongst advisers on the point. Specifically, there are few internationally accepted sets of criteria that set out key characteristics of what makes a bond "green" as opposed to being a conventional bond.  One set of guidelines that has been followed by some issuers (and is getting a modicum of acceptance) are the Green Bond Principles published by the International Capital Markets Association as a voluntary framework setting out transparency, reporting and disclosure recommendations for issuers of Green Bonds.

Investors in Green bonds

From an investment perspective, the community of investors in Green bonds is very diverse and increasing. There is also a trend amongst certain financial institutions to reserve specific allocations to Green bond investment. The motivating factors amongst investors for Green bond investing  includes: -

• A commitment by investors to contribute to the development of a greener economy
• ESG considerations
• A specific ‘hard’ obligation to invest in Green bonds.

Tax treatment 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.

Conclusion

As the demand for ESG-centric investment products continues to grow, Green bonds are becoming increasingly relevant across the Real Estate sector. This is just one area of the sector which is seeing large amounts of change, in addition to a huge number of other economic, political and environmental influences, and it's never been more important for organisations in the Real Estate sector to ensure that they have an advisor who specialises in the industry.

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