The real estate sector is an infamous carbon emitter, accounting for around 40% of the UK’s total carbon footprint, according to the UK Green Building Council. Britain also faces a severe shortage of affordable housing, which has been exacerbated by the Covid-19 pandemic.
The country’s property developers are looking to address these issues, increasingly by tapping into investors’ growing appetite for green, social and sustainability (GSS) bonds.
Last year, UK housing associations issued around £5 billion ($6.8 billion) in sustainable bonds, according to rating agency Fitch. Sustainability linked bond (SLB) issuance has been slower to take off, particularly in the sterling market. Just £1.75billion has been sold across all sectors since October 2020 across five issues, according to Capital Monitor data (see table below), against 27 billion euros (31 billion dollars) on the mainland Europe.
Demand is likely to increase further for this type of debt, suggest the results of a European survey carried out in late January by London-based sustainability consultancy Evora Global. Of 121 real estate investors surveyed, 60% said climate-resilient locations and sustainable property management were their most important considerations when considering future-proofing investments, while 92% consider these two factors as decision-making material.
For example, the first sterling-denominated sustainability bond (SLB) from a property company arrived in mid-January and was twice oversubscribed. The £300m ten-year issue, paying a 2% coupon, was sold by London & Quadrant Housing Trust (L&Q), a not-for-profit social housing provider with £10.9bn of assets.
The price relative to L&Q’s previous ten-year bond – sold in February 2018 for £250m at 2.625% gilt issue plus 118 basis points (bp) – suggests it has achieved a saving of 31 bps on the cost of financing with the last agreement. Depending on where this bond was trading in the secondary market, L&Q paid a minimum new issue premium of 2 basis points.
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The new SLB seeks to tackle both climate change and the UK housing shortage by setting out three Key Performance Indicators (KPIs): two related to the environment and one based on the provision of affordable housing.
London-based L&Q, home to around 250,000 people in 107,000 homes across England, has a proven track record of sustainability. Rated A3/A-/A+, it was the first UK housing association to take out a Sustainability Linked Loan (SLL), in June 2018: a five-year, £100m deal with a margin tied to the return employment of unemployed residents.
The SLB follows the publication of its sustainable financing framework early September of last year.
Martin Watts, director of treasury at L&Q, says he wanted to “back up” the company’s sustainability credentials. “Sharing our commitment from the start” is a way to show the market that the company is serious about ESG, he adds.
One of the ways it has sought to do this is to agree to pay a hefty penalty of 12.5 basis points per year if it fails to meet any of its KPIs. This would equate to a total of 93.75bps of additional interest on the notional amount outstanding, points out Harsh Agarwal, Vice Chairman within the corporate debt capital markets team of BNP Paribas. The French bank is the transaction’s sole sustainable structuring adviser and joint bookrunner alongside Barclays, HSBC and National Australia Bank.
A more common SLB structure would feature a 25 bp increase at maturity and different weightings for each KPI, meaning he would have to miss all of his targets before he had to pay the full penalty.
Realistic but “challenging” commitments
All three KPIs have short-term goals — less than two years — for a reason, Watts says: to avoid accusations of what he calls “jam tomorrow” — a promise that’s unlikely to be fulfilled.
Under the first KPI, L&Q intends to reduce Scope 1 and 2 greenhouse gas emissions by 20% by the end of March 2024 from a 2020 baseline of 33 kilotonnes carbon dioxide equivalent (ktCO2e). This benchmark was set because it was the first year for which L&Q had to publish its figures.
The group has also committed to setting targets by 2024 that will set targets for reducing greenhouse gas emissions from 2025 and will be in line with the 2015 Paris Agreement on climate change. It has also pledged to achieve net zero emissions by 2050.
L&Q tracks emissions reduction guidelines issued by the professional association the National Housing Federation and is already progressing on several of its sites.
In Barking Riverside, east London, for example, it has installed a Envac automated underground waste disposal system for reduce the development’s carbon footprint of 443 acres. And his development of 137 Addiscombe Road homes in Croydon has a hybrid heating system, which, it says, reduced CO2 emissions by 35% since 2016 thanks to high efficiency gas boilers and external air source heat pumps.
I hope we are able [for future SLB issuance]where Scope 3 emissions are a primary objective. Martin Watts, London & Quadrant Housing Trust
Reducing Scope 3 emissions — those generated by the company’s customers and supply chain — are not in the KPIs for this obligation, but Watts says it will be for future sales of debts. “We need to look at Scope 3. That’s where the market is going. I hope we are able [for future SLB issuance]where Scope 3 emissions are a primary objective.
The second KPI is to improve energy use in homes, based on UK government policy Standard assessment procedure calculations (SAP). These compare energy performance on a sliding scale of up to 100: the higher the score, the more efficient the property in terms of fuel costs and emissions.
L&Q intends to achieve an average SAP score in all its developments at least 72 by the end of March 2024, 74.5 by 2030 and 92 by 2050. The group scored 71.5 in March last year.
This is a difficult KPI, as it covers both new construction and the renovation of older housing stock and will mean a significant capital investment, admits Watts. The link is prospectuspublished on L&Q websitesYes, it would cost £90m over the next few years to achieve the second KPI. But it’s just part of L&Q’s longer-term investment in a £1.9billion major works program.
The ultimate goal of the KPI is to build 8,000 new homes by the end of March 2024, 30,000 by 2030 and 100,000 by 2050. In each case, the group has committed to return half of between them affordable – that is, housing for those whose needs are not met by the market and which respects various definitions set by the government. The benchmark is again 2020, when the group built 2,439 homes, 49% of which were affordable housing.
Again, this is an “ambitious goal,” says Watts, especially given market conditions — especially the “huge rise in construction inflation” over the past year. . But he believes the KPI is achievable given L&Q’s sourcing strategies and economies of scale.
Tackling the housing shortage in the UK
L&Q does not receive financial support from the government, so it must subsidize the construction of affordable housing using profits from the sale of half of the homes it builds. The company says it is on track to achieve a goal of 61% affordable housing for this year.
This will be a welcome contribution to the housing supply in the UK. Around 340,000 new homes are needed in England every year, of which 145,000 are expected to be affordable, according to an estimate by Heriot-Watt University, which was commissioned by the National Housing Federation and the homeless and charity Crisis appeared in a British government document published on February 4.
But the supply of new homes is below the government’s target of 300,000 a year. Just 216,000 were delivered in 2020/21, down from 243,000 the previous year, partly due to the Covid-caused housing construction hiatus at the start of 2020.
DNV Third Party Opinion Provider said that L&Q’s KPIs are “relevant, essential and material to L&Q’s overall business, and of great strategic importance to L&Q’s current and/or future operations”.
L&Q is committed to providing annual KPI updates in its sustainability reportwhich will be verified by external auditors and published on the group’s website.
The housing trust had timed the deal both to accommodate its maturity profile and to lock in funding while interest rates were low. It was certainly timely: the Bank of England raised the base rate to 0.5% on February 3, the day before Watts spoke with Capital Monitor.
Of course, investors are likely to find sterling bond issues – durable or not – harder to come by if the Bank of England raises interest rates further to fight inflation, as is widely predicted.
This article originally appeared on Capital Monitor.