With the built environment reportedly contributing to circa 40 per cent of global greenhouse gas emissions it is no surprise that stakeholders within the hotel real estate sector are recognising the considerable traction of sustainable finance within the UK debt market. Given the built environment's contribution to both greenhouse gas emissions and climate change, lenders who fund real estate projects have found themselves under increasing pressure from governing bodies to evidence that they are paving the way to contributing towards a more sustainable way of living. For example, the UK Government publishing its Greening Finance Roadmap back in October 2021 coupled with the COP27 United Nations Climate Change Conference illustrate the external pressures that lenders face to ensure they are tackling climate change through their lending. As a result, lenders such as Barclays and HSBC have created an abundance of sophisticated sustainable debt funds to prove they are aligning themselves with the UK's world-leading net-zero commitment. In the hotel real estate sector this, in turn, creates pressure on borrowers and developers to reduce their carbon emissions as lenders are now scrutinizing sustainable aspects of a hotel real estate project. We note a few lender sustainable assessments as follows:
- Lenders will assess whether financing a new hotel is "green" enough; and
- Lenders will assess the environmental, social and governance aspects of the borrowing corporate group and whether these meet particular sustainable metrics for the lender to provide financing for the hotel asset.
Green Loans vs Sustainability-Linked Loans
Although the above are not the only variables lenders look out for when assessing whether to provide financing in respect of a sustainable hotel asset, they are the most prevalent in this space and it is, therefore, important to identify the difference between Green Loans and Sustainability-Linked Loans (“SLLs”) and how these interplay with the hotel real estate sector.
As published by the Loan Market Association, Green Loans exclusively finance green projects whereas SLLs do not require the use of proceeds for green projects and instead focus on incentivising improvements to the borrower’s sustainability performance by aligning the loan terms with pre-defined sustainability performance targets.
A Hotel Green Loan
A hotel that produces environmentally sustainable economic activity may attract Green Loan funding from a lender. Although the headline terms of a Green Loan are to be agreed between the lender and borrower, the lender is likely to inform the borrower from the outset that a Green Loan can only be used to finance or refinance a green hotel project. The Loan Market Association have detailed in its Green Loan Principles guidance what lenders typically look for when considering financing/refinancing a borrower’s green real estate project.
Subject to a lender’s criterion, if a hotel developer/borrower is able to illustrate that its hotel asset satisfies the “green building” components as detailed in the Loan Market Association’s Green Loan Principles then they are entitled to apply for a Green Loan for the purpose of financing a new green hotel concept or refinancing a green hotel. If the lender is satisfied with funding a green hotel then the financing can attract preferential interest rates which, ultimately, is a commercial incentive for any borrower. On the other hand, Green Loans increase the administrative and reporting burdens on the borrower and, therefore, it should be of paramount important to a developer to assess whether it has the corporate ability to comply with these obligations as required by the loan documentation that is put in place. Nevertheless, a green hotel will have reduced carbon emissions therefore creating a positive public image. This is appealing for future investors and lenders when refinanced or sold, and is an attractive prospect for the borrower at the outset.
A Hotel Sustainability-Linked Loan
SLLs are any types of loan instruments and/or contingent facilities which incentivise the borrower’s achievement of ambitious, predetermined sustainability performance objectives. The borrower’s sustainability performance is measured using predefined sustainability performance targets, as measured by predefined key performance indicators (“KPIs”), which may comprise or include external ratings and/or equivalent metrics, and which measure improvements in the borrower’s sustainability profile.
In the context of a hotel financing, the borrower may apply for a SLL for the financing of a new hotel. If the borrower is able to meet predetermined energy efficient targets, then the interest margin on the loan given by the lender is reduced. As with Green Loans, SLLs carry a higher reporting and administrative burden that the borrower must comply with as set out in the loan documentation. It is important to note that agreeing the correct level of the sustainability criteria that the borrower must meet is crucial. For example, the level of sustainability criteria should not be so high that the borrower cannot meet the standards resulting in a potentially increased margin on the loan and possibly an event of default under the loan facility by the borrower.
Conclusions
Given the debt market’s upward sustainable finance trajectory in the hotel real estate sector, it is apparent that Green Loans and SLLs are at the forefront of borrowers and lenders strategic objectives for the coming years. Although we are currently seeing a fluctuation in Green Loan and SLL metrics and KPIs, we are expecting these indicators to become more commonplace and, therefore, market-standard for sustainable finance transactions in the near future.
This article was written by Katie Allen and Jack Mitchell.