Today’s commercial mortgage lenders are confronted with numerous borrowers who claim to deliver a high return on investment. These borrowers represent themselves as high-value, low-risk vehicles for capital growth.
Increasingly, investors and the public are demanding that their money goes toward ventures with the triple bottom line at heart. The triple bottom line adds impact on people and the planet to the traditional bottom line: profit. Lenders must now consider how their borrowers operate responsibly and sustainably, in addition to their fiscal viability.
While meeting the expectations and objectives of investors is important, lenders also derive practical benefits from working with ESG-centric borrowers.
While compliance with public expectation is crucial, lenders now realize attention to the triple bottom line also creates tangible value that supports the generation of stable returns, risk reduction and new origination opportunities. Commercial mortgage brokers can facilitate the underwriting of projects and mitigate long-term risk by working with borrowers who are on board with the sustainability movement known as ESG.
ESG (environmental, social and governance) is an emerging sustainability framework by which many types of organizations are guided. The framework measures and guides a company’s impact on the environment, how they treat people (both internal and external parties), and their ability to operate ethically and transparently.
ESG is a framework that takes an integrative approach to corporate sustainability. It goes beyond traditional, isolated factors to help organizations and investors guide and measure the impact of their operations in each area. On the environmental side, ESG addresses preservation of the natural environment, stewardship of natural resources, human health, water and energy consumption, renewable energy use, reduction of the carbon footprint and coping with climate risks.
The trend toward environmental, community and operational sustainability is causing borrowers who are more reliable, productive and equipped to flourish.
In social terms, ESG looks at how the operation supports the well-being and success of employees, its positive impacts to the community and its level of social goodwill. Examples of this component include diversity, equity and inclusion in building a team; forming partnerships with nonprofits and other community organizations; and providing the community with equitable access to products, services and resources.
Lastly, governance addresses how the organization implements internal regulation and auditing to stay compliant with legal and regulatory requirements. This component also measures how the organization provides transparency to and supports the needs of all stakeholders.
In a 2022 global ESG study by Harvard Law School, 89% of global investors indicated that ESG is a component of their business strategy, with 26% saying it is central to their approach. Overall, worldwide ESG adoption grew by 5 percentage points compared to 2021. Europe had the highest percentage of ESG users at 94%. In North America, 78% of investors have adopted ESG in some form.
Furthermore, 42% of global investors (up from 37% last year) cite client demand and external pressures as drivers of ESG adoption. Commercial mortgage lenders feel this pressure, too, as investors and administrative agencies increasingly push for sustainability, positive social impact and regulatory compliance.
As the trend picks up steam, North American investors are becoming less cynical regarding the motives for ESG initiatives, although 61% said they believe adoption is driven by public relations and marketing objectives. But concerns over “greenwashing,” or companies appearing to work toward sustainability without making legitimate progress, seem to be thinning.
Although many investors see the pragmatic economic drivers of the adoption trend, the movement is buttressed by a public that is earnest in its convictions. The data makes it clear that ESG is quickly becoming a standard across all industries and regions.
Trends aside, ESG creates value for investors (including mortgage lenders), according to a McKinsey Quarterly report. The study found that strong ESG propositions correlated with higher equity returns and reductions in risk.
With the rising demand for ESG-focused real estate investments, lenders need to build loan portfolios backed by assets and firms that make conscientious operations a priority. While meeting the expectations and objectives of investors is important, lenders also derive practical benefits from working with ESG-centric borrowers.
Lenders prefer to work with borrowers who will produce reliable returns over the long term. And as the McKinsey report stated, ESG-centric borrowers are likely to produce steady returns with less risk. The report also found that organizations with better ESG performance had higher credit ratings, making them more desirable borrowers. Additionally, lenders want to know the firm they’re investing in will scale up and become a viable long-term client, providing future origination opportunities as they grow and optimize their portfolios.
Fortunately, ESG creates operational advantages for companies that adopt it. By putting people, planet and prosperity at the forefront, firms garner the support of their community, their industry and governmental bodies. This backing puts them in an ideal brand and operational position to expand into new markets and develop existing ones.
It’s easier to attract clients, partners, employees and capital with the goodwill generated via ESG. The framework supports a firm’s sustainability in the most literal sense. A commitment to sustainability results in efficiencies that reduce development, construction and operational costs. Minimized energy and materials consumption (and minimized waste) add up to significant savings over the life cycle of a real estate project.
ESG also promotes the upward momentum of an organization by instilling a sense of purpose in stakeholders, particularly employees. Organizations with a conscientious and inspiring corporate culture foster productivity and job satisfaction that contribute significantly to the bottom line and solvency. For commercial mortgage lenders, the results of these considerations are debts serviced on time, the creation of new lending opportunities and goodwill for the entire institution.
In addition to how the noted benefits support the growth and longevity of a company, much of the value created for lenders by ESG initiatives is centered on reducing risk. Conscientious borrowers are more likely to follow through on their loan obligations. That’s not merely the result of good intentions but solid business practices and the support of the public, industry and government. The transparency created by ESG adoption helps lenders better understand their borrowers’ financial and legal statuses.
The governance component of the ESG framework produces borrowers that operate responsibly and transparently concerning legal and regulatory requirements. This aspect gives lenders added assurance that the borrower will not face legal and regulatory hurdles or barriers that could suspend the operation and result in delinquency or foreclosure.
Local governments and taxing authorities are more likely to provide favorable treatment via fiscal incentives and zoning or permitting variances. These variables present significant risk to both borrowers and lenders for new development projects, especially when the sponsor doesn’t have community buy-in.
When it’s time for a borrower to sell or refinance, ESG supports higher valuations and market appeal. Sustainable projects generally experience higher demand, occupancy and valuations that ensure a positive outcome, resulting in successfully paid debts and new financing for subsequent projects.
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The trend toward environmental, community and operational sustainability is causing borrowers who are more reliable, productive and equipped to flourish in the unfolding commercial real estate landscape. ESG creates economic, social and environmental value that mitigates risk for lenders and encourages a generation of new lending opportunities. ●