Banks are applying more stringent sustainability criteria when lending against commercial property. Adam Rock, head of Innes England’s Birmingham office, looks at the consequences for landlords and investors.
It’s no secret that banks scrutinise a commercial property’s sustainability credentials before they consider lending against it. That’s been the case for at least the last decade, as government policy and regulation seek to reduce the carbon footprint of the UK’s buildings – currently 25% of emissions – and pave the way for Net Zero.
Banks lean heavily on third-party certifications when assessing lending criteria. The introduction of EPCs in 2008 and MEES in 2018 – setting out the minimum energy performance required to let a commercial premises – have undoubtedly provoked greater scrutiny,
Higher value properties with BREEAM or LEED accreditations may receive preferential rates. Green discounts are also available against buildings with, typically, an EPC rating of B or above.
Properties with lower ratings face stricter underwriting or lower loan-to-value limits. For non-sustainable assets, financing costs can rise by around 25%. At worst, some lenders will refuse to take on buildings that don’t meet their sustainability benchmarks.
Even when loans are green-lit, banks are increasingly taking a more proactive role in managing their funds. They need to ensure sustainability standards do not slip, impacting rental income and capital value; they also have their own sustainability goals to meet.
As a result, improvement and maintenance plans are now routinely requested and monitored by lenders, often on a quarterly basis. Failure to act mean penalty clauses – which are invariably part of their loan conditions – can be invoked.
Sustainable buildings currently enjoy a ‘green premium,’ which applies to both rentals and value. Research from the UK Green Building Council shows green-certified buildings enjoy 7-10% higher asset value than average, though it’s possible that this bonus may erode over time, as sustainable buildings become the norm, rather than the exception.
In contrast, non-sustainable buildings inevitably lose value. They are more expensive to run and insure. They are also less attractive to occupiers, so longer void periods – to allow refurbishment or tenant fit outs – will have a negative effect on values. These ‘brown discounts’ chip away at a building’s worth, with valuers adopting a higher yield.
Non-compliant buildings are a concern for their owners, as the regulatory burden isn’t going away. However, for progressive investors there is opportunity. It’s possible to pick up distressed/discounted properties which offer significant asset management potential, for example through increased rental premiums, revenue generation (roof solar panels), lower insurance premiums and ultimately, increased asset value.
With a viable upgrade plan, financing is available. The banks are keen to lend and with the new build market – for offices in particular – subdued, many are shifting their focus to retrofitting, refurbishment and ‘brown-to-green’ projects.