Banking on Green Buildings

River or a rock?

A few weeks ago, a senior manager of one of the largest South African banks commented: “we banks are like timber logs floating in the river--we go with the flow to where the business is”. The evidence suggests that the flow of the river is changing toward green construction finance. Governments are attempting to make conducive policies. At the first-ever Buildings Day at the Paris COP21, both the public and the private sector made ambitious commitments.  Over 90 countries have included the need to focus on buildings in their Nationally Determined Contributions (NDCs). It is clear that not only will the public sector have to take a leading role to act on this, but so will the private sector solution providers. [also see my earlier blog Green Buildings in Emerging Markets: Where are they likely to Succeed?] 

With the cost of energy outpacing inflation and reducing disposable income, homeowners are looking for ways to meet this challenge. Some studies in the developed world are providing insight into the financial benefits to developers, occupiers and funders of green buildings. Recent studies have shown that home buyers are increasingly demanding green and that energy efficiency is an important attribute of housing for consumers.

Studies that analyse homes in energy efficient certificates in the US and Europe show that developers can command higher sales prices for green-certified homes, ranging from 4 to 9% higher; Green homes sell as much as 4 times faster; Occupants save 15-20% on lower utility bills for green homes; Re-sale value is 4-10% higher; Banks enjoy up to 32% lower default rate from buyers of green homes [refer to my earlier blog for details]. These numbers are certainly large enough to get your bank started down the green path. The market seems to be getting ready and primed, at least in the West. Just last year Fannie Mae announced 10 basis points reduction on loans to help apartment owners invest in energy and water saving improvements. This year, Federal Housing Association (FHA) is also offering a 0.2%-0.4% discount for loan issuance for energy efficient homes. 

Maria in Medellin (Colombia) has a $200 mortgage installment and $40 utility bills

 

Big challenge, huge opportunity

IEA estimates that the building sector alone needs an additional investment of up to US$296 billion each year if average global temperatures are to be capped at two degrees. This is in addition to the $358billion that already goes into the sector annually.

Population growth, combined with migration to the cities and rising incomes will substantially increase the number of buildings we have currently and it is expected that this in turn will double the global GHG emissions from the buildings sector (making it 40%). This adds to the complexity of tackling climate change.

Global impact of buildings

For the banking sector, meeting these funding needs is a big challenge, but also a big opportunity. The opportunity is in supporting the transition to a low carbon economy by investing in and financing green building projects and technology. By adding a few extra resources, immense existing capital flows into new buildings can be reworked to include and fund green designs.

Greening construction offers a chance to secure emission cuts at a low cost and lock in energy and water savings for decades. A more significant reason to pay attention to it is that it allows lenders to capitalize on a nascent market segment with unlimited potential and generate attractive risk adjusted returns as a result of better asset risk profile and higher revenue per borrower [see my previous blog on Transforming the housing market through green mortgages].

Positioning the financial institution as a sustainability leader. Green building financing also provides branding in an important market segment and spotlights participating lending institutions as leaders in an area of focus among regulators. The evolution of the policy environment at all levels of government is moving strongly in the direction of requiring green buildings and energy efficiency, and financial institutions can benefit by providing products and financing that get ahead of and capitalize on this trend.

From a business perspective, it also makes a lot of sense, as it allows banks to present a new offer for current clients and reaching out to new clients. It offers possibilities for cross-selling i.e. green construction finance to developers and green mortgages to home buyers. And finally, energy efficient assets create a stronger portfolio – as data shows owners of green homes have lower delinquency rates.

The value proposition for banks to offer green building finance

What's hindering the market from responding to demand?

The technologies are already present and well-documented. But the building sector is complex.  Perception of costs and affordability of green buildings are much higher than reality given falling technology costs.  IFC analysis of projects shows that while the cost premium ranges from 1% to 3%, the perception is that it’s from 1% all the way to 30% higher.

Developers often tend to hesitate to invest the additional 1% capital expenditure for fear that they will not be able to pass the cost on to a buyer, despite the lower energy and water utility bills a buyer will enjoy.  A buyer will focus on the living space he can purchase, utility savings will be a secondary issue and lower operating cost claims of a developer may be difficult to believe.  A banker might in theory be ready to give a buyer a bigger mortgage for a green home if it is cheaper to run but how can he assess that?  Bankers typically are hesitant to provide additional financing to cover costs, because of the fear it will increase non-payment risk. They also don’t want to establish systems to validate savings if there is not sufficient level of green building pipeline to finance.

Cycle of Blame: Multiple players with divergent interests and asymmetry of information

Underlying all of this is a lack of data on the financial benefits of green buildings – particularly in developing markets. The real game changer is how to solve the “cycle of blame’ between investors, developers, and buyers? The key is to address each party’s concerns .

In order for lenders to recognize the value of a property’s green measures, large-scale adoption of a universal green performance standard with a sharp focus on areas of cost and resource savings (energy water and materials) is required. A user-friendly investment planning tool which recommends cost-effective solutions to make the building design and specification 'green'.

The standard needs to be defined by an inexpensive, smart and robust certification system -making it accessible to the majority of the market. [see my old blog on The need for a new green building rating tool]. 

And finally, we need to get better at collecting and sharing evidence that prove the positive value and financial savings of green buildings. This is especially important for bankers who can finance a pipeline of green building projects at acceptable rates by monetizing the economic benefits of green buildings.

It is clear that everyone wins financially by building green and it is imperative that collective action is taken to meet this need. International Finance Corporation, has launched Excellence in Design for Greater Efficiencies (EDGE) platform with this global public good in mind. Platforms like EDGE make it easy for financial institutions to get into green building financing. It streamlines eligibility as it is pre-calibrated for local conditions. It simplifies compliance for loan officers and makes reporting easy as the tool has all the savings and GHG reductions built in. This tangibility reduces the cost for green investors.

What comes first- demand or innovation?

In the real estate sector, commercial banks already play a crucial role by providing financing to developers, mortgages to homeowners, or providing insurance solutions. The exciting thing about green buildings is that the investment and financing for the construction industry already exists. The challenge is to incorporate the additional upfront costs for resource efficiency into the financing.

There is evidence that these can be paid for by the increased savings as a result of operational cost reductions, better credit ratings, and higher resale value of the green buildings.  Banks need support to create new products such as green construction finance, Green Mortgages, Risk Share Facilities and secularization of green building loans as collateralized bonds i.e., Green Bonds.  Banks are concerned about the required added resources to develop new products, train staff, and convince their management to take perceived risks if there is no reliable availability of green buildings stock. This is why it is important that both supply and demand aspects must be looked at simultaneously – building green stock while securing financing.

Here are four examples that show innovative thinking from banks that have led to rapid scale up. The case studies below show successes in delivering finance for new green construction in emerging markets.

The market for green building financing can take off quickly with the right incentives 

 

 Case Study 1: INFONAVIT Green Mortgage Program

A green mortgage program was developed in 2007 by the Institute for the National Workers’ Housing Fund (INFONAVIT) in Mexico to encourage the use of energy efficient systems and technologies for low-income households. Families purchasing homes through the bank received an extra credit of up to US$1,250 to cover the cost of green-technologies (these are quality assessed and controlled by third-party auditing agency).

Infonavit has more than 70% of market share in the Mexican mortgage market, it is the largest player in terms of assets (with a loan portfolio of almost $70bn).

Over time, the product became extremely popular and mainstream, especially for low-income housing finance. By 2011, 75% of all originated home mortgages were green. In 2014, Infonavit decided to issue only green mortgages. Their market share has also increased significantly (~12%) during the period. The bank has granted over 1,000,000 Green Mortgages, benefiting over 3 million people.

Green Mortgage system used by ODEA and PNB using EDGE certification

Case Study 2: INDIA: KfW NHB-EE credit line for housing developers

In 2010, KFW extended a re-financing line to National Housing Bank (NHB) of €50 m. Almost no green stock was present in the market at the time of launch, yet within 1.5 years (ahead of the planned 3 yrs) the mortgages were distributed and the line exhausted. 21,000 housing units were developed through the program.

The criterion of green was set-up using the NHB-EE Fraunhofer tool which is also a performance-based standard like EDGE and even uses the same engine for energy calculation. The KfW NHB-EE program is a success story in stimulating supply-induced demand. 

Case Study 3: INDIA: PNB Green Construction Bond

In early 2016, IFC, invested INR 5 billion ($75.8 million) in green bonds issued by Punjab National Bank Housing Finance Ltd. (PNBHFL) to help construct green residential buildings in India.

PNBHFL, India’s fifth largest housing finance company, will use the funds to finance residential projects based on recognized green building standards, including EDGE. The bank's green bond is the first issuance designated to green buildings in India and IFC is the sole investor. This investment will help the bank develop a committed green lending practice and sustained the growth of its green loan portfolio.

Case Study 4: Turkey: Odeabank Green mortgages and green commercial and residential finance

In 2015, IFC, invested $65 million in Odeabank for green building construction and green mortgages. The eligible loans have to demonstrate compliance with green buildings certificate, including EDGE or obtain an "A" or "B" Energy Performance Certificate from the Turkish Government.

The above cases show that housing finance markets can take off quickly as long as there are adequate incentives. A metrics-driven, objective label or standards are required to bring together market players, prove the business case for building green, and reward innovative design.  It is with this background that EDGE was conceptualized and initiated.

Lead or play catch up time for banks

It is clear that banks and financial institutions must develop new strategies, knowledge and operational structures to embody green strategies into their offering.  Undoubtedly, end users are still not totally aware of the virtues of green buildings. The evidence is still quite patchy on the financial benefits in this particular area of operation and all the incentives are still not in place to get many of the developers interested.

However, there is little excuse for inaction. Especially now, with platforms like EDGE, the existing capital flows into new buildings can be reworked to fund green designs.  A CEO of one of the largest banks in India recently said “fundamentally, it boils down to whether we really want to fund these developments which will ruin our built environment- that we and our families live in?-we banks have to show leadership by setting higher expectations”.