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REITs are Hitching a Ride on the Green Bond Bandwagon

This article is the second in a four-part series about how commercial buildings are finding ways to finance sustainability projects through ‘green lending’ and other innovative green finance techniques. The first article focused on ‘green banks’ and how they can help property owners obtain financing for clean energy projects that often have high upfront costs. This second part covers green bond offerings, which are becoming an increasing share of U.S. real estate investment trust’s (REIT’s) debt issuance. The third part will take a look at green loans, whose proceeds must apply specifically to sustainable purposes. The fourth and final part covers green tax incentives, which some say have been too weak, inconsistent, and outdated for years, but could soon get a significant boost from Congress and the Biden administration.

Since opening in 2018, much has been written about the Salesforce Tower, the tallest skyscraper in San Francisco, and the second-tallest building west of the Mississippi River. The Salesforce Tower can be seen in multiple episodes of HBO’s series Silicon Valley and also has a cameo in several shots of the 2018 comic-book film Venom. The crown of the tower features a nine-story electronic sculpture called ‘Day for Night,’ created by artist Jim Campbell and considered the tallest public art piece in the world. The exterior of the top six floors is lit with 11,000 LEDs that display low-resolution moving color imagery. Multiple cameras placed across San Francisco captured scenes from the city every day, and at night, a synopsis of the videos is displayed and visible from 20 miles away. But what you may not know about the Salesforce Tower is that its owner, Boston Properties, has included it as an eligible project in a green bond the company issued in 2018 for $1 billion. The tower has received LEED Platinum certification, and it’s one of the many offices Boston Properties is financing through its issuance of green bonds within the past few years.

Boston Properties issued its second green bond in June 2019 and its third in March 2021, growing its total green bond offerings to $2.7 billion since 2018. Boston Properties’ first green bond offering was set up primarily to finance recently completed or future properties expected to obtain green building certifications. The company’s total property area certified under the LEED program is about 25.8 million square feet, according to its 2020 Environmental, Social, and Governance (ESG) Report. Boston Properties is one of the many Real Estate Investment Trusts (REITs) that have increasingly issued green bonds to finance environmental initiatives, attract eco-conscious investors, and enhance company reputation.

“There’s a lot of investor appetite for green investments,” said Mike LaBelle, Executive Vice President, Chief Financial Officer, and Treasurer at Boston Properties. “We have a responsibility to try to reduce our carbon footprint. And as a public company, our investors are looking to us to demonstrate that we’re making strides to do that.”

Utilities and banks have historically issued most green bonds, but REITs like Boston Properties have emerged as another group using the increasingly mainstream financial vehicle. Green bond offering proceeds have comprised 16.4 percent of the capital raised through all U.S. REIT debt offerings so far in 2021, according to S&P Global, which puts them on track for an all-time high. The most obvious benefit of issuing green bonds is they can provide much-needed capital for sustainability projects that sometimes have significant upfront costs. But that’s not the only benefit. Demand from investors for green bonds is high and continues to grow, and REITs that issue green bonds can further solidify their public commitment to the environment while also gaining positive media attention. A well-structured green bond demonstrates to investors and employees that the company has seriously considered sustainability when thinking about long-term business planning.

Despite all the benefits, key challenges remain for the green bond market as it matures. The Securities and Exchange Commission (SEC) has anti-fraud regulations for all U.S. bonds, but no specific guidelines or oversight exist for green bonds in America. Many green bond issuers enlist third-party verification and release extensive impact reporting on their offerings to earn investors’ trust. But without specific regulations, some critics claim the broad scope of what constitutes a green bond means the projects that get the earmarked capital may actually have a minimal positive impact on sustainability and climate change. The green bond market has proliferated within the past decade, and REITs have become one of the largest corporate sectors for issuance. With the continued rise of ESG investing in commercial real estate, one should expect the green bond market will only get bigger in the coming years ahead.

Fighting climate change ain’t cheap

The World Economic Forum says green bonds work like a regular bond but with one key difference: all the capital raised from investors must go exclusively toward financing projects that positively benefit the environment, such as green buildings or renewable energy. Governments and corporations are turning to green bonds because fighting climate change won’t be cheap. Meeting the goal of the Paris Agreement and limiting global temperatures to 2 degrees Celsius will require about $3 trillion of investment every year until 2050, according to an estimate by the United Nations’ Intergovernmental Panel on Climate Change.

The world’s first green bond was issued in 2007 by the European Investment Bank, and the green bond market grew slowly at first, only totaling about $1.3 billion in 2013. But that’s changed in recent years, due in part to global green initiatives like the Paris Agreement on climate change, UN Sustainable Development Goals, and the recent COP26 summit. Green bond issuance rose to $305.3 billion in 2020, which pushed the value of green bonds issued since 2007 past the $1 trillion mark. The Climate Bonds Initiative, an international nonprofit that works to mobilize the green bond market, estimates that green bond issuance could hit $1 trillion annually by 2023. That seems like a lot, but it’s not much considering the size of the overall global bond market, which has an estimated value of about $130 trillion. The U.S. is the world’s largest source of green bonds, and government-backed mortgage giant Fannie Mae issues the most in America. Along with Fannie Mae, corporations like Apple, Pepsi, and Verizon have issued green bonds, as well as state and local governments to pay for critical infrastructure projects to help fight climate change.

In the U.S., REITs have become a growing presence in the green bond market. Along with Boston Properties, REITs like Kimco Realty Group, Digital Realty Trust, and Equity Residential have issued green bonds in recent years. S&P Global reports there are five new American REIT entrants to the green bond market so far in 2021, including Healthpeak Properties Inc. and Realty Income Corp. For REITs, green bond proceeds are usually earmarked for future or recently completed development of sustainable-certified buildings with office or apartment tenants. Boston Properties is one prime example of this, and so is Healthpeak, which plans to allocate proceeds of a recent $450 million green bond offering to fund the acquisition of Cambridge Discovery Park, a LEED Gold-certified life sciences building in the Boston area. Datacenter REITs have also become a relatively large player in the green bond market, accounting for 42 percent of all REIT-related U.S. green bonds in 2020. Data centers consume vast amounts of energy and water, so the proceeds from green bonds can go a long way toward making them more sustainable.

Just how green are they, though?

One primary reason why green bond offerings keep growing is the pressure corporations and financial institutions face from investors to improve their ESG standards. Eighty-five percent of investors considered ESG factors in their investments in 2020, according to recent research presented at the Gartner CFO and Finance Executive Conference. Increasingly, organizations with poor sustainability disclosures are seen as riskier investment propositions. Investors now see ESG investments as safer bets, and many say the upside of ESG for companies and REITs is typically improved stock performance, access to capital, and better customer and employee loyalty.

“The investment community is really focused on ESG,” LaBelle said. “A lot of institutional investors are all interested in increasing their exposure to green because they all have their own mantras. So, I think interest in ESG and green bonds will continue to grow, and I think there will continue to be opportunities for people like us at Boston Properties to fund our green projects this way.”

As the green bond market grows, a significant challenge will be preventing the perception of ‘greenwashing,’ which is when companies make false or misleading claims about their environmentally-friendly credentials. Many green bond issuers adhere to guidelines called the Green Bond Principles that have been endorsed by the International Capital Market Association to bring transparency. Issuers also use various third parties to assess and certify their green bonds. In the EU, its green deal investment plan in 2020 established the voluntary EU green bond standard. But none of these standards are mandatory, which means issuers wouldn’t be penalized if they fail to follow through on their green commitments.

Critics argue that regulations and a proper definition by the SEC of what a green bond means in the U.S. market would give investors more confidence in this still new type of financial offering, thus growing the market further. William Sokol, product manager of ETFs at VanEck, a mutual fund management firm, told GreenBiz that to truly boost confidence in green bonds, the U.S. Treasury should issue its own sovereign green bonds, which would show the country is serious about fighting climate change. The EU and the United Kingdom have already issued their own green bonds, as the U.K. issued its debut green bond ahead of hosting COP26. Treasury Secretary Janet Yellen has reportedly hinted at a U.S.-backed green bond, which many say would do wonders for the market. But until the SEC or other financial regulators adopt a standard for what a green bond is and isn’t, issuers like REITs will have to rely on voluntary standards like the Green Bond Principles.

‘Greenwashing’ is a serious barrier to the growth of the green bond market, but the market will likely continue to rapidly increase despite it. REITs can gain significant benefits by issuing green bonds, including attracting new, eco-conscious investors and drumming up capital for a wide range of sustainability projects. Already, REITs have collectively become a significant share of green bond issuers, as the sustainable bonds have comprised between seven to 11 percent of REIT portfolios within the last three years. ESG demands from investors, customers, and employees will continue to drive REITs to issue sustainable bonds that showcase their commitment to fighting climate change. As Boston Properties’ Vice President of Sustainability Ben Myers told Nareit recently, “It’s everywhere. ESG has gone mainstream, becoming a top priority for many companies, investors, and policymakers.” So, the next time you’re in San Francisco and look up and see the Salesforce Tower, remember that green bond financing is helping to pay for the skyscraper to be cleaner and greener. Pretty soon, it’s likely that many more REIT properties, from data centers to warehouses to office buildings, will be funded in part by these same types of sustainable bonds.

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