What an ESG loan really is for property investors

If you search for sustainability linked loans you will find a lot of information on corporate finance, but what we want to stress is where ESG bridging loans play a role.

Lenders are able to reward investors for making their properties more energy efficient by tying a financial incentive to an actual improvement in the property’s Energy Performance Certificate (EPC) rating.

What a sustainability linked loan actually is

A sustainability-linked loan is financing in which some part of the loan’s terms is linked to the borrower achieving an agreed sustainability target; in the case of corporate lending this could be that the interest rate is adjusted when the company reaches certain environmental or social performance targets.

This same principle that you may be aware of also applies to a single building for property investors.

“How is this measured?”

There is a practical method of measuring this, namely through the use of an Energy Performance Certificate (EPC). The ratings on an EPC go from A, which is the most energy efficient, to G, the least efficient, you’ve likely seen these ratings before.

The rating given to a property shows how efficient its energy performance is and gives an indication of its energy efficiency; a borrower may therefore receive rewards from an ESG-linked loan as a result of improving the property’s EPC rating during the term of the loan.

The key point is that the incentive is tied to the result rather than just being a promise to make improvements; the borrower has to reach the target they had agreed on in order to be eligible.

Why EPC Ratings are a commercial & environmental issue  

Enhancing a property’s energy performance is not merely a way of reducing its environmental impact since it can also influence how attractive the property is to tenants, how much it costs to operate, and how easy it may be to sell or refinance.

The commercial side…

When preparing a property for the rental market for instance, landlords are now placing greater importance on energy efficiency. 

Consumers tend to place more value on houses which are easier to heat, especially in cases where energy costs are a worry and rising. Enhancing the insulation, heating systems and windows can help to lower energy consumption and increase the property’s appeal, though the real savings and benefits will vary according to the building and the work carried out.

The environmental side…

When judging the regulatory trends in the private rented sector, EPC ratings are also a factor. In England and Wales, minimum energy efficiency requirements have already been applied to a large number of privately rented properties, on condition that the appropriate rules and exemptions are taken into account. 

There is also a financial aspect to consider.

It may be advantageous to improve the property before it goes to rental or sale in order to put the investor in a stronger position, even though a better EPC rating does not guarantee a specific valuation or mortgage offer.

Suppose a property is bought with an EPC rating of D. The investor intends to enhance the insulation, upgrade the heating system and replace the inefficient windows before either letting the property or refinancing it.

In that case, if the improvements raise the property’s rating to C, the investor has altered more than just its aesthetic, they have improved its assessed energy performance and might have made it more appropriate for their intended exit.

How an ESG Bridging Loan Works in Practice

Some providers offer varied products, however typically, an ESG bridging loan works like this.

The incentive is simple in that £1,000 of the gross loan will be refunded at redemption provided that the property’s EPC rating improves over the term of the loan to a minimum of rating C.

The borrower must submit the current EPC before completion and an amended EPC at the time of redemption in order to show that the necessary improvements have been carried out.

For instance, an investor could obtain bridging finance in order to buy a residential property which has an EPC rating of E; the property needs to be refurbished before it can be let or refinanced and the investor plans to improve its energy efficiency as part of the work carried out.

In order to fund the purchase, the investor uses the bridging loan and carries out the planned improvements throughout the loan term. The investor will be entitled to a £1,000 refund if the property obtains an EPC rating of C or higher at the time of redemption, provided that the terms of the product allow for it.

Something to note is that the investor has no need to alter the purpose of the project in order to obtain ESG-linked finance; since improving the property’s energy efficiency is already a reasonable element of the refurbishment, the incentive serves as an extra reason for carrying out the work.

Letting to social housing associations? ESG finance can help

ESG lending can also be used to finance a different kind of property investment, involving social housing providers.

Investors often buy or develop properties with the intention of letting them to housing associations, and so long as the basic agreement and the project are appropriate, such arrangements can offer a good way of securing occupation and income.

In the case of eligible residential projects, gross lending can typically be offered up to 85% of the relevant property value. This applies especially to investors who are dealing with social landlords and who need short-term financing in order to buy or prepare properties before their longer-term investment strategy and funding is put into place.

“What projects work well with ESG bridging loans?”

ESG bridging loans are especially relevant to investors who are already making plans for improvements that will increase a property’s energy efficiency.

• Older residential properties: Properties with low EPC ratings can offer opportunities for improvement, potential measures include improving insulation, upgrading heating controls, installing a more efficient heating system or replacing windows.
• Light refurbishment projects: Energy efficiency improvements can form part of a wider programme of renovation, considering energy performance from the outset can help avoid unnecessary duplication of work later.
• Buy-to-let investments: Investors purchasing properties that need refurbishment before they can be let or refinanced may benefit from ESG-linked bridging finance. The key is to assess the expected EPC improvement alongside the project’s overall costs.
• Social housing schemes: As mentioned, these may also be suitable, particularly where the investor has an eligible agreement for lease and a clear plan for preparing the property for occupation.

In all cases, determine the work that the property requires, check how the improvements support your exit strategy and then decide if an ESG-linked incentive can offer an extra financial benefit.

Make your next property investment work harder

If your refurbishment plans already include improving a property’s energy performance, the finance behind the project should recognise just that. At MS Lending Group, our ESG bridging loans offer a straightforward incentive for eligible residential properties that achieve the required EPC improvement.

Explore ESG bridging loans with MS Lending Group or contact the team to discuss your project.

Frequently Asked Questions

What is the difference between a sustainability linked loan and an ESG loan?

ESG is an abbreviation for environmental, social and governance. The term ESG loans refers to lending which is related to environmental, social or governance factors. A sustainability-linked loan links some element of the loan’s terms to the attainment of agreed sustainability targets. In the case of property financing, this may involve rewarding the borrower for improving the property’s EPC rating throughout the term of the loan.

Is it possible to obtain a sustainability-linked loan for a single property?

Yes, the sustainability-linked principles can be applied to individual property investments, not merely to corporate borrowing; MS Lending Group’s ESG bridging loan is aimed at eligible residential property purchases and capital raises and provides a refund of £1,000 of the gross loan at redemption if the property achieves the required EPC improvement.

What EPC rating must I reach in order to get an ESG bridging loan?

According to the ESG bridging loan criteria of MS Lending Group, the property has to have an EPC rating of at least C and show improvement during the term of the loan. Borrowers are required to submit the existing EPC before completion and an amended certificate at redemption. It is advisable to check the relevant product terms before moving forward.

Can ESG bridging finance be used for social housing projects?

MS Lending Group offers bridging finance for qualifying projects involving housing associations, registered providers, charities and CICs. A signed agreement for lease must be evidenced before completion, with at least ten years remaining. Lending is subject to the property’s circumstances, the proposed transaction and the lender’s criteria.Before proceeding, it is also worth understanding what happens if your bridging loan exit fails, particularly where your exit depends on a sale or refinance completing within a specific timeframe.