LReit all linked to sustainability

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💡This week: Lendlease Global Commercial Real Estate Investment Trust (LReit) has secured up to S$760 million of sustainable-linked debt facilities, further cementing the retail and office property trust’s commitment to sustainable finance.

With structural incentives in place to tie sustainability outcomes to financial performance, LReit’s next challenge is setting a credible set of interim targets towards its longer-term goals.

On Dec 6, LReit announced two sizeable sustainability-linked term-and-revolving facilities. The first is for up to S$420 million of borrowings with an option to increase it by a further S$200 million – also known as an accordion. The second is for up to S$140 million.

LReit will use the proceeds to refinance existing debt and for general corporate purposes.

The facilities come as LReit enters a crucial three-year period for potentially refinancing S$850 million of Singapore-dollar debt. As at Sep 30, LReit had S$360 million of committed and drawn debt maturing by the end of its fiscal year in June 30, 2025. A further S$290 comes due in FY2026, and S$200 million in FY2027.

The new facilities bear sustainability-linked structures, which vary the interest rates on the loans depending on a borrower’s performance against sustainability key performance indicators (KPIs). While exact structures and terms can vary, the general principle is that borrowers will pay a higher interest if the KPIs are missed, and a lower one if the targets are met.

About 85 per cent of LReit’s total committed debt facilities used sustainability-linked structures as at end-September. The new facilities ensure that even after refinancing, LReit will maintain or increase that percentage – already one of the highest among Singapore-listed Reits.

With such a high proportion of its borrowings tied to sustainability outcomes, LReit has put its money where its sustainability mouth is. Companies might declare all manner of ambitious greenhouse gas emissions targets, but in many cases those targets are backed by little more than stated intention. That’s because most companies do not face any economic consequences for missing their climate targets.

However, in LReit’s case, failure to meet the targets directly translates to a higher cost of capital.

It’s a powerful incentive structure that ties financial performance to sustainability outcomes. It aligns shareholders with the company’s other stakeholder groups so that management doesn’t have to choose between higher dividends for the benefit of shareholders and lowering emissions for the benefit of society.

At least that’s how it should work in theory.

Two key variables are unknown in LReit’s case.

The first are the KPIs used for the loans. Climate-related KPIs are typically aligned with a company’s emissions targets.

For LReit, that means an interim goal to achieve net zero carbon by FY2025 for Scope 1 and 2 emissions – referring to greenhouse gases generated directly and from LReit’s purchases of electricity, heating and cooling. This allows LReit to use carbon offsets, and LReit has already reached this target.

LReit’s long-term emissions target is to achieve absolute zero carbon emissions by FY2040 for both direct and indirect emissions, which means its business activities, including supply chain emissions, would generate no greenhouse gases without the need for offsets.

Because LReit’s FY2025 target is quickly becoming obsolete, LReit is now in the process of determining its next set of interim targets en route to the FY2040 goal. Until then, it’s not clear how existing KPIs are measured against the FY2040 goals. For the sustainability-linked loans to be meaningful, LReit’s interim targets and KPIs need to be credible.

The second unknown variable is how much its interest expense is affected by its sustainability performance. The terms of LReit’s sustainability-linked loans are not disclosed, and interest increments could range from five to 25 basis points. That would represent between 1 per cent to 7 per cent or so of total interest expense for a borrower like LReit, which had a weighted average cost of debt of 3.58 per cent in FY2024. Given that LReit paid about S$56 million in interest expense in FY2024, missing its sustainability KPIs could mean a hit of over S$3 million in one year.

That would be up to around 4 per cent or 5 per cent of profit before tax, change in fair value, impairment and share of profit. Of course, these are just hypothetical numbers, but the point is that the strength of the incentive could vary widely.

Companies are not required to – and almost never – disclose the KPIs and margin increments of their sustainability-linked loans. However, in LReit’s case unitholders might desire more transparency simply because almost all of LReit’s borrowings are subject to this variability. While the potential impact on profit is probably small, it’s not non-trivial, and unitholders might want to know how much of the trust’s profits are at risk if the trust doesn’t meet its sustainability goals.

🌱Top ESG reads:

1. While 10 per cent of Asia-Pacific companies disclosed a transition plan, only 2 per cent described measures to implement the plan, says LSEG.
2. Carbon projects under the Reducing Emissions from Deforestation and Forest Degradation (Redd+) framework in South-east Asia could be worth US$27.8 billion, says an industry report.
3. More than 30 of China’s top solar equipment makers have agreed on supply quotas to limit price wars.
4. The aviation industry could miss its sustainable aviation fuel targets, says Willie Walsh, head of airline trade body Iata.
5. Goldman Sachs has left the Net-Zero Banking Alliance amid pressure from US Republican politicians.

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