Real estate debt puts impact principles to the test

PENSIOEN PRO PARTNER ROUNDTABLE

Additionality, intentionality and measurability remain the foundation of impact investing. They provide the discipline needed to demonstrate when capital creates real change. Applying these principles to real estate debt is not always straightforward. However, the investment category has significant potential to accelerate the transition of existing buildings.

Through financing, engagement and sustainability-linked conditions, lenders can influence how buildings improve over time. The challenge is to demonstrate this in a way that meets the expectations of institutional investors, their beneficiaries and other stakeholders.

That tension was at the centre of a Pensioen Pro roundtable on impact investing in real estate debt. Participants agreed that impact principles remain essential, but that demonstrating impact requires an approach that reflects how real estate financing works in practice.

Sean Allen, Senior Director of Stewardship at Barings, believes that the distinction between impact alignment and genuine impact generation is a key part of the conversation. While identifying assets that already have existing positive environmental or social characteristics can raise awareness of positive outcomes, moving toward impact generation means being able to articulate the trio: “what did you intend, where have you added, and how can you prove that through measurability?”

“I think the big conversation is about what is additionality and what is contribution,” states Maaike Hof, Senior Advisor at advisory firm Finance Ideas. “The additionality part – that it wouldn’t have happened if I hadn’t invested – is a very difficult thing to prove. So, nowadays the focus has shifted to being clear about your contribution. What is my contribution to achieving something, to tackling a problem I would like to solve?”

Eszter Vitorino, Impact Lead at Van Lanschot Kempen, adds that this starts with clearly defining the change an investor wants to achieve. “It comes down to what is impact, what is your theory of change? What is it that you are trying to move the needle on? Do you seek to address a gap or improve things?”

Real estate debt as an instrument for impact

Vitorino: “In real estate debt, the emphasis is often on financing assets that are becoming more sustainable, as pure impact strategies are scarce and less scalable. For pension fund investors, generating environmental impact through real estate equity strategies often requires substantial capital expenditure programs, which can increase the investment’s risk profile beyond what is typically desired. Real estate debt offers a more efficient alternative, as it allows investors to directly finance the sustainability improvements needed to transform a building while maintaining a relatively core or core+ risk profile. In addition, the impact generated per invested euro is often higher, as capital is deployed directly towards transformative measures rather than being used partly for the acquisition of the asset or other non-impact related expenditures.”

Rupert Gill, Head of Portfolio Management, European Real Estate Debt at Barings, says transition lending offers many opportunities. “The borrower may typically have an older building in a good location that needs refurbishment and capex. They may switch to LED lighting and improve the façades or roofs. The financial objective may be straightforward: improve the building, attract tenants and increase value, but there is also a significant environmental outcome. We often see an improvement in energy efficiency ratings and green building certifications. We don’t label it as an impact strategy, but the positive outcome is a by-product of enhancing the building.”

Erik Leseman, CIO Investment Management at Achmea Life & Pension: “Personally, I would call transitional financing additional because it was a brown building, and it will be a green building. So, for me, that would be investing for a better world, although it might not meet all the impact requirements of the GIIN.”

Hof: “Many pension funds in the Netherlands have impact allocations focused on energy transition; for this, private real estate debt impact propositions could be an interesting addition, as they could play an important role in filling the financing gap in the brown-to-green transition. Also, from a tactical allocation perspective, it is currently attractive due to the relatively low risk premium on the equity side.”

Sustainability-linked conditions and incentives

Lenders do not own buildings and cannot simply impose changes as shareholders might. Vitorino argues that this does not mean debt investors lack influence. “It is not only about the additionality of the solution itself. I think that is where debt solutions actually have an additional ability, even compared to equity. It is additionality at the manager level, because you can tie financing terms to sustainability.”

Loan structures can include sustainability requirements, reporting obligations or incentives linked to specific improvements, such as margin ratchets.

Gill: “We apply margin ratchets on development loans where feasible, incentivising borrowers to achieve sustainability targets. There are examples where we have worked collaboratively with a borrower to reward progress with modest margin ratchet reductions upon achievement of prescribed milestones, or establish an increase where targets have not been met.”

Gill sees these incentives as part of a broader discussion about how lenders can encourage borrowers to deliver on their sustainability plans. “A borrower may be intending to put solar panels on the roofs or install EV chargers. You can make sure they actually deliver on that with a margin ratchet mechanism.”

Leseman notes that the structure of such incentives is important. “Penalties for missing sustainability targets should not simply become an additional return for investors. I prefer this structure: we are entitled to an additional cash flow, but please use this cash flow to reach another target, employee education, workplace safety or whatever. As an investor, I don’t want to profit from not meeting sustainability targets.”

Bart Reidsma, Investment Director NL Health at PGGM, doubts that ratchets always offer added value. “Many sustainability investments also make sense from a financial perspective. Measures such as installing solar panels can improve a building’s economics and increase real estate value. So if the interests are already aligned from a risk-return perspective, the need for an additional push or ratcheting mechanism may be less obvious.”

Reidsma argues that debt investors should not underestimate their ability to influence companies. “In the end, borrowers need to come back often to refinance and also for new investments. Collaboration between investors in engagement can make their influence even stronger. If there is a lot of capital behind it, you will probably have a lot more power than if you do it alone.”

Risk-return remains the starting point

Even when investors explicitly target positive environmental or social outcomes, the starting point remains whether an investment fits the portfolio and investment goals.

Leseman: “Risk-return is always step one. For an insurance company, there is no separate bucket for impact. You define your ALM, and then within each asset class, you look for the ways you can generate impact.”

He does offer some nuance: “The key is your LTV. Because if the improvements are made and LTV goes down while the building’s value goes up, the implied rating goes up, my capital charges go down, and I can accept a lower yield. If you go from double B to triple B, that makes a real difference.”

Reidsma: “Our team is really dedicated to impact investing. That is not to say that risk-return is abandoned. We still need to make a return that makes sense for the risk that you are taking.”

Vitorino argues that impact should be viewed through a longer-term investment lens, where financial performance and societal transitions increasingly converge. “Impact makes total sense because you are capitalising on the greater transitions.”

Ruud Weerts, Senior Research Analyst, Private Markets at Russell Investments, says the key focus is on how impact within private real estate debt can be made concrete, measurable, and scalable within the expected risk-return profile. “Investors should also be realistic about the differences in appetite for trade-offs. At some point, for some investors, the target expected return is in line with the market, while others accept a slightly lower return because they accept that impact may have a price. We also see large variation across managers, making manager selection key to ensuring alignment. If there is no alignment among the investors and the managers, the strategy will be impossible to execute, emphasizing the need for strong and continuing collaboration.”

Measuring impact: the need for a common language

While definitions of impact receive considerable attention, another challenge is measuring progress consistently and meaningfully across increasingly diversified portfolios.

Weerts: “If I look at our clients, in the last 18 months or so, they have been updating their responsible investing policy, applying it to their total portfolio: for equities, for bonds, and for private markets.”

Applying one framework across very different asset classes creates new challenges, Weerts explains. “They try to measure the impact from real estate debt and compare that to the impact they generate in equities. But these are completely different, so there is a great need for standardisation.”

According to Hof, the need for standardisation is also visible in the real estate industry. “If we talk about energy intensity, what are we actually talking about? If we talk about sustainability capex, what is that? Research by GREEN shows that although there is consensus on which climate metrics are used in investment decision-making, there is actually no real alignment on their definitions. If you talk about an energy reduction, it could well be that it is something totally different from what someone else is measuring.”

Catherine Rice, Sustainability Lead, Real Estate Europe at Barings, points to the challenge of obtaining reliable underlying information. “We rely on information provided by our borrowers, so data quality is critical. High-quality data enables better underwriting, more informed asset-level decision-making and a clearer understanding of transition risk and opportunity. Ultimately, strong data, operational performance and asset resilience are closely linked, and that is increasingly important for both lenders and investors.”

Hof: “Many pension funds intend to re-evaluate their sustainability strategies. Our recent research shows that they intend to focus primarily on creating real-world impact, which will also involve greater allocation to private markets. A prerequisite, however, is that real-world impact must be demonstrable. Sound substantiation and measurement of impact are therefore essential.”

At the same time, Hof stresses that imperfect measurement should not become a reason for inaction. “The data is not perfect, for sure, and there should be more comparability. But that does not mean that if you do not have the data, you should not do it.”

Vitorino: “Let’s try to standardise as much as we can, knowing that it won’t be perfect. And let’s not be afraid of not being perfect.”

Leseman adds that investors need to recognise that impact measurement itself is still developing, especially as data availability improves. “Allow for volatility in the measurements in the first couple of years. If coverage goes from 1 to 5 per cent, then you see all kinds of movements that you cannot explain. Other than: my coverage has increased, which actually is a good thing.”

Selecting managers: KPIs or capabilities first?

Solving the measurement challenge isn’t necessarily about collecting more data, but about identifying indicators that genuinely demonstrate impact. Allen: “On the real estate side, there is a significant opportunity to aggregate more streamlined data. A small number of key metrics can strongly demonstrate impact where data remains available over time.”

His Barings colleague Rice: “Selecting the right metrics starts with understanding what investors are seeking to achieve. Given the transition challenge facing the real estate sector, we focus particularly on energy intensity and greenhouse gas emissions intensity on a like-for-like basis. These metrics help us assess progress in improving asset performance, resilience and alignment with the direction of travel of the market.”

Ultimately, Rice argues, the challenge is choosing the KPIs that deserve the most attention. “The objective is not to maximise the number of metrics reported, but to focus on the indicators that provide the clearest evidence of progress. There is always a temptation to track an ever-growing range of metrics, but if you are spinning too many plates, it becomes harder to maintain focus on what is genuinely material. Prioritisation is essential if impact measurement is to remain meaningful and decision-useful.”

Leseman raises a question here. Should investors first define exactly which impact indicators they want to report on and then search for managers who can provide them? Or should they first identify strong managers and then determine the impact metrics? “Do we want to define the KPIs and find a manager who can do it? Or are we reaching out to managers to ask which KPIs they can deliver? Some team members are afraid that if we define the KPIs upfront, we are restricting our investable universe too much.”

For Leseman, cooperation with managers is essential, as long as outcomes can still be measured and reported. “I think that you can work with a manager and come up with a KPI which the manager can produce and we can measure and report.”

Vitorino argues that the discussion should start one step earlier: “If you align on the outcome you are working towards with the portfolio, then ask the manager: what are the KPIs you think can best measure progress towards this? It is more about alignment one level up.”

Beyond the numbers: understanding real-world impact

Reliable measurement remains essential, but investors also need to understand the real-world change they are trying to support. Real estate debt is part of larger transitions, including climate change, urbanisation, demographic shifts and changing housing needs.

Vitorino: “If you are ahead of these transitions, business and impact can go hand in hand. But also consider this: we always think about what it is worth to take action now versus later, or what is in it for us now. But actually, what will it cost us if we don’t take action? How will society and the environment look in 15 or 20 years if we do not accelerate this?”

Reidsma would like to seemore attention paid to the social impact of real estate. “I would be a big advocate of a social label. We have talked a lot about the E in ESG, as expected. But I would be very happy if, in some years, the S becomes more prominent and we have built a social label for buildings. Our private investments focus on property loans in the healthcare and welfare sector, with a clear emphasis on making an impact in the sector and its material staff shortages on behalf of PFZW.”

Weerts adds that social impact also requires clear definitions. Affordable housing, for example, may sound straightforward, but investors need to understand who benefits and what problem is being addressed. “Affordable for whom? You need to define the target group and the outcome you want to achieve.”

He ends with a positive note. Weerts sees a market shift towards more concrete impact objectives. “The market is moving from broad ESG ambitions towards measurable impact targets, better data and greater transparency. With growing attention to transition finance and climate risks, sustainability is becoming increasingly important from a credit perspective.”

Participants:
→ Sean Allen, Senior Director of Stewardship, Barings
→ Rupert Gill – Head of Portfolio Management, European Real Estate Debt, Barings
→ Maaike Hof – Senior Advisor, Finance Ideas and co-CEO, Global Real Estate Engagement Network (GREEN)
→ Erik Leseman – CIO Investment Management, Achmea Life & Pension
→ Bart Reidsma – Investment Director NL Health, PGGM
→ Catherine Rice – Sustainability Lead, Real Estate Europe, Barings
→ Eszter Vitorino – Impact Lead, Van Lanschot Kempen
→ Ruud Weerts – Senior Research Analyst, Private Markets, Russell Investments