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More than green home loans – Climate transition opportunities for residential property lending

Evolving customer, investor and regulatory expectations are encouraging lenders to take genuine action to address the risks of climate change and to work with their institutional and business customers to support the transition to the new low-emissions economy. But what about our banking sector’s largest portfolio of assets – residential property lending?

We are already seeing the impacts from increasing stakeholder focus and action on climate and other Environmental, Social and Governance (ESG) considerations across the banking sector. Lenders are rapidly enhancing their sustainability credentials by committing to Net Zero emissions targets, re-allocating capital from high to low carbon-emitting sectors and improving their capability and oversight in relation to climate-related risks. At the same time, regulators and investors are pressing banks and other financial organisations to disclose detailed sustainability information aligned with global reporting standards, resulting in increased transparency and comparability on carbon emissions associated with lending activities.  

While banks have been working with larger corporate and institutional customers to support their transition to a low-carbon future and offer ‘green’ institutional lending and wholesale funding solutions, developments in sustainability-linked home loans and consumer lending products have been more limited. Australian households contribute approximately 20% of the country’s total carbon emissions , meaning that Australian household consumers are among the highest emitting groups of consumers anywhere in the world. Significant opportunities exist to support household decarbonisation and lenders are starting to consider the opportunities in the household sector that the transition to a low-carbon future provides.

Lenders with genuine sustainability credentials can attract and retain customers by offering products aligned with their customer’s personal values and objectives, particularly when combined with attractive borrowing rates and efficient processes.  
A recent Deloitte survey found that protecting the environment remains a top priority for younger customers with 64% of those willing to pay more to purchase environmentally sustainable products. Applying this to the home loan market, younger generations of borrowers may require fewer financial incentives to purchase or renovate an energy efficient or climate resilient home via a genuine sustainability-linked ‘green’ home loan. By doing so, first home buyers, investors and renovators can align their home lending with their personal values while minimising their household carbon footprint and reducing the cost of utilities at the same time. 
Lenders seeking to improve their market share amongst younger, climate-aware customers aspiring to reduce their household financed emissions profile, may also consider alliance arrangements with utility providers to offer further incentives for consumers to invest in more energy efficient technologies or appliances.

The market for green and sustainability-linked debt has expanded materially in the last few years, with bank-issued bonds backed by green residential properties becoming an important component of the ‘green’ wholesale bank financing market.
2021 saw both record high issuance and a persistent price differential between green and non-green bonds.  Demand appears to be growing faster than supply, giving banks and other financial organisations an opportunity to source cheaper wholesale debt funding for verified green or sustainability-linked lending activity, at least in the short to medium-term.  The extent to which a pricing differential remains once the market becomes saturated is unclear, though it is hard to see it eroding completely.
A price differential has also emerged in the residential property market, with recent academic studies  finding evidence of buyer preference for energy efficient homes. A study has found that homes with energy saving features can attract a price premium of as much as 10% compared with less energy efficient homes of otherwise similar characteristics; while another has concluded that green homes sell more quickly . As with the wholesale market, it remains unclear whether these market characteristics will persist as government policies change and energy efficiency improves overall, but the research suggests that lenders are less likely to lose money lending against a green home. 
Australian banks are also increasingly factoring climate risks, primarily floods and bushfires, into their lending processes. Further opportunities may exist for lenders to optimise their credit policies and appetite regarding development on high-risk areas (based on standardised risk ratings such as the Bushfire Attack Level (BAL)) and supporting customers to invest in resilience measures to lower their household risk profile. 
With these factors in mind, lenders are considering whether verified energy efficient and climate resilient homes should attract lower credit provisions vis-à-vis other forms of residential property assets.

The ability to attract younger customers, fund green home loans with cheaper debt and hold lower credit provisions makes a compelling financial rationale for lenders to compete in this market, as they are starting to do.  To be successful at appropriate scale, three hurdles need to be addressed:

1. Customer engagement

We are in a period of transition as climate thinking progressively becomes mainstream.  

Limited green home loan products are currently available in the market and lack widespread knowledge or adoption. Existing products are typically restricted to customers who are either purchasing or building new homes aligned with modern energy ratings or scorecards, or who undertake significant effort to meet detailed verification criteria – making them unavailable for many borrowers purchasing or refinancing an existing home. 

These strategies will support customers today who both want to lower their household emissions and have the financial resources to do so. The key challenge for lenders will be how they increase engagement, growing the market by encouraging and helping less climate-sensitive homeowners to lower their emissions profiles.  

2. Channel management

Around two thirds of new residential home loans are facilitated through third party mortgage brokers. Lenders developing new sustainability-linked home loan products will need to work with the mortgage broking industry to develop systems and processes to support enhanced data collection requirements and to raise customer awareness.  

3. Data

Australian Lenders have been restricted in their ability to meet the growing market appetite for green home loans by a lack of accessible, quality data to measure household carbon emissions accurately and seamlessly, at scale. 

A recent government initiative to promote low emissions housing in Australia, the Nationwide House Energy Rating System (NatHERS), is welcome and can be used to support the green home lending market in alignment with green or sustainability-linked debt standards, however it is currently only available for new homes and major renovations. While the government joint initiative has announced plans to expand NatHERS to established homes in late 2023, it is expected to remain voluntary and will require a specialist on-site energy assessment. 

With similar energy ratings having been implemented in Europe and the UK, a known limitation of an upfront qualitative rating system such as NatHERS is its inability to monitor home energy performance on an ongoing basis or to measure the level of reduction in an existing household’s emissions from investment in energy-efficient appliances or improvements. NatHERS does not, for instance, update when a home is renovated, and this limitation can impact on its utility to verify the eligibility of existing homes for green and sustainability-linked debt funding on an ongoing basis. 

In the meantime, lenders are starting to engage with Australia’s retail energy suppliers to obtain more regular and granular information about residential property-related energy consumption. Such data must be validated and matched to the lenders’ existing collateral management systems, and the analysis can rapidly become complex for multi-occupancy dwellings such as inner-city apartment buildings. That said, the early efforts to build an ecosystem of data suppliers marks an encouraging step towards delivering the necessary reduction in Australia’s household carbon emissions.

Lenders able to easily identify and verify household carbon emissions profiles will be well placed to meet increasing stakeholder demands, attract new customers, evidence genuine sustainability performance, and lower household financed emissions. By verifying the emissions performance of their ‘green’ home loan portfolio, lenders may also be able to access ‘green’ funding markets, including the growing cohort of investors with ESG-linked mandates. This could result in a broader range of funding sources with preferential funding terms and higher overall profitability. 

Continued innovation in business strategies and competitive product offerings is crucial to take advantage of the opportunities that will undoubtedly arise. Banks and non-bank lenders will need to consider the longer-term impacts of climate on both operations and business strategy to ensure climate resilience.