Recap on the 's' within ESG 

The 'social' aspect of ESG continues to be one of the most difficult areas in which to implement measures to achieve ESG targets. As a sequel to our article included in Lending Focus last year, ESG: examining the 'S' in ESG in the context of 'Social Loans, this article looks to examine an emerging solution to the 'S' (being social) in ESG for the real estate finance market. 

As a reminder, the starting point for addressing the 'social' element of ESG involves a focus on 'human' obligations, in particular implementing strategies that impact people and communities in a positive way and provide clear benefits of a social nature.

As discussed in our previous article, when compared with the 'environmental' limb of ESG, the 'social' element can be particularly hard to identify and quantify. This can be particularly difficult in the real estate finance market given that social outcomes can be much less tangible and lend themselves less to metrical analysis in comparison to those that are 'environmental' in nature. 

In terms of environmental targets, metrics are readily available to assess the carbon footprint of a business or a building, net zero initiatives and/or emissions. In terms of social targets, these are less obvious and a qualitative analysis is more likely to measure the impact in a meaningful way: fiscal and economic outcomes generated by the social initiative can be analysed.

Co-living 

This article focuses on the real estate finance market and an emerging type of real estate investment, co-living schemes. Co-living schemes could offer stakeholders an opportunity to meet the 'social' element of ESG criteria based on the benefit of living in a communal setting.

The focus on this type of asset as a 'social' purpose may benefit borrowers, sponsors, investors and lenders who are seeking to participate in the ESG related lending market. 

The article will also look at the voluntary guidance for 'Social Loans' produced by the Loan Market Association (LMA), the Loan Syndications and Trading Association (the LSTA) and the Asia Pacific Loan Market Association (APLMA) to ascertain whether this type of real estate investment might fall within its parameters.

What do co-living schemes look like?

Co-living schemes typically refer to residential developments (purpose-built accommodation) where each tenant leases their own living space (either in the form of a bedroom or a studio flat) and has access to shared areas and a range of amenities. Amenities on offer tend to include gyms, exercise and other classes, laundrettes and even cinemas for all residents to utilise. Co-living models currently in the UK (mostly in the major cities) reportedly allow residents the option of both short-term rentals (from around 3 months) to longer-term rentals (up to 3 years).

What attracts tenants to co-living schemes?

One key advantage and defining factor of co-living schemes is the flexibility provided to individuals looking for an alternative to the more typical build to rent accommodation which tends to attract longer term rental commitments but also higher rental costs due to the individual space being provided to tenants. 

Due to its set up, notably the location, flexibility and amenities it offers, co-living looks to be predominantly marketed to young professionals who:

• work in major cities
• want to live in central locations
• are seeking to limit their rental costs
• want to take advantage of the comfort and convenience provided by a purpose built development. 

Furthermore, the communal living space brings a feeling of a community which would not be achieved in a usual purpose-built scheme or residential letting. The 'pre-made social' side of the accommodation avoids tenants needing to look for 'house share' arrangements and mitigates the alternative of living alone.

As the cost-of-living increases and purchasing property becomes more difficult, the demand for rental properties, particularly in cities where the cost of living is higher, is on the rise. As a smaller amount of space is available to each individual tenant, this could be a more cost-effective alternative to many looking for affordable rental options.

What attracts sponsors and lenders to co-living schemes?

Sponsors

Notwithstanding the above, while rents may typically be less for tenants individually than more traditional residential lettings, the flexibility (particularly in providing short-term rentals) and additional amenities provided mean a premium can be charged for the actual space on offer to each individual tenant.

As a result, compared with some other types of real estate investment, co-living schemes can offer attractive yields due to higher rental income per square foot generated by higher density occupation and shared amenity space.

The co-living sector is expected to continue to grow across the UK and offers a diversification from the build to rent schemes many sponsors (and consequently lenders) are familiar with. 

Lenders 

Of course, lenders will also be attracted to the reasons set out above including the potential return opportunities highlighted in this article.

However, there is arguably a potential reputational benefit to lenders lending into the co-living model. Whilst it is interesting to be one of the first lenders involved in a new type of real estate asset, there is also a real prospect of co-living schemes answering many of the ESG criteria which are becoming increasingly important to all types of lenders (including their internal committees, credit teams and investors). In particular, by promoting community and social connectivity, co-living models potentially fulfil many more of the "social" ESG criteria than other real estate models.

Generally, how does co-living specifically meet ESG requirements?

'Social'

Broadly speaking, the 'social' element of ESG may be met in various ways, but looking specifically at those that may be relevant to co-living projects; a focus on affordable housing and benefits to the community may meet the criteria. When assessing a particular real estate project in terms of its 'social' impact it is important to consider all of the ways that the development or building impacts the individuals within and community around it.

The key features of co-living which allow the model to fit within the 'social' aspect of ESG are as follows: 

• firstly, shared living space means residents have the opportunity to socialise with others on a daily basis
• secondly, this allows residents to embrace being part of a community, as well as enjoying the amenities on the premises together
• thirdly, the set-up of co-living schemes, often including a gym, allows each resident to focus on their own health and wellbeing. 

As mentioned above, community has become increasingly important following the Covid-19 pandemic, during which many people experienced feelings of loneliness and isolation. This was a particular issue for young professionals who may not live with or close to family and friends.

Further, by providing more affordable rental options (on an individual basis) in areas which would otherwise be unaffordable for many, there is a clear benefit to people and the community being formed. 

'Environmental'

There may also be environmental benefits to co-living schemes. As a new type of asset, property will require development to fit the co-living model. This development allows sponsors to fulfil their own environmental requirements and credentials or deliver on those set by lenders under sustainability linked loans.

On a base level, by combining the social and amenity spaces for the whole building, environmental efficiencies can be achieved in respect of the carbon footprint of the building at the outset and throughout its life cycle. Any additional requirements or targets can be built into the development financing discussions and process between sponsors and lenders. 

What are the LMA, LSTA and APLMA's guidelines for social loans and could co-living projects fall within them? 

The LMA, LSTA and APLMA updated their voluntary recommended guidelines and supporting guidance for sustainable finance on 23 February 2023, including in relation to loans in the social loan market. The guidelines are to be applied on a transaction-by-transaction basis. The LMA's Social Loan Principles (the SLP) referred to social loans as "any type of loan instruments and/or contingent facilities (such as bonding lines, guarantee lines or letters of credit) made available exclusively to finance, re-finance or guarantee, in whole or in part, new and/or existing eligible Social Projects and which are aligned to the four core components of the SLP". All loans originated, extended or refinanced after 9 March 2023 must be fully aligned with the SLP to be classified as Social Loans within the LMA's criteria. 

A set of four criteria is established by the principles, each of which is examined below in the context of co-living projects:

• Use of the loan proceeds for 'Social Projects': indicative, non-exhaustive examples of such projects given by the SLP include affordable housing which is one of the key benefits of co-living schemes.
• Process for project evaluation and selection: the borrower should clearly communicate the social objective and target population of the social project, the process by which the borrower determines it will fit within the social loan criteria and how the borrower will manage risks associated with the relevant project. Borrowers looking to satisfy this requirement could focus on the affordable housing and community elements of co-living. 
• Management of proceeds: the proceeds should be credited to a dedicated account or tracked by the borrower in an appropriate manner.
• Reporting: the borrower would need to maintain up to date information on use of proceeds and include a list of projects to which the loan proceeds have been allocated, and their expected and where possible achieved impact. 

What is the future for co-living?

Whilst co-living is still a relatively new prospect with only a few developments being seen across London and the UK, examples can be seen of this idea being pushed further to benefit a wider cross section of society than just young professionals. A more radical approach which can be seen in a development in the UK but mostly elsewhere in Europe, is co-living between different generations (otherwise called co-housing or multi-generational housing). This approach, again, targets loneliness and creates a sense of community for some of the most isolated people in society, providing community space which can be shared and managed by all residents together.

Whilst this approach could arguably have benefits for society as a whole and perhaps bring opportunities for the model to be brought into residential areas other than cities, the ability for one scheme to cater for the wants and needs for all age ranges to comfortably live together (albeit likely in multiple homes rather than a co-living building) could be difficult and involve some risk and cost to sponsors and lenders. 

The future of co-living (and how far stakeholders are willing to take such an idea) remains to be seen, however, it arguably brings many benefits which other types of asset are not able to provide. 

Find out more

To discuss the issues raised in this article in more detail, please contact a member of our Banking and Finance team.