How is the real estate sector tackling climate change?

Weaving sustainability into the real estate sector is beyond an ethical cause, it’s imperative for long-term investment prospects. Progressive and forward-facing players are already leaping to the challenge for their stakeholders, their employees and the world we live in.

Stepping back in time

At some point during the late eighth and ninth centuries, the Maya civilisation in what is now Mexico and Guatemala disappeared. It was a dominant civilisation in that region of the world, known for its expertise in agriculture, pottery and mathematics.

Sometime during the 15th century, the Viking population of Greenland who had migrated from Iceland around 1,000 AD, became extinct. The Vikings were great builders and users of natural resources such as timber and soil.

While historians aren’t definitive, the consensus is that both great civilisations disappeared as a result of the environment around them changing. The Maya civilisation suffered at the hand of a long drought, while the Vikings couldn’t adapt to a fall in temperatures.

In that sense, climate change has always played a role in civilisations. Sometimes its impact has been marginal, and in other instances, such as the Maya people or the Vikings of Greenland, it has been catastrophic.

Two decades into the 21st century, climate change, no matter what the causation, is a major challenge for society. For business, it has become the major risk to long-term performance.

The World Economic Forum’s Global Risks Landscape Report, released last year, said seven of the 10 top risks for business are climate related¹. They range from weather events and major natural disasters through to large-scale involuntary migration due to climate change, and collapses in ecosystems.

The major global instrument to deal with the crisis – the Paris Agreement signed in 2015 – is under threat after the United States recently announced it was withdrawing from its commitments. While there is disagreement among governments about climate change, the private sector has gradually been developing a consensus about the need to act.

Drivers of change

The real estate sector has adopted new practices in response to greenhouse gas emissions, but it hasn’t always been for altruistic reasons. Rather it is a reflection on what investors, customers, directors and employees want.

Australian real estate companies are in the process of carrying out, or have already undertaken analysis, of exposure to the physical risks associated with climate change, the worst of which are expected to be heatwaves and severe storms. New asset acquisitions are being screened for climate resilience, and this will start to be reflected in valuations.

Climate change is only part of the upheaval going on in the sector. More broadly, real estate is addressing environmental, social and governance (ESG) challenges. ESG is a term popularised in a 2005 United Nations landmark study Who Cares Wins⁴ that showed better consideration of each of the three factors would contribute to stronger financial markets and the sustainable development of society.

1. Customers

Tenants, employees and their visitors look for recycling bins when throwing out garbage. They expect lights that turn off when no-one is in a room and demand efficient elevators. They want somewhere to leave their bikes and have a shower when they ride to work. In short: customers are driving the push to consider ESG.

Tenants, or customers of landlords, look for buildings that reduce exposure to ESG costs such as energy. Just as importantly, they minimise exposure to ESG risks. This involves ensuring a safe and comfortable workspace, supporting people’s health and wellbeing, and addressing social issues.

In 2019, customers expect a building will align with their corporate sustainability beliefs and commitments.

2. Investors

Investors are looking for ESG initiatives and opportunities. According to data from Deutsche Bank and the Global Sustainable Investment Alliance, investors are set to triple the amount of global assets with an ESG mandate over the next decade⁵ , from the current level of around $30 trillion.
Those opportunities aren’t just investments. They also refer to mitigating investment and reputational risk, and taking evidence-based ESG action that supports strong, long-term risk-adjusted returns. As part of the process, investors want reporting that is transparent, benchmarked and aligned to global standards.

Real estate investors are particularly cognisant of ESG initiatives. According to the 2019 PERE ESG Investor Survey⁶, 70 per cent of institutional real estate investors have an explicit ESG policy in place, and nearly all respondents said that ESG principles have a role in shaping their investment decision-making.

The survey shows that 35 per cent of investors already expect ESG action from their investment managers, with a further 13 per cent saying they will require ESG initiatives in the next three to five years. Investors are appointing in-house ESG experts and insisting on participation in global ESG benchmarks.

Investors in real estate also want participation in global initiatives such as the WGBC (World Green Building Council) Net Zero Carbon Buildings Commitment; RE100 (Renewable Energy 100), Science Based Targets (SBT), and demonstrated alignment with the UN Sustainable Development Goals (SDGs) and Global Reporting Initiative (GRI).

It isn’t just big investors. Retail, or direct ‘mum and dad’ investors, look for ESG credentials as well. In Australia, the Responsible Investment Association Australia (RIAA)⁷ found that 92 per cent of Australians expect their superannuation or other investments to be invested responsibly and ethically.
Significantly, four out of five Australians would consider switching their superannuation or other investments to another provider if their current fund engaged in activities inconsistent with their values.

3. Employees

“Employees want to be proud of where they work and want its purpose, mission, and culture to reflect, or at least not oppose, their values,” posted Paris-based Deloitte Global Head of Sustainability, Olivier Jan recently. “This is especially true of younger professionals. Corporate value statements and management’s cultural messaging may mean little to these workers in the face of negative ESG impacts, which can compromise an organisation’s ability to attract talent.

“A favourable ESG profile and an absence of negatives can be an asset, particularly in areas where talent is scarce and competition is strong,” he said in a Harvard Law School Forum on Corporate Governance and Financial Regulation⁸.

It eloquently captures the mood of employees. People want to work for a company that they can be proud of, that is trustworthy, has integrity and is committed to doing the right thing.

4. Directors

Directors duties increasingly include the impact of climate change and ESG responsibilities. It is now accepted in Australian Corporate Law that directors’ duties encompass an obligation to understand climate-change related risks and opportunities, take appropriate action to transition to a zero carbon future, and manage the risks associated with the physical impacts of climate change.

These obligations have been reinforced by the G20 through the Task Force on Climate-related Financial Disclosures (TCFD) and large companies are expected to work towards TCFD compliant financial reporting. Eventually that will encourage real estate companies to declare ongoing energy efficiency improvements, install on-site solar generation, procure 100 per cent renewable electricity and buy carbon offset credits to compensate for any unavoidable residual emissions.

How the real estate sector can channel change

• Improve energy efficiency and increase use of renewable energy.
• Strengthen resilience to climate-related hazards.
• Improve resource efficiency, reduce waste generation and improve recycling, limit food waste and prevent marine pollution.
• Increase water efficiency.
• Protect natural heritage, limit biodiversity loss and improve access to green space.
• Tobacco control.
• Protect labour rights and promote safe and secure working environments.
• Education, training and awareness raising about sustainability, developing partnerships that mobilise and share sustainability knowledge, expertise, technology and financial resources.
• End all forms of discrimination against women, promote flexible work arrangements, monitor and promote gender diversity – particularly in leadership positions.
• Improve accessibility for people with a disability.
• Promote sustainable transport.
• Identify and tackle corruption and bribery and address modern slavery.
• Promote transparent sustainability disclosures and reporting.

The real estate sector’s role

Sustainability has become a dominant global economic risk and business megatrend that will transform business, industries and society. Until now, most investors have not got to the point of avoiding assets deemed as high risk on the basis of climate change and sustainability. But it is inevitable.

The real estate sector holds many of the solutions to alleviate ESG concerns. These include targets for zero net carbon output, energy efficiency and adoption of renewables. It includes peak energy demand reduction, electrification of buildings, refrigerants, climate change resilience assessments, waste avoidance and recovery and water efficiency initiatives. The opportunity for the real estate sector isn’t only in physical buildings. It is also in health and the wellbeing of customers and employees, social sustainability, inclusion and diversity, accessibility and electric vehicle take up.

Sustainable development goals

Demonstrating and recording progress against climate change and other ESG goals is best done against the United Nations Sustainable Development Goals – a collection of 17 global goals for 2030. Member states adopted the goals in 2015 and while governments are tasked with achieving them, the private sector have widely embraced the goals.

AMP Capital’s real estate team mapped its sustainability targets against the SDGs. The exercise showed that that there were a number of specific SDGs that it could influence directly. The strongest correlations between the SDGs and real estate sustainability activities are in the table to the left.

Putting targets into practice

Reflecting on the demand to implement change and policies to both alleviate climate change and respect ESG initiatives, the real estate sector has undertaken a number of tangible steps. There is still some way to go but the sector is at the forefront of the ESG movement.

In Australia, the commercial real estate sector has almost universally adopted zero net carbon targets. The target dates vary from between 2020 for new buildings, and 2050 for existing buildings. Typically dates around 2030 have been targeted for carbon neutrality in real estate portfolios.

These targets normally include gas and electricity emissions with some also including more indirect emission sources such as tenant energy consumption, methane emissions from decomposing landfill, carbon emissions associated with water treatment and disposal. The next frontier includes initiatives to offset embodied carbon and other supply chain impacts.

Also almost universally adopted in the Australian market are energy efficiency targets, using the federal government’s NABERS Energy standard as the performance benchmark.

Renewable energy targets are increasingly common and have triggered large rooftop solar photovoltaic installations. These are particularly well suited to shopping centres with large expanses of available roof area, seven-day trading, and with peak energy demand generally occurring during the day when the sun is shining and the panels are generating power.

In addition, some companies have commenced – and most are considering – various ways to cost effectively procure renewable energy. There is also a shift towards peak energy demand reduction strategies, such as demand response programs used in the United States.

Hydrofluorocarbon-based refrigerants punch well above their weight when it comes to global warming potential. In 2017, managing refrigerators was ranked the number one solution to climate change, by sustainability guru Paul Hawken⁹. Landlords are thinking more about their refrigeration options.
Commercial real estate owners and managers have a significant role in reducing the waste generated by building users and influencing them to adopt more sustainable consumption behaviours.

Construction and operational waste targets are universal across real estate companies, including waste sent to landfill, collection of organic waste, disposal of electronic waste and greater education around recycling.

Water efficiency initiatives are omnipresent in the real estate sector, though not always as well developed as energy initiatives. They include everything from water efficient fixtures and fittings, rainwater collection capture, grey and blackwater recycling to landscape infiltration and other sustainable drainage systems.

More than just a building

Away from the physical building, the real estate sector is taking the opportunity to lead the way in other ESG initiatives. These include:

• Biodiversity: planting only native species, creating habitats for threatened and endangered species.
• Health and wellbeing: a major focus of most real estate companies including metric rating systems for evaluating the contribution of the building to occupant productivity and wellbeing.
• Social sustainability: social impact assessments of assets, supporting social enterprises, deepening charitable partnerships, improving stakeholder engagement.
• Inclusion and diversity efforts: gender equality including targets for women in senior roles.
• Reconciliation action plans: recognise and celebrate Aboriginal and Torres Strait Islander culture and promote indigenous employment.
• Accessibility: encouraging walking, running or cycling to work, or use of public transport; more could be done to improve accessibility of buildings given one in five Australians have some form of disability, according to the Australian Network on Disability.
• Electric vehicles: adoption in Australia has been comparatively slow, though there is increasing demand for charging infrastructure, increased use of share vehicles and pick-up and drop-off bays. 

Further, ‘green leases’ – which incorporate rules around how a building is to be occupied and operated in a sustainable manner – are now relatively common in Australia. They will remain an important way to elicit the cooperation of building users in whole building sustainability initiatives.

Innovation in the sector to address ESG challenges is continuous. One example is the use of green bonds to secure favourable finance based on the strong sustainability credentials of Australian institutional real estate. Another is the creation of new funds focused on attracting impact investors or delivering enhanced social and environmental outcomes. A third is experimentation and scaling up of solutions like cross-laminated timber structures.

This innovation will continue. Energy services are likely to be increasingly incorporated into property management via embedded networks, solar power purchase agreements and district scale utilities. Expect to see the increasing deployment of Internet of Things sensors, advanced building management control systems using machine learning and artificial intelligence and a variety of other prop-tech initiatives.

Case study: Green alpha

As explained by Head of Real Estate Research at AMP Capital, Luke Dixon, green alpha is a relatively new term and is a way of quantifying the proportion of a return from an asset that is attributed to sustainability and energy efficiency initiatives.

From a real estate perspective, maximising returns is primarily linked to boosting rental income and keeping operational costs down. Cutting energy costs is a relatively simple method to boost income yields. According to market evidence and international studies into green buildings, this can make significant differences to the return an asset delivers over its life. More sophisticated energy procurement strategies, such as three-to-five year fixed-price contracts can also help.

Asset valuations and returns are showing a growing divergence between high-standard green buildings and their less-green peers. According to the MSCI Green Property Investment Digest, over the past three years, prime CBD office buildings in Australia with a NABERS star rating higher than four stars (the maximum is six) have delivered a total return to their investors of 13.4 per cent, versus 12.9 per cent for all other assets in this category. The NABERS rating system aims to help building owners understand how their asset impacts the environment³.

Green alpha, and the positive boost it provides to total returns, has become a part of an asset manager’s toolkit. Greener buildings, apart from delivering superior returns, tend to offer investors lower systemic risk with a more stable income profile, lower incentives and enhanced tenant “stickiness” which can reduce the vacancy of a portfolio.

Conclusion

Unlike the Maya civilisation of central America, or the Vikings of Greenland, society now better understands the causes and impact of climate change and broader ESG challenges. It is the responsibility of the current generation of governments and business leaders to find solutions. The real estate sector has taken on that challenge. It hasn’t beaten it – there’s still much to do – but it has shown leadership in the 21st century’s greatest dilemma.