The recent company earnings season showed that environmental, social and governance (ESG) factors have become a core part of how organisations are reporting on their operational performance.
However, assessing ESG in the unlisted real estate industry has been more difficult for investors.
Real estate is a fragmented asset class and some of the changes needed to deliver real sustainability require significant capital investment.
ESG matters for real estate investors as buildings are responsible for 40% of the world’s carbon emissions, use 40% of the world’s energy and consume 30% of world’s available drinking water. 1
Fundamentally, for the real estate industry, ESG is a tool to assess, measure and manage risk.
There are a wide range of ESG risks that property investors consider. These range from physical risks, like how exposed a property is to rising flood waters through to risks of perception, like whether a shopping mall is behaving in a way that maintains its social licence to service a community.
For active managers, consideration of ESG risks occurs at every level of an asset’s lifecycle, from acquisition, leasing, day-to-day management, development and divestment. For these managers, the objective is to protect and grow an asset’s income and value in order to continue to deliver to investors long-term sustainable, risk-adjusted returns. To be able to do this, ESG risks can no longer be ignored.
How can investors assess whether their real estate funds and the underlying assets are delivering on ESG promises?
The first place to look is at published ESG ratings. There are two leading rating systems: NABERS, which stands for the National Australian Built Environment Rating System, and GRESB, a global ESG sustainability benchmark.
NABERS is a national initiative managed by the NSW Department of Planning, Industry and Environment that provides sustainability measures for real estate assets including hotels, shopping centres, apartments, offices, data centres and more. 2
NABERS ratings help building owners and tenants benchmark their building’s performance compared to other similar buildings. It measures things like energy and water use, waste and the indoor environment. It is a star model – 1 star to 6 stars – that rates buildings every year.
GRESB takes a wider approach than NABERS by assessing real estate and infrastructure with standardised global benchmarks for sustainability. GRESB is used by investors to monitor investments and engage with managers. 3
Beyond the headline ratings, investors can also take a closer look at exactly what building managers are doing to deliver sustainable ESG outcomes.
Environmental factors are top of the list.
Leading building managers are focused deeply on reducing energy use in their buildings. Sometimes, this will be through using passive design principles that take advantage of local weather conditions to reduce the need for heating and cooling. Examples include features such as orienting a building to catch the sun’s heat in winter or a cooling breeze in summer or using materials that help manage internal temperatures and humidity.
However, there is not often the opportunity to build a building from scratch, so real estate managers are also focused on the adaptation of existing buildings to be more energy efficient by installing shades, insulation or even solar panels. Power-purchasing agreements also assist in minimising carbon emissions and providing certainty of the cost of occupying a building, through the fixed energy costs established in renewable energy supply contracts.
Technology is also playing a big part, with cutting edge buildings using a network of sensors backed by artificial intelligence to constantly monitor all parts of a building and how people are using it, automatically managing heating, cooling and lighting to reduce energy costs and cut a building’s carbon footprint.
This is not only good for the planet but also for tenants as lower energy costs get passed through. From an investor point of view, the capital spending on these kinds of projects can pay dividends in terms of higher rents and better occupancy. With energy costs usually passed onto the tenants of a building, occupiers of buildings that have lower energy bills should have the capacity to pay higher rents in our opinion.
Some tenants, notably government departments, are restrained from renting buildings that fall short of environmental standards. Ensuring a building is attractive to the widest range of tenants is critical to maintaining occupancy and income levels throughout the market cycle.
ESG is not only concerned about the ‘e’ for environment.
For real estate, the ‘social’ component of ESG is an important factor too.
To assess the social sustainability of a building, we believe investors should look out for signs that building managers are effectively maintaining good relationships with the local communities they operate in and creating places where members of the community feel safe and included when visiting.
This may show up in the way a building engages and pays respect to the local First Nations people, acknowledging their role and ensuring elders are part of on-site events. A manager’s approach to this relationship will be articulated in their Reconciliation Action Plan.
Many shopping centres are playing a wider role in the local community beyond merely operating the building by encouraging charities and community groups to operate on site for the benefit of other users of the site, allowing walkers to use the building for exercise before the shops open, and providing spaces for mothers’ groups or Justice of the Peace services. Provision of adult change facilities, multi-faith prayer rooms and quiet shopping hours are also part of bringing the community together, which is an important role real estate plays in society. In addition, it can also have a positive impact on investment returns. We believe that people who feel an affinity to a building that is part of their community are more likely to live, work, shop and play there, making the asset an integral part of their daily lives.
But sustainability is about more than just a happy local community.
The Modern Slavery Act requires businesses to assess their supply chains for exploitation and the real estate industry is no different.
Investors seeking to assess sustainability should also check a building manager’s modern slavery statement, which should include information on how outsourced services like cleaning and security are managed.
Looking forward, another thing investors might want to assess is how attractive the asset is, with health sustainability of a building a more heightened consideration in a post-COVID world where air quality, ventilation and distancing might be key to encouraging people back to work.
This could include features like windows that open or various vertical transport options including staircases in addition to lifts connecting multi-floor tenancies. However, it could also be the provision of wellness facilities, like yoga studios and green space.
Australia’s institutional managers of real estate are very much leaders in ESG with clear benefits for investors, the community and the planet in ensuring the ESG risks facing real estate assets are effectively managed.
We believe that investors who are taking a close interest in how ESG factors play out in real estate investment will be better positioned to benefit from this active management approach.
Subscribe below to Market Watch to receive my latest articlesClaire Talbot, Fund Manager, Real Estate
While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) (AMP Capital) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided and must not be provided to any other person or entity without the express written consent of AMP Capital.
This article is not intended for distribution or use in any jurisdiction where it would be contrary to applicable laws, regulations or directives and does not constitute a recommendation, offer, solicitation or invitation to invest.