Good governance for real assets is not a new concept. Successful investors have always paid close attention to governance, especially with regulated asset classes such as real estate, because of the risk that their investments could lose value from compliance issues, says Chintan Panchal, founder of RPCK, an ESG and impact law firm in New York. But as ESG standards have gained prominence, governance metrics have become better defined, making it easier to compare potential investments.
ESG “is focusing attention around governance as an issue,” Panchal says. “There is intentionality around governance and how governance-related risks manifest themselves in respect of a potential investment.”
For the real estate industry, good governance seemed to take on greater importance following the 2008 financial crisis, which spurred a greater focus on whether companies had strong frameworks in place for solid decision-making, says Helen Gurfel, head of sustainability and innovation for CBRE Investment Management. “Companies that have a proper structure of rules, practices and processes in place to make good, sustainable decisions are the companies we feel comfortable investing in,” she notes.
For CBRE, governance is the structure of rules, practices and processes for managing a company. Those rules can focus on ethical behavior, environmental action, compensation and risk management.
When CBRE invests directly in an asset, then the manager becomes the governance structure. But when the company invests in an asset indirectly, such as through a joint venture partnership or through a fund, then assessing the governance is critical. “It plays a much more substantial role when we don’t have direct control in asset operations,” Gurfel says.
Good governance for real assets should be based on internal oversight, policy, process and reporting – all integrated with the investment strategy, says Lauren Winkler, senior director of ESG at The Green Cities Company, a real estate private equity manager based in Portland, Oregon. Also, the focus in governance should be on the integrity of the management for the property. That is slightly different than for private equity-owned companies, where the focus is on board governance and perhaps the board’s audit
Climate risk demands attention
The basic parameters of what strong governance means for real estate have not changed much over time, but the requirements are becoming more detailed, Winkler says. Real estate managers should demonstrate what their responsible investment policy is, which can include reporting under GRESB, using key performance indicators established by NACREIF and evaluating climate risk via TCFD criteria.
“I expect to see TCFD becoming more and more prevalent within the real estate space as it is becoming more and more prevalent within the broader private equity space,” she says.
Climate risk is a critical issue for real estate, not only for buildings in areas at risk from rising ocean levels, for example, or drought or flooding, but also for stranded-asset risks if a property becomes devalued under new climate regulations. From a governance perspective, climate risk has commanded more oversight and reporting from managers in recent years, Winkler says.
Kristina Arsenievich, who leads ESG strategy for European real estate at Barings Real Estate, says she has seen less clarity recently in governance requirements for real assets, even while new frameworks for governance have been mandated more clearly for other asset classes. For example, under financial disclosure regulations, governance requirements have been aimed only at real estate index companies and not the real estate itself.
Part of the reason for the lack of a broad mandate for real estate governance – at a pan-European level, for example – is the wide variation of local requirements, Arsenievich says. Individual municipalities may each have their own requirements for meeting net-zero carbon goals, construction employment targets and sourcing materials locally. So, regulators have found that trying to develop governance standards for real estate “where one size fits all has been somewhat challenging,” she says.
However, best practices have been developed for responsible procurement that can be applied to real estate. “Addressing the G of ESG takes us back to corporate social responsibility in terms of being clear on what must be embedded in documentation, what is the right protocol for compliance monitoring, how improvement measures are tracked and how that feeds into disclosure,” Arsenievich says. “We are not waiting for pan-European or global criteria to define this; we leverage internal expertise and industry best practice.”
Instead, real estate managers and investors are looking to old protocols such as ISO 20400 sustainable procurement and ISO 14001 environmental management standards, which were developed in 2017 and 2015, respectively. Procurement would be the main pathway for a real estate project to deliver on a net-zero carbon objective, for example.
For certain themes, such as net-zero carbon emissions, real estate managers are relying on local guidance, such as the Better Buildings Partnership in the UK. The partnership has defined best practices for property managers on developing net-zero criteria, including how to incentivize the supply chain to get on board.
“If you aren’t able to adequately measure what you are doing, then it is very hard to actively manage it”
Also, for real estate investors who abide by the UN Principles for Responsible Investment, the principles can provide an overall framework for good governance, with the details on meeting those principles coming from the ISO standards and local ESG requirements, Arsenievich says.
“That is kind of your umbrella or Holy Grail of what you should start with, then this variation of localized criteria shouldn’t affect you that much.”
In some cases, the real estate manager might also mandate that its suppliers align with the standards, for example stating in a contract that it prefers its suppliers to have instrumented environmental management systems according to ISA 14001.
Many of the new governance frameworks don’t actually provide dos and don’ts for good governance, says Rob Day, co-founder of Spring Lane Capital, a private equity firm in Boston.
“Even though everybody is now signing on to various frameworks, a lot of the frameworks are really more about: ‘Hey, we are requiring you to clearly state what your governance standards are, and then to show that you are adhering to them. We are not telling you what your governance actually needs to be,’” Day says.
Good governance should ensure that management teams and their companies are aligned in building, nurturing and advancing a best-in-class compliance culture, Jon Samuels, partner and co-head at private investment firm Vistria Group, says. For investors seeking to benefit the communities they invest in, a strong compliance regime is necessary, which should include access to real-time data.
“If you aren’t able to adequately measure what you are doing, then it is very hard to actively manage it,” he says.