Real estate portfolios contain assets with unique characteristics that can sometimes be difficult to evaluate or describe within a standardized ESG reporting structure. So how can investment managers avoid a broad-brush ESG approach and adopt a strategy that reflects the nuances of each asset within their portfolios?
Here are five key considerations suggested by real estate and private equity investment professionals.
1Do not be too quick to dismiss an asset that at first appears to be an ESG underperformer
At CBRE, when an asset doesn’t seem to fit in a real estate portfolio from an ESG perspective at the fund level, the investment committee for the fund discusses the issue, says Helen Gurfel, head of sustainability and innovation for CBRE Investment Management.
The point is to understand how and why the asset doesn’t fit, Gurfel says – perhaps from an energy usage or carbon emissions standpoint, for example. The committee examines where the asset should be performing according to benchmarks and according to the overall fund’s performance or ESG certification levels, and it determines the level of capital expenditure needed to bring the asset in line, how the capex would affect returns and whether the expenditure is something the investment manager should take on.
“We believe that we are good stewards for our clients and the environment and therefore if we think that we can invest in a poorly performing asset and make it a really strong-performing asset, we will take that on because it is potentially better to have it in the hands of responsible managers,” Gurfel says. “We believe that we are going to make good decisions and take the right actions to make a positive impact.”
Kristina Arsenievich, head of ESG strategy for European real estate at Barings Real Estate, says her firm also views some assets with less-than-pristine ESG profiles as investment opportunities. “Our approach is to take a granular view and consider a range of opportunities for improvement,” she says.
ESG strategies for real estate investment are built on the “old stock” assets, not new construction, Arsenievich says. “If you want to be on this journey, then you have to take responsibility for that old stock,” she notes. “It is not about building brand new, pretty, net-zero glass boxes. It is actually about the old stock that needs to shift and improve.”
2Invest locally to understand the asset better, and give ESG ownership to the asset’s manager
In real estate investing and in executing ESG strategies, nothing beats local knowledge.
“When it comes to real estate, we invest in jurisdictions where we have a strong local presence,” Arsenievich says. “We are closer to the assets; we know and appreciate the context. Considering ESG integration or setting targets for an asset that we are looking to acquire, we are able to take a more detailed approach to due diligence, understand exactly what we are getting into and how we can improve asset credentials.”
By giving the ESG responsibility for a specific property to that property’s asset manager, Barings can ensure that the manager will carry out a granular approach to the ESG strategy, Arsenievich says.
“For us, avoiding the broad brush approach is about giving our people the bandwidth and the trust, but also the ownership of this agenda and making sure it is an explicit part of their day-to-day job rather than something driven by an external consultant,” she says.
3Create an ESG plan for each individual asset, with guidance from a broad framework
“You have to do it asset by asset, but you also have to have a north star and an internal framework for what you want to do broadly,” says Lauren Winkler, senior director of ESG at The Green Cities Company, a private equity real estate manager based in Portland, Oregon.
Green Cities has developed a playbook for its acquisition of existing buildings, considering energy options asset by asset, for example: where it can electrify, bring in onsite renewable energy sources, bring in offsite power purchase agreements, and replace equipment and seek operational efficiencies to drive down energy needs. Beyond energy considerations, the real estate manager also identifies ways in which each building could have a positive impact on the environment, biodiversity and the people inside and around the property, Winkler says.
“When you have the specific goal in mind, and you know exactly what you want to achieve, and you lay out the toolkit of the different ways that you can get there, then you look asset by asset and ask: what is the difference that we can make at this property?” Winkler says.
“It’s not just energy,” she adds. “Everybody is really excited to put solar on the roof, but the ESG opportunity at every asset goes so far beyond just renewable power.”
The options can range from improving tenants’ lives through improved air quality or acoustic comfort or thermal comfort, to adding furniture to accommodate different body types and people with disabilities, to biophilic design – design that connects building occupants to nature. As an example, for a building in Boston, Green Cities installed smart glass so tenants could use their phones to control the tint of their apartment windows for sleeping comfort in daylight, or to reduce energy costs by blocking sunlight or allowing it in, and studies showed that installing the glass improved tenant circadian rhythms and tenant health, Winkler says.
4Do not forget the follow-on impacts
Sometimes the secondary ESG impacts can counteract or significantly outweigh the initial good ESG impact of an asset, says Rob Day, co-founder of Spring Lane Capital, a private equity firm in Boston. For example, someone once pitched him on an investment in energy efficient oil derricks, which was a concept that would produce less carbon emissions during drilling but, obviously, encourage more oil production.
“You as the LP want to make sure that on the most critical issues, your GPs are actually paying attention to the second-order effects,” Day says.
5Ditch the offsets strategy
Finally, like a lot of firms, Green Cities has committed to a 50 percent reduction in greenhouse gas emissions by 2030 and net zero by 2050. But, Winkler says, a lot of real estate investors are leaving themselves wiggle room to reach their goals through carbon offsets.
“There are lots of firms making claims like that, but when you look and you see the asterisk down to the bottom of the page, 90 percent of it is just buying offsets,” she says. “That is not actually decarbonizing.”