Investors are demanding more ESG reporting on their real estate investments from managers, forcing them to dig deeper to prove their sustainability bona fides. Investors have replaced simple thematic questions with detailed, probing queries, and managers cannot use PR photo opportunities to mask organizational deficiencies.
As investors have ratcheted up their demands, the less-prepared real estate managers and investment firms have had to scramble for help from consultants, says Kristina Arsenievich, head of ESG strategy for European real estate at manager Barings Real Estate.
“Over the last 18 months, driven by stakeholder and regulatory pressure, the scope and depth of LP requirements have significantly increased. They continue to become ever more stringent, hence the increase in sustainability consultants popping up like mushrooms after the rain to help managers figure out how to address this,” she says.
The ESG queries about real asset investments have swiftly shifted from elementary to graduate level.
A year ago, investors were asking simple questions, like “What are you doing about climate risk?” Arsenievich says.
Now, their queries are much more detailed, asking managers about how they differentiate between physical and transitional climate risk, levels of exposure, ESG-related capital expenditures and operating expenses, transitioning assets, mitigation plans and how it all translates into their governance approach.
“There is a degree of variation in investor priorities – some wish to go into more detail on governance and engagement, others are focused on net-zero targets and delivery timeline. But broadly speaking, physical and transitional risk is top of the list,” she says.
Divestment is also now one of the key questions posed by investment. Arsenievich says: “If this asset is drawn to high risk, will you exclude it?
“Naturally LPs want to avoid risk, and we have to make sure that we are on the same page with regards to our commitment to sustainability and ESG more broadly. If it is about generating positive impact alongside returns, then divestment is not always the best approach. Taking responsibility for performance of our assets and delivering tangible improvements is arguably more impactful,” she says.
“Broadly speaking, physical and traditional risk is top of the list”
Kristina Arsenievich
Barings Real Estate
For example, investing in a petrol station would typically be avoided under a fossil-fuel exclusion, but the answer may change if the petrol station is part of a larger retail park and there is an opportunity to encourage the tenant to add EV charging stations and improve ESG stewardship of the property.
“When divestment comes up, we talk about stewardship and see if that strikes a chord,” she says.
The increased investor scrutiny gives the managers more opportunities to explain their ESG approaches. Arsenievich says: “The pressure from the regulators with regards to climate risk is actually helping us to broaden the discussion and demonstrate the value of a more proactive approach.”
A giant seeks data
This year, one of the largest pension funds in the world, California State Teachers’ Retirement System, became a GRESB investor member, requiring the managers of about 75 percent of its real estate assets – the separate account and joint venture investments – to report property-level information to GRESB.
“As a result, we now have a baseline of data to evaluate the effectiveness of future asset-management efforts and improve our operational performance on these criteria,” says Mindy Selby, information officer at CalSTRS. The ESG information is fed into CalSTRS’ management information system to help guide ongoing asset and portfolio decision-making. Along with financial information, the ESG data helps the pension fund in evaluating its assets and further decarbonizing its portfolio, Selby says.
The overall change in reporting requirements is being driven by institutional investors in the US, particularly pension funds, which are feeling pressure from their constituents to tighten up their ESG standards, while peer pressure also has an effect. In Europe, mostly it appears driven by regulatory changes, such as the EU’s SFDR and the UK’s SDR, Arsenievich says.
Smaller investors have developed ESG due diligence questionnaires for their managers based on standards suggested by the Institutional Limited Partners Association. The biggest area where most investors are making more reporting demands is in diversity, equity and inclusion, says Lauren Winkler, senior director of ESG at The Green Cities Company, a real estate private equity manager based in Oregon.
Many investors have adopted diversity standards suggested by ILPA and are requiring managers to report gender, race, ethnicity and diversity, not just companywide but at different levels including senior leadership and management. Investors are asking specific questions on DE&I issues, such as whether managers have implemented gender pay equity or held unconscious bias training sessions and whether specific policies are in place to support the recruiting and retention of diverse team members. “The questions being asked are more extensive,” Winkler says. “They are really holding GPs accountable for not just saying that they have a focus on DE&I and then just showing a picture of their team doing a Habitat for Humanity volunteer day.”
Winkler suspects many managers “may be scrambling to really understand how to promote diversity, equity and inclusion at the corporate level as well as at their properties.” More ESG reporting pressure on managers should ultimately help them extract the data from other parties and to better manage their real estate.
The real estate industry as a whole had already been focused on collecting environmental data, such as data on energy, water, waste and emissions, says Helen Gurfel, head of sustainability and innovation for CBRE Investment Management. But the recent investor push for more transparency, aided by the regulatory requirements for more, will help the industry’s ability to extract that information.
Gurfel says: “It is easier to obtain data in certain geographies where it is law. We are able to then utilize that data to understand how the asset is performing and then propose interventions” such as energy efficiency, resource efficiency, decarbonization or resiliency changes.
Even as European regulators and the US SEC propose ESG reporting standards, managers will face many different reporting requirements from a range of investor types, probably for years, says Chintan Panchal, founder of RPCK, an ESG and impact law firm in New York. He points to GAAP standards for accounting – which are continually updated and have been developed over nearly 100 years – as a comparison to the ESG space.
“Critics of the space say, ‘Oh, there are no uniform standards.’ Well, of course there are no uniform standards. Uniform standards just don’t come out of nowhere; they develop over time,” Panchal says.
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