The COP27 summit has once again pushed ESG issues to the top of the agenda. Gone are the days when real estate investors and lenders sought and appraised property assets while considering their ESG credentials as a ‘nice to have’ at the end of the process.

Now, environmental concerns are a top priority, and social and governance factors have also been pushed to the fore. Assets are now expected to perform equally well across all three metrics. But is it worth it? As much as ESG credentials are ethically a good thing for companies to be pursuing, is there true value beyond the approval of their investors or shareholders? Can prioritizing ESG values really give companies a financial advantage?

A report from JLL published in January 2022 suggested that new dimensions are quickly emerging to influence what really drives value. These include climate risk and resilience; carbon emissions; and occupier health, which will all trickle down to impact due diligence, buyer pool, liquidity, ability to insure and overall access to capital, it suggested.

“There is no time to waste,” the report said. “Disruptive technology solutions are cost-effective and becoming normalized, renewable energy prices are competitive, governments are mobilized and generations are galvanized. And the momentum with which these value determinants are entering the mainstream will likely catch some flatfooted. This structural change will bring about value premium opportunities for first movers.”

New perspectives

Real estate investors tend to attribute ESG-linked values in two ways: firstly, in the long-term performance of a building against sustainability metrics; and secondly, in its appeal to an increasingly selective tenant base.

Abigail Dean, head of strategic insights at Nuveen Real Estate, says new ways of measuring ESG performance have allowed the company to draw much tighter links with value factors.

“Over the last 18 months, how we look at the role of sustainability and net-zero carbon, particularly in relation to value, has transformed quite significantly,” Dean explains. “The reason is that for the first time we have had access to some tools that we can do some proper analysis with, including the CRREM pathways.”

This tool is essentially a carbon risk assessment for the real estate sector, allowing users to empirically quantify different scenarios and their impact on portfolios. Nuveen uses it to compare buildings it is keen to invest in against the CRREM statistics for carbon emissions for average UK buildings.

“What it means is that we have something to assess building performance against and [ask], quite categorically, ‘Is this in line with where it needs to be?’” Dean explains. This avoids so-called early ‘stranding,’ where a building fails to continue to gain value or improve because of building codes, regulation or carbon prices, for example.

“Good practice now is that it would be very unusual to have a building that has a stranding year before 2050,” Dean says. “However, if you were buying a building for a value-add strategy where the intention was to convert it and make it greener, then you probably would want it to have quite a near stranding year because then you can make quite a significant transformation of it.

“For a core portfolio, you want to make sure the building has a good time period on it.”

Nuveen, along with some of its partners, also recently invested in a desktop tool that allows it to model the cost of bringing a building up to different standards along CRREM’s risk curve. Dean says: “What that means is that we can get a better sense of how far buildings within our portfolio, and those that we are looking to acquire, are adrift of those pathways and what the potential cost is going to be to get them to get that stranding year pushed to an acceptable point in the future.”

Coupled with on-site net-zero carbon assessments, this helps the team to work out how rentable a building will be and understand its long-term value.

Building value

Tenant experience has become a key driver in ESG activity. For Bain Capital, producing workplaces that actively look after occupiers means their investments become more valuable compared to potential competitors.

The company says it “integrates ESG in [its] investment approach, anchoring [its] investment decision-making in strategic, fact-based due diligence that considers a broad range of risks and value levers, including those related to ESG factors.”

Bain invests across different asset classes and industries, which it says increasingly require attention on ESG-related issues, including tackling the known impacts of climate change and making advancements on diversity, equity and inclusion, as well as creating workplaces that support people’s wellbeing.

The firm points to Genesis Marina, its life sciences campus in Sierra Point, northern California, as an example of how improving tenant experience has added value. Acquired in January 2019, the 561,000 square foot project will feature three purpose-built life science campus buildings, with health and wellbeing amenities built in.

“Prior to acquiring Genesis Marina, Bain Capital Real Estate engaged a biologist to ensure the protection of the clapper rail habitat, commissioned a survey to ensure the burrowing owl habitat was not disturbed by the site development and conducted a survey of tree removal to identify native bird nesting,” a spokesperson explains. “The project’s footprint was also redesigned in consideration of new sea level conditions.”

The campus also has innovative waste solutions and low water usage. All this means the building is future proofed, climate resilient and will maintain its value within the company’s portfolio for years to come. It is also very rentable to an increasingly demanding tenant base.

“With the environment becoming a priority for those who construct, manage, live and work in buildings, the performance gap between green buildings and their less efficient peers should widen further over the coming years,” says Zsolt Kohalmi, deputy CEO and global head of real estate at Pictet Asset Management.

Kohalmi says Pictet thinks all types of properties can be made more sustainable, making it a key part of its value-add proposition. “Such initiatives can add substantial value to the assets’ bottom line, and thus are an integral component of our active asset management strategy,” he adds.

ESG credentials have moved from an opportunistic way of tagging on environmental or social credentials to a building, to being an active part of most investors’ decision-making. And that only looks set to continue.