Location is key with sustainability

Real estate is the ultimate local business, and that applies to sustainability matters too; investors and managers must grapple with variations in climate, culture, regulations and risks across regions, nations and cities.

While real estate investors might welcome an international set of standards and regulations regarding ESG issues, there is a multiplicity of regulations around the world. The EU makes the regulatory picture somewhat easier in Europe, but elsewhere, regulations may vary widely between jurisdictions.

Richard Hamilton-Grey, head of sustainability, Europe, at manager Nuveen Real Estate, says: “Europe is furthest ahead, with regulations coming into force covering buildings standards or transparency.

“Across the US, building energy and carbon regulation is inconsistent but continues to grow in scope and reach across the nation. Asia-Pacific is a highly bifurcated region, with clear leadership in some locations but others further behind.”

Keeping ahead of regulations by adopting the highest standards with regard to ESG can help managers and investors. Andy Haigh, director, climate positive solutions at sustainable neighborhood specialist Grosvenor Property UK, argues that, while there can be enormous variation between jurisdictions, “this only affects asset owners in the sense that it may impact market expectations.

“Regulation is typically a minimum standard, not an ambition. So, asset owners can set their own investment criteria and parameters. However, many are still working on how to normalize a global portfolio analysis where ESG standards are driven by local approaches that may vary widely.”

“Climate risk is financial risk”

Lindsay Brugger
ULI

Local climate and culture also need to be taken into consideration with regard to ESG issues. For example, US-originated DE&I practices do not always translate to other countries and cultures, while attitudes toward LGBT issues can be very different in conservative and religious cultures.

The challenges of energy and water efficiency depend to a great extent on local climate, says Hamilton-Grey: “From a net-zero carbon perspective, climate differences can significantly impact the relative energy efficiency of an investment.

“Performance benchmarks are increasingly accounting for these climate differences, through the use of ‘climate zones’ and weatherization adjustments.”

Location, location, location

Geographical and climate differences drive a different picture for climate risk, which is increasingly on the minds of investors and managers. A low-­lying coastal city, for example, is at risk of flooding in the longer term, while a city that already experiences hot summers could see assets hit by extreme heat events.

Hamilton-Grey says: “Physical climate risk varies significantly based on geographical location, with exposure to hazards such as wildfire, flooding, high winds, heat stress and drought very much determined by location. These physical climate risks are an important part of investment decision-making and should be screened early in the process using a suitable third-party tool.”

The more immediate risk to real estate assets is not necessarily that they become a victim of extreme weather, but that the risk of them falling victim means they become uninsurable. Grosvenor’s Haigh says: “Investors are still trying to understand how to best understand and integrate climate risk into decisions.

“At present, climate risk is hugely underappreciated, and in the next few years we will start to see big swings as future climate risk begins to be baked into valuations and insurance premiums. We are already seeing these signals in the insurance sector for certain physical risk categories and geographies, and this will only become more significant.”

A report by the Urban Land Institute and investment manager Heitman, published in September, suggests that new rules on climate risk disclosure will help real estate investors to manage those risks. “Governments and investors alike recognize that climate risk is financial risk,” says Lindsay Brugger, head of urban resilience at ULI.

“New regulations are proliferating across the globe and offer new data sets for enhanced investment decision-making. Investment managers will need to stay ahead of these rules for success in a rapidly evolving global market.”

Investment managers are beginning to take note of climate risk. Chicago-­headquartered LaSalle Investment Management’s latest European Cities Growth Index, which ranks the top cities in Europe for projected occupier demand, now includes a metric for extreme weather. The metric for extreme heat is based on data that tracks worsening weather conditions over the next 50 years from Copernicus Climate Change Service. Cities including Florence, Palermo, Bologna, Rome and Marseilles have seen their index score hit by climate risk considerations.

However, market attitudes toward climate risk vary as widely as the risks, says Hamilton-Grey. “Market and sectors have varying levels of exposure and we also see varying levels of tolerances for such climate risk – what is an institutionally acceptable level of climate risk within one market may be very different in another. Being able to understand the extent to which such risk may play out into liquidity and pricing is key.”

Another localized factor attracting increased attention from real estate investors is access to renewable energy. This is especially significant in energy-hungry assets such as data centers, which may consume enough energy to power a town. Data centers with access to renewable energy are particularly attractive to investors, and also to tenants. In some places, renewable energy is simply not available. For example, Singapore’s limited land means it has very little scope for renewables, which means real estate investors there with net-zero carbon ambitions will be forced to rely on offsetting or carbon credits, which brings a new set of risks and potential difficulties.

A final, but more difficult to quantify, variation is the attitudes toward sustainability among investors. Anecdotal evidence suggests a much greater focus on the topic from European pension and insurance funds compared with their peers in the US, where there has been talk of an ‘ESG backlash.’

Nonetheless, there has been a wave of ESG-related regulation in the US in recent years, such as the SEC’s rules on climate-related disclosure, which suggests it is heading in the same direction as the EU.