This article was sponsored by M&G. It appeared in the Sustainable Investing supplement alongside the October 2019 issue of PERE magazine.
The rapidity with which demographics and technology are reshaping the world in increasingly visible ways while throwing up a series of pressing social and environmental challenges has begun to focus the minds of an increasing cohort of investors on how their activities impact on the wider world. Nina Reid, director of responsible property investment (RPI) at London-headquartered fund manager M&G Real Estate, tells PERE’s Stuart Watson how managers are developing investment strategies that aim to be kinder to the planet and its people while maintaining the bottom line.
How have investor attitudes to responsible property investment evolved?
There has been a noticeable increase in both the extent to which investors are considering sustainability and the extent to which it is becoming embedded within investment decision-making. Eight years ago, we might have been asked whether we were signed up to the principles of responsible investment (PRI), so it was a bit of a tick-box exercise.
Three years ago, the question might have been about whether we participate in GRESB. Now, many leading investors are asking more detailed questions around risk, like the extent to which our portfolios are exposed to climate risk. Most of those questions are still environment-focused, but there is also rising interest in impact investing and how real estate affects the societies and communities in which investors operate. Meanwhile, we have seen the topic of wellness come to the fore among investors in offices as it rises up the agendas of corporate occupiers.
There is a growing movement that is saying we cannot wait long to act if we are to have an impact on environmental issues. If we are to hit carbon reduction targets then real estate will have a major role to play because the built environment is responsible for 40 percent of carbon emissions. Real estate is a low-hanging fruit for government action on climate change, so we can expect the industry to be heavily regulated because they will need to really drive down buildings’ energy consumption if they are to limit global warming to a target of 1.5 or two degrees centigrade. If those targets are missed, and we are looking at an increase of four or five degrees, real estate will be heavily impacted from a physical risk perspective. Rising sea levels would make a significant number of cities uninvestable. Meanwhile, financial regulators are pressing insurance companies and other institutions to stress-test their exposure to climate risk.
How are investment managers like M&G responding?
We are trying to stay ahead of the curve by anticipating what investors might ask for. That can be challenging because RPI encompasses a wide spectrum of issues, some of which are changing rapidly. For example, wellness was a very niche subject five years ago and now has considerable significance. In this area, the range of issues is very broad and prioritizing which aspects to focus on is key. We have the challenge of working across practically every real estate asset class, and we are also global, so we try to have some degree of consistency around the world while also being able to tailor solutions to the individual markets in which we operate.
All our funds under management have the same over-arching strategy, which aspires us to manage world-class places to benefit the societies and communities in which we operate, our investors and also the environment. Within that, there are four key impact areas: environmental excellence; health, wellbeing and occupier experience; socio-economic benefit; and smart, secure and connected places. We have a series of global targets to drive progress in that by 2025. We want to achieve a 25 percent improvement in energy efficiency and we are currently running at 23 percent. We are also aiming to achieve green building certification for 50 percent of our assets under management by 2025, and we want to reach 10 million people with our health, wellbeing and inclusivity programs.
Then each of our funds has its own set of targets to achieve by 2020. A lot of our funds are growing quite quickly, and we do not know what type of assets they may hold in 2025, so we set a shorter program of work tailored to the markets in which they are operating.
How is RPI shaping your approach to acquisitions and asset management?
We have integrated material sustainability considerations such as flood risk into our investment process. We also look at known legislative risks. For instance, in the UK there are regulations that prohibit landlords from letting buildings with low energy performance certificate ratings, and there is similar legislation mooted in the Netherlands. That risk is taken into account when considering acquisitions, so if we buy assets that will require improvement the cost is fully reflected in our underwriting.
On the asset management side, we have tiered all our assets in terms of their significance for the RPI performance of the fund. Significant assets tend to be multi-let offices or large shopping centers where we have a high ability to influence performance and work with property managers to implement improvement programs. Tier one assets have a series of annual energy, water and waste targets, they will often require a green building certificate, and will have a program of community and occupier engagement activities. There are slightly lower requirements for tier two assets which cannot be managed quite so closely, and then all remaining assets will have sustainability embedded in their asset-planning process.
Does RPI enhance investment returns?
Recent academic research in the US tested the premise that sustainable properties offer financial benefits to investors by comparing the cashflow REITs generated from certified and non-certified buildings. We sought to replicate that study using data drawn from our European property portfolio, which demonstrated that while the operational costs of green buildings within the portfolio were higher – possibly because they tended to be bigger and have a larger onsite team – there was a net benefit, with a higher distributable income to the investors, although with the slight caveat that the sample was not huge. For individual projects, the business case for sustainability stacks up. Installing LED lighting and other energy reduction projects tend to have the benefit of either lowering service charge costs for occupiers, or reducing non-recoverable costs for funds, or both, while making the assets more attractive to future occupiers.
As more studies come out about how wellness affects the productivity of staff, it may be possible to tie the wellbeing agenda to an economic gain, but in cases where the benefits are currently unquantifiable, businesses often make the investment nevertheless because it comes back to the view they take of the risk and the opportunity, and they have a gut feeling about it.
How can RPI achievements be measured?
GRESB remains the only measure to compare performance of non-listed funds so it is a hugely important benchmark for our investors. It has also started to include wellness, which is a bit of a driver for investors in that area. However, GRESB is still focused on processes, policies and data rather than the actual perfomance of the underlying assets, and it will come under greater pressure to measure how the assets compare in terms of climate change risk and well-being performance.
Wide use of green building certification provides more visibility to owners and occupiers about asset performance, but at the moment the proportion of certified buildings varies widely from market to market. In the UK, most new buildings are certified, but there is a low take up of operational certification, while in continental Europe there has been a significant uptake of the BREEAM ‘in-use’ designation. We are seeing REITs and fund managers there getting nearly 100 percent certification for their portfolios, or starting to commit to that. In Australia, NABERS in-use building performance ratings are mandatory and you can see the impact the ratings have had on investment performance. Assets with higher NABERS ratings show lower void rates and achieve higher values and rents.
What will be the most influential future trends in responsible investing?
Leading fund managers will do a lot more thinking around net-zero carbon targets – how resilient buildings are to that standard, and strategies for getting buildings to achieve it. I suspect there will be some price chipping for buildings that cannot easily be future-proofed. Within five years we may well see some investors uncomfortable about investing in some markets without a very clear understanding about the management of the physical risks posed by climate change.
Data is a bit of a game changer as well. Investors will demand to see the underlying sustainability performance of the assets they invest in, and the greater availability of data will allow them to do their own modelling, which may change the dynamic in discussions with managers. There will be a big growth in the number of investors with an impact mandate. Smart building technology and the ability of people to access information on their phones about air quality and temperature in their workplace will mean there is much more scrutiny of, and real time feedback about, the performance of buildings. That will change what we provide in buildings and how we provide it.
Good for the Seoul
Centropolis Towers, South Korea
Completed in 2018, M&G’s Centropolis Towers mixed-use development in Seoul’s central business district of Jongno achieved Leadership in Energy and Environmental Design (LEED) Gold certification, the second highest rating, thanks to a range of environmental features. The 26-story twin-tower complex offers 132,440 square feet of offices built on top of a shopping mall as well as an underground museum that preserves the remains of 16th- and 17th-century houses discovered during its construction.
The project’s green features prioritize renewable energy and include photovoltaic panels on the rooftops and exterior, which power the building by converting sunlight into electricity. Meanwhile, seven fuel cells substitute for a higher carbon-emitting boiler system and feed the building’s remaining electricity requirements using water and natural gas. Geothermal heat pumps, an uncommon feature in offices, channel heat from the ground to supply hot and cold water, while air conditioning is controlled by a thermal ice storage system.