Navigating the ESG maze in developing markets

Sustainability is as much a part of the investment mandate for developing markets as it is for the more mature economies, but the type and extent of ESG policies may differ. By Arshiya Khullar

Since completion last summer, Palácio Tangará has become one of Sao Paolo’s most luxurious hotels; a sprawling urban retreat located at the center of Burle Marx Park, a vast expanse of dense Atlantic rainforest.

The story behind what it took to complete this redevelopment project, undertaken by the New York-based private equity real estate firm GTIS Partners in 2013, is also a case study in sustainability. The land was previously being built for residential use, but construction work was eventually abandoned. That, combined with the surrounding native tropical forest, meant GTIS had to deal with how to get rid of the wildlife invading the property. The firm engaged the park’s operator and the neighboring community to develop what its executives call an organized approach to safely capture the animals and move them out.

Sustainability is integral

Environmental, social and governance policies form an integral part of GTIS Partners’ investment strategy in Brazil, Josh Pristaw, the firm’s co-founder and senior manager director, tells PERE.

“We did not just do it because we were looking for points in a survey. We did not want to run the risk of [getting] an injunction to stop construction,” he says, explaining the sustainability efforts taken with the hotel.

“People often underestimate this issue in emerging markets, but it is true that a lot of people get into trouble with projects with things they don’t control or understand. Brazil has sophisticated laws about the environment and labor. I can give you examples of companies that have had issues with labor authorities or received fines because the wood installed was illegally harvested in the Amazon rainforest.

“Our [ESG] effort is to our benefit because it helps us save costs, attract great tenants and comply with rigid guidelines and regulations.”

Investment managers globally are embracing ESG-compliant investment strategies and the developing markets-focused firms are no exception to the trend. There is increasing demand from investors and corporate tenants for sustainable buildings in places like Brazil, China and India, but the scope and nature of how ESG policies are implemented may vary in each market.

GTIS, for instance, has developed six LEED certified office towers in Brazil in the past 10 years. Pristaw says having an ESG focus has helped in leasing commercial space to global multinational companies with a sustainability policy. The firm is now going a step ahead and exploring the possibility of developing rooftop solar systems at its industrial distribution centers in a bid to reduce the cost of power.

“If we can reduce their [tenants] operating costs, we can potentially charge more rent. We make more money and they save money. It is good for everyone,” Pristaw says.

Changing mindsets

For any new investments made globally by Allianz Real Estate, a green building certificate is a minimum prerequisite. In Asia, however, especially in China and India where Allianz is an active investor, every asset may not come with such certification, and so the investor factors in the cost of getting one in their deal underwriting, explains Rushabh Desai, the firm’s Asia-Pacific chief executive. The office asset in Beijing acquired by Allianz in July for around $185 million at a core-plus yield, for example, did not come with a green label, but the firm has plans to undertake the relevant asset management work to get the certification.

In Desai’s view, there is a gradual change in the mindset towards adopting sustainable investing practices in these growth markets.

“The main reason why companies moved to China and India was because they found it cheaper than having an office in Hong Kong or Singapore for instance. There was a cost arbitrage, and so the owner or developer of buildings did not feel the necessity of putting in more money to get a certificate. But these markets have developed to a level that cost arbitrage is not the only reason; there is a consumption, growth and talent pool story. We expect more developers will be able to spend money to make their buildings green and still offer attractive rents.”

Watch out for a standards gap

Even then, international firms need to be alive to the gap between the local green certificates in some markets and the global standards for sustainability.

“Some of these local level certifications are not too detailed. So, as a long-term investor we factor in the cost of getting a global certification. In the years to come, national and local standards would hopefully match global standards and we won’t need two certificates for the same building, but that is a process of evolution,” Desai agrees.

Indeed, embracing ESG also works as a defensive strategy in markets like China. An office building’s favorable sustainability rating can help managers command a premium price, once it is put on the market.

“It may not make sense to make a building LEED platinum, but building an asset that has all the characteristics of a LEED silver, gold or even certified, makes good sense,” says Tom Miller, head of development and regional sustainability officer for Asia, at the Chicago-based investment manager LaSalle Investment Management, explaining the firm’s ESG policy in China. “It is a downside protection against the asset turning into a Grade B product if suddenly potential purchasers enhance their ESG requirements.”

LaSalle has made several logistics investments in China in the past few years and these too have a sustainability play.

“Whether or not a certification helps or hurts [in logistics], we don’t know yet. But given the competitive environment, new modern warehouses being developed are incorporating more sustainable features, including energy-efficient fixtures and fittings,” he says.

Realistic goal

Efforts being made by these firms and their peers is proof that sustainable investing is an achievable goal in developing countries. In the 2018 Global Real Estate Transparency Report published by property services firm JLL in June, countries like Vietnam and South Korea stand out for the progress made in sustainability transparency. With implementation of mandatory minimum energy efficiency standards for all new buildings and major retrofits, Vietnam has now entered the low transparency tier in JLL’s sustainability sub-index.

At the same time, industry observers also admit the nascent stage some of these markets are in, from a sustainability point of view, makes the formulation of appropriate investment strategies more complex. As one manager explains, the trick is to go a little ahead of the market, but not too much, with ESG implementation and the resulting increase in rents, in the hope that the strategy proves to be a return enhancer when the asset is ready to be sold in a few years.

Tracking sustainability

South Korea and Vietnam stand out for their progress in sustainability transparency, but other emerging and developing markets score unfavorably


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Source: JLL Global Real Estate Transparency Index 2018