This article was sponsored by Nuveen Real Estate, and appeared in the A-Z of Responsible Investing special section in the November 2019 edition of PERE magazine.
Q Responsible investment has become a critical part of real estate today. What is driving the industry’s adoption of these practices?
One of the biggest changes we have seen over the past few years has been a heightened public awareness of the realities of climate change and the role that the real estate industry has to play in terms of the carbon emissions it is producing. That has made the industry think more carefully about these issues and the implications they may have for the future value of real estate.
There has also been a more general move toward responsible investment from the institutional investor community in recognition that their end customers want them to be thinking about considerations beyond financial performance. Aligned with that, there is an understanding that responsible investment can protect them from risk and, in fact, drive positive returns as well.
Q How are these changing attitudes manifesting themselves in terms of investors’ approach to due diligence and manager selection?
Responsible investment has been included as a question on RFPs for a long time now. But over the past three to five years, there has been a real change in the level of engagement and understanding among the investor community, particularly around environmental issues.
Investors have notably upskilled, hiring specialists within their own organizations to focus on these areas, and we now get some very detailed questions around how we manage climate change risk and the transition to a low-carbon economy.
European, Australian and Canadian investors, in particular, are very diligent at the point of investment and then monitor our performance closely on an ongoing basis. Responsible investment is something, as a manager, we have to take extremely seriously or we just would not be able to compete for capital.
Q How easy is it for investors to measure and benchmark responsible investment practices?
GRESB has done a great job in assisting the measurement and benchmarking of responsible investment, and is now so widely used that it has become the de facto standard. It is really helpful to have that objective, third-party assessment of the sustainability performance of funds. Transparency and comparability have been greatly improved.
That said, there will always be challenges around comparing the different sub segments that exist within real estate, as well as the different locations. The relative illiquidity of the asset class also means that changes to the composition of portfolios will happen quickly, which can hinder the performance of some funds.
GRESB has done the best job it can in creating peer groups for like-for-like analysis and in continually evolving its question set to ensure it stays relevant. But, ultimately, benchmarking will always be challenging and GRESB can only ever be a starting point. Investors then need to delve into the sustainability strategies of individual funds.
Q Looking at responsible investment decision-making, what do you consider to be best practice, and what processes and structures do you have in place to achieve that?
The Task Force on Climate-related Financial Disclosures (TFCFD) has set out a framework which we consider to be best practice. What that means is that when we are making a new investment, we consider the climate vulnerability of locations, how energy-efficient buildings are and how much money we might need to invest if they are not energy efficient enough.
We also look at whether or not the buildings have sustainability certification, and if they don’t, how challenging it will be to get that if we feel that is the market expectation.
What we are trying to develop is a clearer understanding of the financial implications of climate change risk and transition risk at the point of making any investment decision, whether that is buying a new building, investing capex into a building or at the point of disposition as well.
Q Net-zero carbon is the big real estate goal. What are the challenges and how do we get there?
The World Green Building Council has said that all buildings must be net-zero carbon by 2050 if we are to meet the requirements of the Paris Agreement, and that is a position that we, as an organization, very much subscribe to. In fact, we are in the midst of developing our net-zero carbon pathway, which entails developing an understanding of what net-zero carbon means for different building types, in different locations. We are addressing numerous questions: what is the definition of net-zero carbon? What will we have to do to our buildings to get there? How much money will we have to spend on them and how are we going to do that in a realistic timeframe?
Q The world is undergoing a period of rapid urbanization. What does this mean for responsible real estate investment?
Rapid urbanization has placed cities at the heart of real estate. For us, that means focusing on understanding the sustainability credentials of those urban areas. We have developed a process to identify which cities are investable. Alongside a range of other factors, we look at their vulnerability to climate change in terms not only of how geographically exposed they are, but also the extent to which they are able to protect themselves from the impacts of climate change and how readily they are able to bounce back from climate change incidents. We also look at air quality and how carbon-intensive the grid electricity is.
Those factors give us a high-level overview of the sustainability of a city. We then look in more detail at things like transport strategies, sustainability targets and how well a city is going to be able to cope with an influx of people.
Q What do you consider to be the correlation between responsible investment and returns?
The reason that responsible investment is so core to our approach is that we believe there is a positive correlation between responsible investment practices and returns. I think that is particularly the case with environmental concerns, where it is very clear that buildings that do not have the ability to become net-zero carbon are in danger of obsolescence. Equally, by understanding what the potential risk to value there is from climate change, we are protecting our clients’ investments.
The vast majority of investors are fully on board with this hypothesis and are pushing us in this direction as well. We do not believe that responsible investment involves sacrificing financial performance, we believe it mitigates risk and improves potential returns.
Q How successful has the real estate industry been, overall, in terms of responsible investment and how much variability still exists between managers?
There have been huge leaps forward over the past few years and there are some clear leaders in the industry.
The recent commitment from organizations that are part of the Better Buildings Partnership, of which we are one, to net-zero carbon buildings is a good example of real estate organizations working together to take a collective position. But I do think the reality is that there is still a lot of variation within the industry, and outside of this group of leaders, there is still progress to be made.
What needs to happen is for sustainability to become a more mainstream topic. At the moment, the majority of firms have a sustainability team, but it is those that have integrated an understanding of sustainability throughout the whole organization that are really succeeding. Everyone needs to understand what a net-zero carbon building is and how we achieve that. Everyone needs to understand what the implications of climate change will be for real estate value. That broader understanding is what we need to see develop in the years to come.
Q What do you think can and will realistically be achieved when it comes to responsible real estate investment?
There is starting to be a very positive approach among the leaders in real estate, particularly in Europe, around achieving net-zero carbon buildings. So I hope this is something that is going to take root within the industry.
We have the technical capability to make good progress, and the reality is that these buildings will not only be better for the environment, but also more affordable to run, and that they will provide better health and well-being outcomes for the people who live and work in them.
It is a big challenge and we should not underestimate the scale of change required, but I think there is a clear pathway ahead of us and I have a lot of faith that, as an industry, we will get there.
Beyond the environmental
Responsible investing encompasses more than energy efficiency and meeting net-zero carbon targets. The social is critical too.
Affordable housing is one of the most significant areas of responsible investment, outside of purely environmental concerns. Nuveen is a significant investor in residential property in the US, and affordable housing is a key part of its strategy. As the firm expands its residential investment across Europe and Asia-Pacific, affordable housing will also be a key part of its strategy. This is an important way in which the real estate sector can be a force for good, helping solve what is a global problem.
Nuveen is also very focused on health and well-being. Over the past few years, knowledge has emerged about the extent to which buildings can have an impact on the health, well-being and productivity of the people who live and work in them. Nuveen has started trialing various air quality sensors in its buildings, for example, as well as rolling out well-being certifications and developing an understanding of the benefits of natural light and plants within building design.
Finally, the socioeconomic impact that buildings can have is critical. Nuveen is just coming toward the end of developing a large, mixed-use retail-led scheme in Edinburgh St James. Socioeconomic considerations have been central to that development by prioritizing local employment within the construction phase, creating a skills academy and going to great lengths to source local goods. Once up and running, that scheme will provide an additional 3,000 jobs. It is a great example of a development that has had a positive socioeconomic impact.