This article is sponsored by Savills Investment Management
ESG has been a hot topic in real estate circles recently. But while PERE’s Investor Perspectives 2021 Study reveals more investors than last year are reporting that evidence of ESG and of diversity and inclusion formed part of their due diligence process when selecting managers, only 38 percent say ESG comprised a major part of the process, with the corresponding figure for diversity and inclusion just 14 percent.
Emily Hamilton, head of ESG at Savills Investment Management, evaluates private real estate’s performance in this area, and sets out the steps that will be necessary to ensure further progress on the ESG journey.
Do investors and managers need to do more to drive the ESG agenda?
Real estate is waking up to its moral responsibilities. There’s been a massive shift in the past two years in areas like tackling climate change, but we still have further to go on the social elements of ESG. It will be interesting to see how the pandemic prompts real estate businesses to work actively with their teams to understand their needs. Many organizations are coming out with big statements about how diversity and inclusion (D&I), work-life balance and resilience are absolutely fundamental to their business. However, there’s frequently no plan behind those words. If we’re going to get our post-coronavirus working practices right in real estate, then we must give a higher priority to the human element.
What factors are propelling efforts toward better ESG performance?
ESG is becoming more front of mind for investors for two key reasons: the EU Sustainable Finance Disclosure Regulation (SFDR), which comes into effect in March, and an increased focus on climate change disclosure and resilience, promoted by the Taskforce on Climate-related Financial Disclosures (TCFD). SFDR requires managers to categorize their vehicles as Article 9, impact funds with sustainable investment as their objective, Article 8, funds with sustainable characteristics, or Article 6, products without ESG objectives. Managers then must report back to investors, and the disclosure has to go into fund documentation, marketing brochures and quarterly reporting. What makes this different from other regulations covering the built environment is that it’s not just about real estate; it’s about equities and securities, as well.
We’re already starting to see investors prioritizing Article 8 funds, and they want to invest in Article 9 products where they can because improved ESG is linked to higher investment returns. Although it’s a European regulation, overseas investors owning assets in the EU will also have to comply.
Meanwhile, there’s also more pressure to assess climate change risk in line with TCFD, which aims to get the financial sector to properly assess climate change in reporting. It’s set to become mandatory for many UK asset managers from 2022. It requires disclosure of climate-related risks like flooding and hurricanes, and also the business risks posed by legislation and new technology.
Only 4 percent of Perspectives 2021 respondents strongly agreed that managers are taking the risks of climate change seriously enough. Is that an accurate representation of the sector?
I’d argue that managers are further ahead than that. Savills IM recently joined the Better Building Partnership, a collaboration of leading UK commercial property owners, collectively with £249 billion AUM, working together to improve the sustainability of existing commercial building stock. BBP has published a framework to support the sector map a credible path to net zero carbon emissions to meet the Paris Agreement’s objectives. It’s possible managers in Asia and the US are not yet as fully on board with this as those in the UK and Europe, although while they may not have the same policy or legislative drivers, there are lots of companies in the US that see sustainability as good business.
However, I don’t think we are good enough yet at evaluating climate change impacts in asset-level due diligence. Some of the data is very complicated, and it’s challenging to distil it down so that managers can apply it to the investment process. If it’s not to be tokenistic, more training is needed for non-sustainability professionals working in real estate investment to be able to interpret the results in areas like whole life costs, physical risk and transition risk associated with legal and policy changes.
Are social considerations becoming a serious factor in value creation?
There’s a lot of focus on having great organization-level policies. But the real estate sector is about buildings, so we need to be much better at understanding the social side of risk at the asset level. For equities and securities, you can type a company name into Sustainanalytics software and it tells you what they’re doing on ESG. It’s harder to do that at an asset level because you do not always know whether policies have been put into practice unless you’re there to observe it. We need more data and we need to analyze it better.
Assessing other areas of performance can help, for example management of money laundering and financial crime, because companies that have good governance in place tend to follow through in their practical application of policies in areas like modern slavery. Asset managers also need to form closer collaborative partnerships with tenants, so that they can have adult conversations around social issues.
Is real estate making swift enough progress on diversity and inclusion?
The PERE Perspectives 2021 Study results reflect where the sector is at the moment. Real estate is giving much more airtime to D&I. The challenge is how to integrate it into business strategies, and at an organizational level.
To date, the focus has largely been on gender and ethnicity. But it’s only when organizations start to embrace thought diversity that you get more inclusive behaviors because people challenge each other more. Thought diversity is about different skill sets, and that is something real estate has lacked. Not many companies in the industry have ESG expertise, or an individual from an inclusion background on their board.
It’s also about recruitment. If a property company is recruiting mainly RICS-qualified professionals, educated in a similar way through the usual real estate pathways, then there’s a danger of creating an echo chamber. Whereas if you’re offering more apprenticeships and bringing in people who would never have thought of real estate as a career, that diversity of viewpoints and opinions encourages innovation.
It’s impressive that 13 percent of respondents have refused an opportunity based on a lack of diversity and inclusion at the manager level, particularly because it’s hard to measure and get accurate data. I would like to see a higher percentage. But it’s good that the question is even being asked. If you’d asked that question a year ago, I doubt it would have been so high.
Diversity has a much higher profile than in previous years. Part of that is because of movements like Black Lives Matter, and part is because with covid a lot of childcare responsibilities have been falling to women, so there’s more discussion around supporting them. There’s also more evidence now that funds led by women, or with women as part of a mixed management team, have outperformed.
What ESG considerations will soon become more pressing for investors?
As more companies analyze the future effects of climate change, they are realizing what a massive financial impact it will have, particularly after 2030. Climate risk will become much more important in fund strategy and asset selection. It may be that some locations are favored over others because they seem to be more resilient. Biodiversity will also become a bigger factor in decision-making.
For standing assets, that will be about facilitating better access to nature, managing water use and ensuring building operations do not disrupt habitats. For new developments, investors will need to be conscious about their supply chain impacts, and whether they’re sourcing materials from environmentally sensitive locations.
Covid not unhealthy for ESG
The pandemic has seen sustainable buildings outperform, and sharpened real estate’s focus on the social agenda, argues Hamilton
During the pandemic we’re observing that ESG-focused investments are performing better, and that’s helping the argument for ESG investing in real estate. A covid-secure building is one that is good for health and wellbeing. Occupiers are putting a higher priority on the wellbeing of their employees, which is driving managers like us to offer better space with sustainability incorporated into its design and operation. The buildings that attract the most demand and transact quickest are often those that are most sustainable. In the office market, we’ve also seen them attract premium rents in Europe and in Australia. There’s some nervousness around UK office markets. But where investors are making acquisitions, they are prioritizing sustainable buildings because they believe they will be re-occupied more quickly when the pandemic is under control.
It’s also about the human factor. When you see people in their homes on videoconference platforms, with kids running around and their other struggles outside of work, it makes the whole social agenda much more real, so we start to have more productive discussions about whether we’re doing enough in the social space. Could we be doing more volunteering, for example? There’s also a need for employers to demonstrate what they’re doing to support people in the pandemic. Real estate has really stepped up in repurposing buildings for vaccinations; we saw the ExCel London conference venue become a temporary hospital, and hotels have become accommodation for the homeless, so it shows real estate can have a big impact. That encourages managers to make positive social action more central to their agenda because investors favor it – it improves their reputation, and playing their part in society helps them to recruit and to increase employee engagement.