The concept of environmental, social and governance considerations are generally considered a positive for institutional investors. So why is it not being more widely implemented?
ESG investment is far from a new concept, and yet global investors that deem it to be important are still in the minority, according to a report released last week from London-based consulting firm bfinance. In a survey of 485 investors – including pension funds, endowments and foundations, sovereign wealth funds, insurers, family offices and others – worldwide, only 39 percent consider ESG to be a high priority for their institution, while 40 percent are neutral and 21 percent do not consider it to be important. Moreover, while 41 percent of respondents have either adopted a new or different ESG policy in the past three years or plan to do so in the next 12 months, 59 percent do not.
One reason some investors have not adopted sustainability measures is because of the belief they can have a potentially negative impact on returns. In a report released this week, the Institute for Pension Fund Integrity said when it comes to public pension plans, ESG investments may hurt rather than enhance overall performance, especially if the investments are being made for political, not financial, reasons. The report went on to cite a 2016 study from the Center for Retirement Research at Boston College, which found that public pensions engaged in ESG investing tended to have rates of return that were almost 40 basis points lower than those of organizations that did not.
Meanwhile, some skeptics believe that the financial benefits of sustainability measures – even when they are not politically motivated – either are insufficient to justify the costs or require a long payback period. But as PERE reports in its Sustainable Investing supplement this week, not all sustainability measures are costly or involve delayed benefits. In one of the stories in the publication, Dan Winters, GRESB head of America, says that marginal investments to lower operating expenses have an immediate impact on net operating income. For example, at a 6 percent cap rate, a property acquired for a value-add fund can gain nearly $17 per square foot in value for every $1 per square foot in operating expense savings, he says.
But sustainability adoption in private real estate has been steadily catching on, thanks in part to the clout of institutional investors. Indeed, 41 percent of investors in the bfinance survey said ESG will play a major role in future manager selection, while 10 percent even said they had terminated or changed asset managers because of ESG issues.
For example, California Public Employees’ Retirement System, the largest US public pension plan, has continued to see increased participation from its managers in the Global Real Estate Sustainability Benchmark Reporting. In 2018, 11 CalPERS real estate managers representing 82 percent of the pension plan’s real estate net asset value reported to GRESB, up from 9 managers representing 77.6 percent of real estate NAV in 2017, according to a real estate program review by Pension Consulting Alliance, CalPERS’ real estate consultant.
And overall GRESB participation has increased dramatically in the past eight years – from 198 in 2010 to 903 in 2018, as our sustainability coverage this week will show.
With time, it will become less of a challenge for managers to generate strong performance with sustainability measures. New York-based private equity real estate firm GTIS Partners, for example, had considered installing solar panels on its industrial properties in Brazil five years ago, but such an investment did not pencil out then, because of both the cost and weight of solar panels at the time. Fast forward to today, and solar energy is an increasingly viable part of GTIS’s sustainability strategy, facilitated partly by the significant reduction in the cost – which has come down by 90 percent – and weight of solar installations over the past several years.
As such innovations continue to evolve and improve, sustainability adoption is likely to continue to gain traction among global investors in the years to come.
To read more on how sustainability is affecting private real estate today, click here.
To view our downloadable presentation on sustainable investing strategies, click here.