30 May 2019
The demand for environmental, social and governance (ESG) strategies in real estate continues to grow. Investors are becoming increasingly focused on responsible practices and how these are integrated into funds. Sustainable strategies, in their widest sense, are now a top priority, and with the release of the recent report from the Intergovernmental Panel on Climate Change (IPCC), there is a clear moral imperative to consider ESG practices. But can we conclusively prove any effect on investment performance?
We believe that understanding the inter-relationship between ESG factors and underlying investment performance is pivotal to embedding ESG even further into our investment process. With this aim, we have developed a database containing the scores for multiple ESG metrics for a large number of the buildings we manage, in order to examine the relationship between an asset’s investment performance and its core ESG factors.
Despite the perception of many naysayers that there is an impact on returns when considering ESG, our research shows that the converse is in fact true. Perhaps the most notable and compelling finding of our research to-date is that we could find no detrimental effects from integrating ESG factors into real estate investment management. And, in many instances, a positive contribution can be clearly demonstrated. In our view, good ESG risk and performance management should be viewed as a proxy for good investment management as they are inextricably linked.
We could find no detrimental effects from integrating ESG factors into real estate investment management
When considering this research, we were mindful that both real estate and ESG are heterogeneous by nature. In essence, very few properties can be fairly compared. This means that we are typically missing a clear “control” asset when comparing performance. Measuring real estate investment performance itself is not straightforward, but it is complicated further when trying to unpick the contribution from ESG factors. The perception that ESG is a single factor is misguided. ESG is short hand for a multi-faceted and holistic assessment of material risks and opportunities that affect an asset. This can include issues and opportunities arising from climate and environmental change; urban living and population dynamics; governance and engagement; and the effects of rising technology and connectivity. Trying to distil this into a small number of ESG factors isn’t easy.
Since the clarity of ESG factors and their relationship with investment returns remains complex, we initially sought to investigate the income components to simplify the analysis. In theory, ESG factors should encourage tenants to pay higher rents – either through a simple preference for better buildings or because of a clear economic benefit in terms of lower utility costs – but the link to higher rental growth is not always apparent. We conclude that to measure these relationships fully, we need much more data on very similar assets within the same cities and within similar micro locations; the buildings would ideally be of a similar size and of a similar age and quality. Even as the UK’s largest landlord, we still don't have a large enough sample size to do this factor analysis accurately.
The difficulties associated with measuring how ESG factors affect performance are also exacerbated by the relatively short time frame over which data has been collated. Identifying the positive effects of ESG in isolation from other initiatives or, indeed, from market movements is also problematic. The benefits of ESG integration are only likely to be realised over long periods of time once trends, such as climate change, have started to play out – either through regulation or through physical effects. But these time horizons are much longer than those used to measure investment performance.
Given our findings to-date, we have committed to expanding our database and research to all of our direct real estate assets under management, and we are confident of identifying clearer results in the future. We have already ensured that all prospective acquisitions and all annual strategic planning of assets reflect ESG factors; but on the basis of our findings, we have committed to using this scoring system within our strategic cashflow forecasting too.
Given the volume of work we have undertaken in this regard against one of the largest real estate investment data sets in the UK, we believe that there is a need for industry collaboration to take the work further. Like-minded real estate owners could work together to share data on ESG factors and investment performance, so that we can all reap the benefits.
In the meantime, we remain committed to ESG being embedded within our investment behaviours. We anticipate that this important area of work will ultimately demonstrate that appropriate adoption of best-in-class ESG behaviours will not only enhance investment performance, but that it will also limit longer-term risks. In essence, it is simply a matter of good, modern, investment management practice, which has a benefit to society, tenants and clients.
We urge an open debate in this regard, but perhaps the first question should be: “if you can achieve at least market returns and generate a positive environmental or social benefit, then why wouldn’t you?”