Private real estate managers with an ESG policy may be starting to see improved returns
Private real estate managers with an ESG policy may be starting to see improved returns
Private real estate managers with an ESG policy may be seeing the initial sparks of success, as the median net internal rate of return (IRR) for recent vintages of these funds is rising (Fig. 1).
For the first time in nine years, real estate funds with ESG issues in their investment policy outperformed those without, albeit marginally. This is preliminary evidence of a narrowing gap in performance between funds taking ESG into consideration and those not. The tide may be starting to turn on sentiment regarding whether sustainable investing can benefit investment performance, as well as positively impacting the planet.
Many private real estate managers have been skeptical of ESG's ability to enhance performance, and clients primarily focused on absolute returns have preferred longer track records. In our survey conducted in November 2020, 30% of real estate managers cited ESG as an additional challenge to outperformance, the largest proportion among all asset classes.
It should be noted that the 2019 vintage is still too young in its life cycle to represent a meaningful interpretation. Nevertheless, the latest shift in returns offers a glimmer of hope that real estate funds committed to ESG principles may have a greater competitive edge than their non-committed counterparts.
Real estate: the planet’s biggest polluter
The built world is among the planet’s worst climate polluters. With its huge carbon footprint, real estate drives nearly 39% of global carbon dioxide emissions. The physical effects of the climate crisis on the built environment have become increasingly evident in recent years, prompting a sense of urgency in the real estate sector.
The realization of looming devaluations of 'brown assets' in real estate portfolios has forced many managers to re-evaluate their mispriced assets and consider mitigation strategies, including decarbonization. ‘Brown assets’ are those with poorer environmental performance, and for which investors have priced in a ‘brown discount’ to account for future weaker rents and capital values, as well as higher operating and maintenance costs.
‘A lot of the ESG measures we deploy into investments are to protect their reversion value when we come to sell,’ said Carly Tripp, Global Chief Investment Officer and Head of Investments for Nuveen Real Estate. ‘But these measures also result in cost savings, such as through lower energy use. Overall, ESG is value protective.’
Once a secondary consideration for real estate, climate intelligence has become a key factor in preserving or increasing property values in the coming decades. This shift in perception is partly due to the pricey climate transition that many older, high-cost properties are being forced to undergo. The backdrop of shrinking demand and stricter regulations for older brown buildings also makes the prospect of stranded assets a real risk to portfolios, as remediation and redevelopment may be too costly and complex.
With about 80% of the buildings that will exist in 2050 already being built today, decarbonizing the existing stock, including through introducing energy efficiency solutions and retrofitting sustainable materials, is a top priority for governments and developers aiming to achieve net-zero.
The transformation to a global net-zero economy will drive historic capital reallocation worth trillions of dollars. This will create considerable opportunities for property managers to maximize returns for investors who respond well to changing regulations and consumer demands.
ESG credentials shine through in large APAC real estate deals
Singapore’s leading investors, including sovereign wealth fund GIC and the investment management arms of developers CapitaLand and Mapletree, have recently been active in some of the largest single-asset real estate deals in APAC, all of which share a focus on ESG.
GIC and Australian property fund manager Charter Hall closed the country’s largest direct office tower transaction at AUD 2.1bn in April 2022. The acquisition involves Southern Cross Towers in Melbourne that has an impressive ESG credentials through the National Australian Built Environment Rating System (NABERS) ratings. The NABERS rating is Australia’s benchmark in the real estate sector to assess the level of environmental sustainability of a commercial property. It is also used as a regulatory tool by state and federal governments to promote sustainable practices in the sector.
In December 2022, Mapletree Investments and PAG jointly acquired Goldin Financial Global Centre in Hong Kong SAR for HKD 5.6bn. The premium office building achieved both LEED Platinum and BEAM Plus Platinum certification upon completion in 2016, which are the highest industry standards both locally in Hong Kong local and globally, for healthy, sustainable, and cost-saving green buildings.
In January 2023, CapitaLand Investment acquired The Springs, a mixed-use complex in Shanghai, for RMB 7.6bn. The complex has earned the LEED Gold certification, which demonstrates its commitment to using sustainable materials and energy-efficient sources with the aim of having a positive impact on the environment. With sustainability at its core, CapitaLand Investment is working toward net-zero by 2050 and has set targets to transition to a low-carbon business over the next decade. As of May 2022, nearly half (48%) of the MSCI ESG AAA-rated manager's global portfolio had achieved green-building certification.
ESG affiliations
ESG affiliations are a way to assess GP and LP commitments to ESG as they reflect firms' public declarations of commitments to various ESG frameworks, initiatives, and programs.
Specific to the real estate sector, the Global Real Estate Sustainability Benchmark (GRESB), established in 2009, is a leading barometer that provides standardized and validated ESG data for financial markets.
There has been growing participation of real estate managers affiliated with GRESB. With at least 317 general partners (GPs) as signatories as of today, it is fast closing the gap with the UN Principles for Responsible Investment (UN PRI) affiliation, which has 506 GP signatories, according to Preqin Pro.
As ESG evolves from a niche to a mainstream field in financial markets, real estate managers who lack an ESG strategy will be seen as falling behind the curve and the cost of inaction could ultimately outweigh the initial investment outlays. ESG strategies are no longer a distinguishing feature, but a necessity for staying competitive.
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