Key Elements of ESG relevant to commercial real estate investment funds
Environmental, social, and governance (ESG) factors within commercial real estate investment are becoming more influential: ESG was a major focal point of discussion at this year’s PFA 2022 Conference and the recent PFA Master Class Series, and is likely to remain a key issue as investors increasingly demand investment products with an ESG focus.
Atchison Consultants has put together an interesting summary article which explains some key ESG factors relevant to the unlisted property funds community:
ESG – Summary
ESG (Environmental, Social, Governance) is a rapidly growing investment theme in Australia. ESG funds under management in Australia now exceed $1 billion.
What is ESG?
An ESG framework provides broad standards by which companies and their impact can be evaluated beyond traditional financial metrics.
The term ESG is often used interchangeably with “ethical investing”, “responsible investing”, “sustainable investing” or “impact investing”.
Environmental
Environmental criteria include use of renewable energy sources, waste management, management of air or water pollution arising from operations, deforestation and climate change. Raw material sourcing including fair trade suppliers and biodiversity practices on land are also relevant.
Social
While there are many separate social aspects of ESG, all are essentially about social relationships. A fundamental relationship is with employees. Social metrics include employee turnover and incident rates, gender equality and ethnic diversity.
Governance
Governance is about direction by Boards and management by executives. How well do executive management and directors address the interests of stakeholders being employees, shareholders, customers and the community?
ESG Factors
Common ESG factors are listed. Investments with positive ESG scores have the potential to drive strong returns. Those with poor ESG scores may inhibit returns.
Environmental
– Energy consumption
– Pollution
– Climate Change
– Waste production
– Natural resource preservation
– Animal welfare
Social
– Human rights
– Child and forced labour
– Community engagement
– Health & Safety
– Stakeholder relations
– Employee relations
Governance
– Quality of management
– Board independence
– Conflicts of interest
– Executive compensation
– Transparency & disclosure
– Shareholder rights
SRI and Impact investing
Socially responsible investing (SRI) and Impact investing are part of ESG investing.
SRI may be driven by religious, personal or political beliefs. These beliefs will form the basis of negative or positive investment screens. Negative and positive investment screens will exclude and or include investments based on investment philosophies.
Impact investing prioritises investments which are viewed as having a positive effect in areas of concern or interest. The positive effect may include goals which are beneficial to society or the environment.
ESG Standards
There is no standard definition of ESG investment within Australia. Fund managers rely on the UN Principles of Responsible Investment or voluntary certification from Responsible Investment Association Australasia to verify compliance with ESG investment philosophies. Some managers have their own definition.
Management
Performance
CBRE have undertaken analysis which indicates that regulation seems to be the trigger for revaluation of assets rather than performance of the assets. They also note assets with highest energy ratings have achieved higher valuations through lower cap rates.
Reporting
Australia has now introduced a Climate Change Bill. At this stage the legislation is silent on reporting. It is likely that mandatory climate related financial disclosure regime for Australian financial institutions will be introduced. Managers will be required to provide regular and transparent reports on compliance with and continual adherence with an ESG philosophy.
Criteria
CBRE have outlined 10 key criteria for ESG management in real estate portfolios.
– Energy saving/net zero are the new normal.
– Gap between green rental premium and brown rental discount is widening.
– Green construction materials are available and viable
– Regulatory requirements will continue to tighten.
– Effective risk and cost management can enhance resilience with consequences of lower insurance costs
– Affordable housing offers attractive impact investment.
– Health and wellness is influencing building design and operations.
– Corporate social responsibility is key to governance.
– Benchmarking and reporting will be essential.
– Technology is critical in achieving ESG goals.
These reflect the sentiment of the UN principles of responsible investment. MSCI state that most of the variation in risk measured by VaR is driven by physical risk rather than transition risk. Physical risk reflects the potential for stranded value or loss of usefulness.
Benchmarks
Global Real Estate Sustainability Benchmark (GRESB) is the standard benchmark.
NABERS is an Australian rating system that measures the environmental impact of buildings and tenancies.
Factors
In real estate four utilities are key for financial outcomes from environment factors.
They are energy, water, recycling, and waste. Efficient management of each factor will enhance financial outcomes while enhancing ESG ratings.
For more information please contact Atchison Consultants: phone 03 9642 3835 email enquiries@atchison.com.au
Image: Charter Hall