However, the success of ESG investing is not news to charities, many of which already have a substantial presence in this area. For years, charities have worked on developing ESG investment strategies that comply with the strict rules and legislative framework that govern their operation.
While they may initially have looked to ESG as a matter of principle, it is its success as an investment choice that has contributed to its take-up, alongside wider social awareness of ESG matters. Now, it is causing conventional investors to follow suit.
Charities in the lead
Charities are subject to strict rules in relation to investment but can, in certain circumstances, take into account factors such as the alignment of their investment approach with their charitable purposes and any negative effect that an investment strategy may have on their charitable work.
As such, some charities have taken an early interest in developing ESG real estate investment frameworks that focus on ESG-positive assets.
ESG shoots up advisers’ agendas amid pandemic
This may include adopting a holistic ESG policy that covers all aspects of real estate management, including the acquisition, administration and disposal of assets. But now that ESG compliance is driving up occupier demand, rental potential and disposal values, charities that were early investors in ESG compliant assets have been given a significant head-start.
ESG scepticism
By contrast, traditional real estate investors have been slower to trust ESG investment potential, with many previously seeing it as a box to be ticked.
As a result, metrics used to measure ESG performance, such as GRESB, have not fully matured, and some commentators have claimed that the qualitative-type assessments do little to mitigate the risks of greenwashing.
Furthermore, the social and governance elements of ESG are more conceptional in nature. As such, they have been difficult to quantify and can prove particularly problematic to measure in a real estate context.
It is therefore unsurprising that the quality and consistency of ESG-based disclosures has been poor across several sectors.
Many investors have also been worried by the greater upfront cost on capital expenditure to improve their property portfolios to ensure ESG compliance.
Research has shown that 35% of buildings in Europe are over 50 years old, and almost 75% of existing buildings are energy inefficient. Bringing these properties up to ESG standard will come at a cost. Even the most minimal retrofitting and modification would prove too expensive for some investors, especially in a post-pandemic world.
That said, over the last decade, charities have helped show that this landscape is not only navigable with some thought and care, but that it can also provide stronger investments in the longer term.
A bright future
Morningstar recently reported that ESG funds have outperformed, outlived and overshadowed conventional funds over the last year.
Real estate managers face greatest ESG challenge in taxonomy compliance
This trend is only likely to continue as the real estate market adapts to a post-pandemic era.
With the UK government implementing further ESG investment and regulatory policies, the introduction of new ESG metrics such as NABERS UK, which seeks to measure and rate the actual energy use of offices, and the introduction of new ESG-focused real estate funds, it is clear that environmentally friendly and ethical real estate is here to stay.
However, as charities and others have shown in recent years, investors must do more than simply comply with current reporting to truly realise the potential of an ESG-positive asset.
Investors must track the actual performance of their portfolios as the legal landscape continues to shift. If done correctly, ESG investment can provide a real competitive advantage and can add considerable value to a real estate portfolio.
The pandemic has undoubtedly pushed climate change, sustainability and social injustice to the centre of public attention.
As these factors continue to drive and influence public policy, traditional real estate investors must learn to balance their investment decisions against ESG objectives to future-proof their portfolios.
If these considerations are ignored, they run the risk of being left behind.
Ultimately, it seems that we are on a one-way street, which only leads towards a time where ethical investment increasingly influences decision making at all levels of real estate management.
Barbara Webb is senior associate in Farrer & Co’s real estate team, and Laetitia Ransley is senior associate in the firm’s charities team
