ESG strategies differ among investor types
Here we delve deeper into the results of our ESG Property Investor Survey and analyse nuances among investor types and focus.
7 minutes to read
Our recently released ESG Property Investor Survey highlighted some key industry trends. Here we delve deeper into the results and analyse nuances among investor types and focus
In September, we released our first ESG Property Investor Survey, which encompassed the views of 45 investors representing around £300 billion of assets under management (AUM) across Europe, to understand how ESG-related themes are influencing the capital markets. In the world of commercial property, institutional investors were generally early adopters regarding ESG, due to regulation, disclosure, and investor pressure.
With our Active Capital report delving into investor type strategy and allocations, we wanted to explore how ESG factors were influencing each of these in differing ways.
Our survey shows that private equity, listed property companies/REITS and investment managers are also keenly addressing and incorporating ESG into property investments and this may influence not only how assessments are viewed but they type of investment.
Whilst the number of respondents in each investor type is limited, they cover a significant depth in the market. Of the four private equity responses, the collective Assets Under Management (AUM) is in the region of £30 billion, for the seven listed property companies its some £40 billion of AUM and investment managers – our largest cohort – account for around £200 billion.
To put these numbers in perspective there was £352 billion (€402 billion) of investment transactions in European commercial property in the year to June 2023.
ESG screening including private equity
There may be a prevailing assumption that private equity (PE) investors are more risk-taking, yet our survey indicates that this does not preclude an enhanced ESG lens on investments and assessment.
In-line with the broader market, three-quarters of the PE investors surveyed have a minimum environmental certification (e.g., minimum EPC, HQE, DGNB or BREEAM rating) for assessing an asset under review for new acquisitions. Similarly, three quarters of PE investors survey use CRREM analysis on their existing portfolios and as a requirement on new buildings under review.
This can be used to limit and understand stranding risk of assets and what the pathway to decarbonisation may look like. As PE shifts towards the logistics sector, we estimate that asset allocation will go from 17% logistics in 2022 (was 7% in 2018), to 26% by 2027, the requirement for greener assets will continue as demand from prospective tenants grows.
Nine out of 10 of the top ten 3PL companies are committed to reaching net zero, with seven aiming to do so by 2050, and the remaining planning to do so by 2040.
PE investors are also implementing the use of green/sustainability lease clauses. Akin to the wider market, all our surveyed investors, including PE, state they use these lease clauses as a structure to help realise their own ESG targets.
When asked which clauses, for PE investors, all four respondents said these would include energy/water/waste data sharing. Three-quarters would include restrictions on alterations which may adversely impact energy efficiency ratings, stricter than the wider market response of 65% restricting alterations.
Listed property companies set closer net zero goals
Across our entire survey sample, of those who declared:
- One respondent has already reached net zero
- 41% have a target of 2030
- 15% are looking to 2040
The remainder are aiming for 2050.
However, when we look by investor type, the listed property companies have a greater urgency, with almost 90% of those surveyed targeting net zero by 2030 – just over six years away. This may be due to the public nature and external stakeholder pressure being greater and more accountable in public markets.
Does this match their plan? Maybe not exactly.
With a shorter decarbonisation period, there might be the assumption that these investors want to dispose of poor ESG-performing assets, particularly if they don’t have the size or expertise to upgrade assets. By their nature listed companies for property will be large and should have expertise and our survey finds that, of those listed companies surveyed, around 70% aim to acquire poor ESG-performing assets to upgrade/reposition and just shy of 60% look to improve the quality of their existing portfolio.
This compares to 58% and 76% for the whole sample, respectively. However, when looking at listed property companies, all of those surveyed have a minimum environmental certification requirement indicating new assets are considered against the wider portfolio and in-line with net zero goals.
Listed companies more broadly targeting value-add opportunities
Knight Frank data shows that in London the proportion of value-add[1] acquisitions has been rising since we began tracking in 2018, from 8% to almost 40% of total volumes in the year to Q2 2023. In the first half of 2023 £2.1 billion was invested in London offices for value-add purposes.
More broadly across Europe, RCA data tracks those for renovation or redevelopment[2] which accounted for 7% of investment volumes in H1 2023, some €4.5 billion. Some of the property investors are dedicating funds to repositioning and improving assets.
Given the current interest rate environment, real estate values are seeing a correction and investors may also be waiting for prices to ‘bottom out’ to act for these opportunities.
In addition, the rise in build costs over recent years has made scrutiny over refurbishment and redevelopment projects much greater, with redevelopment also requiring planning as well as examining the embodied versus operational carbon considerations. As these begin to level off and real estate pricing stabilises, this is likely be a growth area of the market in the coming years.
The lending market, particularly the banking sector, is moving to facilitate such transactions with a growth in sustainability-linked loans which offer favourable lending rates for improvements to energy efficiency and go beyond loans with green credentials.
Sustainability-linked loans require a framework and metrics by which to measure improvement to qualify whereas some banks may use green credentials as a screener on whether or not to make a loan due to their internal requirements. For the non-bank lending sector there is a more mixed approach. Sustainability-linked lending is still in its infancy but highly likely to be an area of growth over the coming years.
Investment managers focus on improving existing assets
Investment managers are most likely to improve existing portfolio and purchase compliant assets.
In terms of strategies relating to ESG:
- 83% of investment managers surveyed are looking to improve the quality of existing portfolios through refurbishing and repurposing.
- 66% of those surveyed look to acquire ESG-compliant assets.
This is compared to 76% and 51% of all respondents, respectively.
They are also more likely (81% of those surveyed) to be utilising CRREM analysis understand the stranding risk and dates on existing assets to inform this approach.
This may, in part, be due to their stricter regulatory requirements. Of those surveyed, 57% assess assets under review for their alignment with SFDR Article 6, 8 or 9 and EU Taxonomy compliance which assesses and defines what constitutes a sustainable activity.
Further ESG momentum
ESG-criteria for new assets under review as well as understanding existing portfolio credentials and risks are increasingly commonplace across all investor types. There is a demonstrable demand for high efficiency assets moving beyond just EPCs.
Be it for the increase in disclosure requirements, financial pressures from lenders, companies' own net zero targets or to meet the ever-increasing demand from occupiers for sustainable, wellbeing-supportive buildings and truly futureproof use and value.
Interestingly, looking between types, private equity tends to act as a leading indicator, by creating stabilised product. What our survey indicates is that with even PE increasingly focusing on ESG, this could mean adoption of practices as the new normal and for ESG-criteria and themes to become globally embedded.
[1] Properties that require capital expenditure to raise the quality for future occupation.
[2] RCA define renovation when upgrades are to be made at the time of acquisition or refinancing that add to a property's value and do not involve a change in its use or a substantial reconfiguration through construction. Redevelopment indicates that a property will undergo a change in its use and/or a substantial reconfiguration the existing property to be demolished. This may be an underestimate as assets may be labelled as sold as there may be limited factors, such as lease events, which means renovation will happen later