Reconciling cost with conscience: what does ESG mean for the Retail Property sector?
As ESG rises up the agenda, we explore which Environmental, Social, and Governance issues are relevant to the sector.
11 minutes to read
Engagement with Environmental, Social, and Governance (‘ESG’) factors will undoubtedly accelerate in 2021 as the retail sector seeks to build back better from the biggest stress test the industry has faced – Covid-19.
Interest in the topic has heightened throughout the pandemic, with a growing body of research finding companies with stronger ESG credentials generally outperforming their conventional counterparts, experiencing lower volatility and resilient cash flows.
The commercial real estate sector is no exception. 95% of real estate investors now report paying closer attention to ESG when making decisions, given increasing stakeholder pressures, risk of asset impairment, and regulatory requirements. However, progress across the sectors varies significantly.
A survey by PERE found 80% of investors saw ‘significant or moderate’ progress within the office sector, compared with just 7% in retail. Retail is most definitely the laggard, something of a short-term existential crisis taking precedence over a longer term view of wider sustainability.
But what does ESG mean in the context of retail property, and what sorts of issues are viewed as pertinent? ESG covers a dizzying array of topics ranging from climate change to gender diversity, many of which will hold greater relevance to the industry than others.
As ESG gains traction amongst a wider set of stakeholders including landlords, retailers, and consumers, each will develop their own interpretations of what is significant, and the methods by which progress can be measured and achieved.
‘E’ – Environmental:
The ‘E’ of ESG is perhaps the most pressing issue in retail given the sector possesses a substantial carbon footprint. Retail is the second highest consumer of all energy in the UK, responsible for a fifth of all carbon emissions originating from across its value chain, from upstream factory production, to downstream customer consumption and disposal of goods. This places retailers in a highly influential position to lead the transition to a lower carbon future.
Physical bricks and mortar are responsible for a significant chunk. According to the Building Energy Efficiency Survey (BEES), retail ranks as the top energy consumer, accounting for 17% of total energy used by non-domestic building stock.
Small high street stores generate some of the highest levels of energy demand, followed by large grocery stores, with heating, lighting, and refrigeration the biggest sources of consumption, representing 79% of energy usage.
Although demand will vary between sub-sectors, these common sources of consumption reveal where some of the biggest savings can be made, often at minimal cost. The ‘Close the Door’ initiative achieved significant reductions in operational carbon generation – slashing each store’s annual carbon by up to 10 tonnes – the equivalent of three return London to Hong Kong flights, with no adverse impact on footfall.
Given the cost of emissions to the sector (ca. £3.3bn) minor increases in efficiency can deliver substantial economic benefits. The Carbon Trust calculates a 20% reduction in energy costs is equivalent to a 5% increase in sales.
Hammerson, a retail REIT, has been particularly transparent on the financial benefits of implementing energy and water efficiency measures in its shopping centres, revealing £900,000 in annual savings were generated from a 31% reduction in emissions which it said made investments ‘worthwhile’. Installation of sub-metering allowed one high street brand at its Union Square Shopping Centre to reduce water consumption by a whopping 98%, the technology flagging a major leak which would have previously gone undetected for 3 months.
Although there is growing interest amongst retail owners to optimise the environmental building performance of assets, sustainable upgrades tend to be viewed as best practice due to the existence of a cost-benefit misalignment. Many benefits materialise in the form of reduced energy costs which flow to tenants, making it problematic for landlords to justify capital outlay.
Practically many landlords lack control over the use and fit out of spaces, which whilst an expectation of the market, makes it difficult for environmental initiatives to be implemented, requiring extensive cooperation with retailers and supported by changes to the lease. At best, many landlords encourage alignment to ESG objectives - The Crown Estates Retail & Leisure Fit Out Guide provides a framework of best practices retailers can adopt to minimise both operational and ‘embodied’ carbon (i.e., that generated during construction of a building).
Question marks remain as to whether strong environmental credentials can enhance the value of retail property, given little expectation of return on investment to exceed beyond reduced costs. ESG is becoming a clear differentiator amongst prime residential and office properties, generating value premiums with impact on rent and occupancy rates.
But in retail, where vacancy rates continue to grow, landlords’ main focus remains securing beneficial occupation by retailers with strong covenants, most commonly achieved through offering rent-free periods, service charge caps, or other negotiated terms. In a Covid-19 ravaged environment, this focus has become even more desperate, any tenant being preferable to an empty store.
The pursuit of sustainability appears somewhat unattractive among older retail centres given constraint of investment budgets, particularly so for initiatives with payback periods spanning several years at a minimum.
However, the significance of retrofitting older centres must not be understated. With two-thirds of heat lost through building fabric, and a quarter of retail stock pre-dating the 1940’s, retrofitting will have far greater impact than development of modern centres given the lack of current pipeline and slow rate of new builds.
In any case, greater focus on ESG is challenging the sector to consider indirect value impacts of environmental factors, which may be currently misattributed to other property factors.
Landsec is just one REIT that is examining the role of the environment on its assets. Although difficult to quantify, the 50 acres of parkland its Bluewater Shopping Centre in Kent sits within undoubtedly contributes to its marketability, and attraction to consumers far and wide. Landsec has since partnered with the Wildlife Trust to enhance biodiversity at five operational sites, allowing it to better discern indirect value generation, such as on risk of obsolescence.
Bricks and mortar stores can be a real asset to those seeking to bolster their environmental credentials, particularly so given the rise of online shopping. To date, there is very little research on how e-commerce is transforming retailers’ carbon footprints, and the sector must remain vigilant to inefficiencies created by the channel to ensure it does not unravel environmental gains made elsewhere.
Two of the biggest challenges arise not from the practice of online shopping itself (although the convenience of the channel frees consumers to undertake more carbon generating activities, often simultaneously), but to last mile delivery and packaging of individual goods.
Consumers are becoming increasingly conditioned to expect next day, and even same day delivery, often at little to no additional cost, placing strain not just on retailers’ profit margins but also on the environment.
Shorter delivery timeframes add complexity to logistics operations, requiring routes to be speed driven, necessitating higher polluting transport such as air freight. Multiple purchases are increasingly split shipment to maintain high customer expectations, requiring multiple deliveries and individualised packaging, which has higher propensity to end up in landfill.
Factor in multiple delivery attempts if customers are not at home, not to mention high volumes of product returns, and the carbon footprint of online shopping soon adds up. In contrast, products sent to store will be packaged optimally for mass transit, with retailers under legal obligations to ensure plastics and carboards are responsibly disposed or recycled.
This is not to suggest that simply having an online channel is detrimental to retailers’ ESG credentials. A US study by Bain & Co found although bricks and mortar purchases were generally more environmentally efficient - with consumers buying larger volumes and combining visits to other retailers - this was heavily dependent on consumers’ mode of travel and basket size.
Online was more likely to be environmentally friendly when consumers purchased a single item which would have otherwise been obtained via dedicated car journey.
Although it’s evident more research is required on the topic, what is clear is that multi-channel retailers possess a significant competitive advantage over pureplay competitors. By leveraging physical stores, retailers can provide consumers with a greener (and sometimes faster) alternative to home delivery without compromising on convenience, with click & collect and pick-up lockers.
‘S & G’ – Social & Governance:
Environmental has a tendency to dominate ESG narrative, but Social and Governance issues are of equal significance. Amongst the headlines heralding the decline of the high street, it’s easy to gloss over the fact the retail industry is the UK’s largest private employer, providing jobs to over 2.8m people, approximately 9.3% of the working population.
Retail remains a core component of the UK’s social fabric, with retail vacancy frequently cited as a barometer of a town or city’s health. Retail bricks and mortar contribute a huge amount of wealth for communities and the public purse - with retailers paying 25% of all business rates.
With shops being so visible in our everyday lives, consumers increasingly expect retailers to provide them choices which are socially responsible. 42% of shoppers claim they would step away from brands that do not align with their values, but it’s evident many are ‘radicals’ at the research questionnaire and ‘reactionary’ at the checkout. Put simply, do consumers always practice what they preach?
Iceland is a self-proclaimed leader in responsible retail, becoming the first grocer to fully disclose its annual plastic package footprint, revealing it generated 1.8bn items of primary plastic in 2019 – a significant volume given its 2.5% share of the market.
In doing so, Iceland highlighted the issue of non-comparable targets and inconsistent reporting across the industry, calling for increased transparency from competitors given the ‘relatively cheap and painless’ process it experienced to collect the data.
CEO Malcom Walker has become a strong proponent of balancing climate and social justice alongside healthy business performance. Whilst sustainability, he believes, cannot remain the reserve of the middle-class consumer, Iceland has a responsibility to deliver affordable price points, which it says it can achieve in tandem through focus on the ‘triple bottom line’ of profit, people, planet.
It can be difficult for even the most conscientious consumer, or investor, to understand whether a retailer is truly committed to its causes, or simply greenwashing. With ESG rising in prominence, a proliferation of rating platforms has emerged which act to distil a company’s ESG achievements into simplistic scores.
Although intended to aid investors’ due diligence process, the ratings have acted to muddy the water. An emerging ESG minefield was revealed last year when cases of modern slavery were found in Boohoo’s supply chain.
Finance company MSCI had previously given the online pureplay a double ‘AA’ ESG score, distinguishing it above industry average in term of supply chain labour practices. 20 ESG funds were found to have invested in the company, including Premier Ethical, Aberdeen Standards UK Ethical Equity, and ASI UK Impact Employment Opportunities, raising questions over the credibility of such ratings.
Although the scandal attracted serious criticism and saw it lose one of its largest investors, Aberdeen Standard Life, it’s debatable whether Boohoo’s poor governance will cause long-term damage to the brand in the eyes of the consumer.
Boohoo’s profits have soared throughout the pandemic, with annual revenues up +45% to £816.5m to August 31, allowing it to emerge as one of the few winners, and seeing it scoop up failing Oasis, Warehouse, Debenhams, and Arcadia brands. What is certain is that the rise of ESG will see investors and asset managers face up to a dilemma they can no longer ignore: whether to engage or divest from controversial, yet profitable companies like Boohoo.
ESG is definitely rising up the retail agenda, but there are still as many questions as answers.
Key Takeaways
- Focus on ESG has heightened significantly throughout the pandemic and is set to accelerate in 2021.
- Progress across commercial real estate sectors varies: retail property lags, whilst offices lead.
- Understanding and prioritisation of ESG themes varies between stakeholders (investors, landlords, retailers, consumers) who each have a view.
- ESG covers a wide variety of topics but some are more pertinent to the retail property sector than others.
- Environmentally, retail possesses a significant carbon footprint, with bricks and mortar responsible for significant operational and embodied carbon emissions.
- Significant cost savings can stem from environmental strategies, with retrofitting playing a greater role than new build in cleaning up the sector;
- But more research is required to understand environmental enhancements on other property metrics.
- Bricks and mortar stores will be an asset to multi-channel retailers, lessening the drag of e-commerce operations on its carbon footprint.
- ‘S’ and ‘G’ elements of ESG are equally relevant; as consumers look to retailers to provide sustainable and ethical choices that are also convenient and affordable.
- But consumers and investors alike remain vulnerable to greenwashing;
- Proliferation of ESG ratings has only muddied the water on retailers’ credentials, with ethical funds investing in companies like Boohoo found to have weak governance.
- Continued focus on ESG will challenge investors to focus on questions of engagement or divestment.