ESG investing and operational real estate

A study by the UN revealed 93% of investors now include ESG in decision making. The change in sentiment has been dramatic, but not surprising. The widespread global clamour for action on climate change is influencing consumer behaviour in every market from the coffee we choose to buy every morning to the equities our pension providers hold and the real estate assets they buy.

As investors seek to diversify from traditional core property markets and look particularly at the operational real estate sector, it is long income transactions that are proving to have the most appeal for them. However, the sector holds some challenges for the ESG investor. Green leases are currently scarce, if not absent altogether, across operational real estate and for most ESG investors they are the ultimate goal. Without them a vital means of collaborating between owner and operator is missing. Compounding this, the nature of long income is a challenge itself. For all the financial certainty it provides, it means that day to day building operation remains in the hands of the tenant, leaving the owner with little control and less influence when it comes to driving their ESG strategy. The investor has to accept a more passive position without the opportunity for active asset management that might also yield additional capital growth. Effectively the achievement of an ESG driven investment strategy rests largely with the operator and its willingness to collaborate with the owner. As ESG practice continues to permeate every sector of business the possibility of common aims increases, but without green leases collaboration will always be at the election of the operator. 

The work of organisations like GRESB which was founded by a group of pension funds in need of reliable ESG data to inform investment decisions, sheds some light on the relative performance of sub sectors in Operational Real Estate. Perhaps unsurprisingly across all property sectors, offices lead given their global appeal as an investment medium. Retail and residential are not far behind. Healthcare and hotels for example, are so far the poorest performers or perhaps it is better to say they have the most ground to catchup. GRESB does not yet distinguish long income property and treats it like an FRI asset; without recognising the distinction and the unique challenges faced by property investors in this sector there is risk that slow progress in achieving improvement may be seen as an owner’s failure rather than a product of the tenure structure. It would be interesting to consider whether businesses going to market on a sale and leaseback basis may perform better with green leases given the volume of ESG investor demand. 

For purchasers analysing the performance of buildings in this much less homogenous category can seemingly be more complicated too. For example, building typologies that fall outside the scope of a BREEAM or LEED assessment, like a holiday or leisure park, for example. Specialist technical due diligence is essential. CBRE’s Environmental Consultancy team is working with our technical due diligence experts helping a range of institutional investors by providing analysis and guidance on sustainability and sustainable buildings. It is our experience that many of the criteria used in formal assessments methods can be used to analyse bespoke assets to yield a valuable set of insights even where a formal assessment could not be carried out.