Assessing ESG Factors in Real Estate
Article5 mins16 September 2021
Environmental, social and governance (ESG) factors have become a core part of how organisations are reporting on operational performance. However, assessing ESG in the unlisted real estate industry has been more difficult for investors.
Real estate is a fragmented asset class and some of the changes needed to deliver real sustainability require significant capital investment.
ESG is critical for real estate investors since buildings are responsible for 40% of the world’s carbon emissions, use 40% of the world’s energy and consume 30% of world’s available drinking water.1
Fundamentally, ESG is a tool to assess, measure and manage risk for the real estate industry. There are a wide range of ESG risks for property investors to consider. These range from physical risks, such as property exposure to rising flood waters, through to perception risks, including whether a shopping mall’s behaviour maintains its social licence to service a community.
For active managers, consideration of ESG risks occurs at every level of an asset’s lifecycle, from acquisition, leasing, day-to-day management, development and divestment. The objective is to protect and grow an asset’s income and value to continue to deliver long-term sustainable, risk-adjusted returns to investors. To achieve this, ESG risks can no longer be ignored.
How can investors assess whether their real estate funds and underlying assets are delivering on ESG promises?
The first place to look is at published ESG ratings. There are two leading rating systems: NABERS, which stands for the National Australian Built Environment Rating System, and GRESB, a global ESG sustainability benchmark.
NABERS is a national initiative managed by the NSW Department of Planning, Industry and Environment that provides sustainability measures for real estate assets including hotels, shopping centres, apartments, offices, data centres and more.2
NABERS ratings help building owners and tenants benchmark their asset’s performance compared to similar buildings. It measures energy consumption, water use, waste and the indoor environment. It is a star model – from one to six stars – that rates buildings annually.
GRESB takes a wider approach than NABERS by assessing real estate and infrastructure with standardised global benchmarks for sustainability. This system is used by investors to monitor investments and engage with managers.3
Beyond the headline ratings, investors can also take a closer look at exactly what building managers are doing to deliver sustainable ESG outcomes. Environmental factors are top of the list.
Leading building managers are focused deeply on reducing energy use in their buildings. Sometimes, this will be through passive design principles that take advantage of local weather conditions to reduce the need for heating and cooling. Examples include orienting a building to catch the sun’s heat in winter or a cool breeze in summer or using materials that help manage internal temperatures and humidity.
However, there is not often the opportunity to build a new building, so real estate managers are also focused on the adaptation of existing structures to be more energy efficient by installing shades, insulation or solar panels. Power-purchasing agreements also assist in minimising carbon emissions and providing certainty of the cost of occupying a building, through the fixed energy costs established in renewable energy supply contracts.
Technology is also playing a role, with cutting-edge buildings using a network of sensors backed by artificial intelligence to constantly monitor building features and occupant usage, automatically managing heating, cooling and lighting to reduce energy costs and minimise a building’s carbon footprint.
This is not only good for the planet, but also for tenants due to lower energy costs. From an investor perspective, the capital spending on these projects can pay dividends in higher rents and better occupancy. With energy costs usually passed onto building tenants, occupiers of buildings with lower energy bills should have the capacity to pay higher rents in our opinion.
Some tenants, notably government departments, are restrained from renting buildings that fall short of environmental standards. Ensuring a building is attractive to the widest range of tenants is critical to maintaining occupancy and income levels throughout the market cycle.
ESG is not only concerned about the ‘E’ for environment. For real estate, the ‘social’ component of ESG is an important factor too.
To assess the social sustainability of a building, we believe investors should look out for building managers who are effectively maintaining good relationships with the local communities they operate in and creating places where members of the community feel safe and included when visiting.
This may appear in the way a building engages and pays respects to the local First Nations people, acknowledging their role and ensuring elders are part of on-site events. A manager’s approach to this relationship will be articulated in their Reconciliation Action Plan.
Many shopping centres are playing a wider role in the local community beyond merely operating the building, by encouraging charities and community groups to operate on site for the benefit of other users of the site, allowing walkers to use the building for exercise before the shops open, and providing spaces for mothers’ groups or Justice of the Peace services. Provision of adult change facilities, multi-faith prayer rooms and quiet shopping hours are also part of bringing the community together, which is an important role for real estate to play in society. In addition, social sustainability can also have a positive impact on investment returns. We believe that people who feel an affinity to a building within their community are more likely to live, work, shop and play there, making the asset an integral part of their daily lives.
But sustainability is about more than just a happy, local community. The Modern Slavery Act requires businesses to assess their supply chains for exploitation and the real estate industry is no different.
Investors seeking to assess sustainability should also check a building manager’s modern slavery statement, which should include information on how outsourced services like cleaning and security are managed.
Investors can also assess the attractiveness of a building’s health sustainability. This is a heightened consideration in a post-COVID world where air quality, ventilation and distancing might be key to encouraging people back to work.
This could include features like windows that open, or various vertical transport options including staircases that connect multi-floor tenancies. However, it could also be the provision of wellness facilities, like yoga studios and green space.
Australia’s institutional managers of real estate are very much leaders in ESG with clear benefits for investors, the community and the planet, ensuring the ESG risks facing real estate assets are effectively managed.
We believe that investors who are taking a close interest in how ESG factors in real estate will be better positioned to benefit from this active management approach.
To read more about Dexus’s commitment to ESG, click here.
References
1 https://www.nabers.gov.au/about/what-nabers
2 https://www.nabers.gov.au/about
3 https://gresb.com/
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