ESG investments and real estate funds
Covid-19 has significantly influenced preferences, expectations and valuations in real estate, accelerating some trends that were already ongoing. These include the global digitalisation of work, the transformation of buying habits and an increased focus on environmental, social and governance sustainability, the so-called ESG factors. In the valuation of a real estate asset, these factors have now become a fundamental component alongside traditional economic and financial criteria.
Sustainability is no longer just a responsibility of non-profit or so-called green entities but a requirement of any investment. Market players are increasingly oriented towards basing their investment and management policies no longer on mere profit, but also on the adoption of ESG best practices and procedures.
According to the Schroders Global Investor Study 2020, 77% of investors would never make investments against their moral principles. Only 23% would be prepared to do so with the prospect of higher returns. Furthermore, up to 47% are ready to invest in sustainable funds to contribute to a greener society – a percentage that has increased by 42% compared to the 2018 figure.
In Italy and France respectively 82% and 78% of investors say they would never invest against their ideals. In Russia 80%, while the United States revealed a figure of just 67%.
ESG funds in real estate
In the real estate market, ESG funds are a booming trend. These investments are halfway between solidarity-based transactions to fulfil social and cultural purposes, and traditional operations. This does not mean that traditional real estate transactions systematically neglect the environment and social aspects. However, it is clear that the primary goal of traditional real estate deals is the profitability of the operation, regardless of the type of assets and companies involved.
This differentiation is essential when choosing the type of property or real estate operation to focus on. According to UNEP – UN Environmental Program, in 2015, CO2 emissions from real estate accounted for 30% of the annual emissions recorded, while energy consumption in real estate was close to 40% of global emissions. This contributed first and foremost to the indispensability of the 2015 Paris Agreement, the first legally binding international pact on climate change to reduce CO2 emissions by 77% by 2050, but also to raising public awareness of the importance of climate change.
Hence the turnaround in real estate, which has led to greater responsibility for the environment and the initiation of virtuous ESG dynamics.
But if environmental factors are more easily identifiable, the link with social and governance factors is more difficult to grasp. Buildings serve a social function, they are part of the community, they are being used by people who expect quality, modern and efficient environments.
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ESG-friendly assets: how do they look like?
There are several asset classes that can be easily associated with ESG real estate funds. First and foremost, schools, nursing homes, hospitals, RSAs, student housing and senior living facilities. In this case it is the social contribution of these realities that makes them attractive to investors. However, efforts to redevelop areas and places in accordance with sustainability criteria and to save land consumption are also increasingly linked to ESG funds. One only has to consider the redevelopment of derelict areas, disused buildings, the rehabilitation or extension of urban green spaces, public spaces and sustainable mobility. The focus of such projects is no longer only on the social impact, but also on the environmental and economic impact on an entire community and its well-being.
Conversely, ESG funds are in stark contrast to investments and transactions that have a strong environmental impact, do not comply with the Paris Agreements or put the economic needs of a company or investor ahead of those of collective social welfare.
ESG fund ratings: factors taken into account in the assessment
To date, no unified process or methodology has yet been established and recognised by all players to develop an ESG rating. In addition to the traditional agencies (Fitch, Moody’s, S&P, etc.), new agencies have emerged that are committed to rating ESG funds. These have a specific focus on these issues, such as GRESB, which was created on the initiative of major investors in real estate. The measurement parameters and weights may differ from agency to agency, as each component may affect the overall result in a completely different way.
But let’s see in detail which criteria can be used to perform an analysis and assign an ESG score.
ESG scores are based on public data, either directly from the companies concerned or from reports, mainly for non-governmental organisations. Using this data, it is possible to give a ‘boxed’ rating based on the 17 themes of the UN Sustainable Development Goals. The methods of measurement can vary, as can the importance attached by the evaluating agencies to the factors analysed.
ESG investments and possible risks
ESG funds and a proper application of the criteria should contribute, in the medium to long term, to the optimisation of an investment. It is not possible to know in advance the risks or the scope for improvement of the assets involved, but it is certain that poorly managed or inefficient properties have unexpressed potential, both in economic value and return.
ESG-compliant asset classes attract qualified investors, who are incentivised by the potential for returns with a gradual increase over the long term. On a smaller scale, well-managed properties will be more valuable and attract quality tenants. According to a report by INREV, the European Association of Investors in Non-listed Real Estate Vehicles, the difference in returns between the companies at the top of the GRESB (Global Real Estate Sustainability Benchmark) and those at the bottom is 2.75%.
The future of ESG in real estate
While the US is still the clear leader, it is expected that in Europe, too, compliance with ESG factors will become a priority objective. This is not only for property owners but also for property users themselves, ensuring that assets are managed in a responsible and sustainable manner.