Posted by Macquarie Asset Management
October 3, 2022
Climate change and the actions needed to combat it have never been higher on the priority list for institutional investors, which means that their partners need to be aligned with their ambitions.
Perhaps the most substantial change in recent years is the increasing number of organizations that have committed to a quantified pathway for ensuring their investments are net-zero carbon. Investors do not simply agree that something must be done, but increasingly agree that the ‘something’ is a programmatic reduction in emissions.
Investor bodies such as the UN-convened Net-Zero Asset Owner Alliance, which consists of 74 global investors with more than $10 trillion of assets, are driving decarbonization efforts across multiple asset classes, including real estate.
More real estate investors and managers are committing to the Science-Based Targets Initiative, which sets out a clearly defined pathway for companies to reduce emissions. Targets are considered ‘science-based’ if they are in line with what the latest climate science deems necessary to meet the goals of the Paris Agreement: limiting global warming to below 2°C above pre-industrial levels and pursuing efforts to limit warming to 1.5°C.
“Sophisticated investors are responding to an evolving regulatory environment and to the demands of stakeholders. So they are, in turn, increasingly demanding of their operators,” explains Dana Gibson, head of real estate, Europe at Macquarie Asset Management.
“The minimum expectations are a clearly articulated pathway to be at least operational net zero, by a specific date. And investors are really demanding accountability, which is reflected in reporting. Along with asset- and portfolio-level execution, partners and operators need the capability to accurately report and hold themselves, their partners and their tenants to account.”
Not all institutional investors are at the same stage, however, nor have all completed the work needed to set out a net zero pathway. “Different organizations have different target dates. We set ourselves a goal to hit net zero across our portfolio by 2040, although 2050 is obviously the key year for many investors,” says Gibson. “Even investors without a commitment tend to be in the process of setting out their pathways, and it’s no easy task. There is a huge amount to be done and although 2050 seems a long way off, it isn’t a long time in the life of an institutional real estate portfolio.”
Coen van Oostrom, founder and CEO of sustainable real estate developer EDGE, says: “We are in a confusing period. Because sustainability in itself has become completely mainstream, everybody has some sort of strategy; however there are a lot of institutions that are not doing enough and others are really pushing forward quickly. More generally, I am surprised that – despite all the information available – real estate worldwide isn’t further ahead than it is.”
Bayerische Versorgungskammer (BVK), the largest German pension fund with total assets of more than €100 billion and an allocation of 24 percent to real estate, is a major institutional investor with a stated net zero target. “The overall plan for BVK is to be carbon neutral across all asset classes by 2050,” says Rainer Komenda, head of real estate investment management at the pension fund. “We are at the preliminary stage of analyzing the portfolio and gathering information from our managers so we can plot a roadmap to achieve that target.”
“Talking to peers, it is clear that institutional investors are setting the baseline and looking at their portfolios to understand their carbon intensity and working on their own roadmap.”
With a global portfolio, BVK does not differentiate between different geographies, he explains, “because we have a goal as BVK to achieve.” But, of course, “different regions come with different climate risks and different regulatory issues, which is something we really need to consider.”
Institutional commitment to decarbonization varies around the world, but Europe is generally regarded as the leader. “Europe is at the top end, and the further north you go in Europe, the more sophisticated the approach. US and Asia are probably at the same level but Europe is leading,” says Komenda.
Gibson claims that Macquarie Asset Management’s data backs this up. “Our investor surveys in 2021 show 70 percent of European investors have a dedicated ESG function, for example. And generally the further north you go in Europe, the higher decarbonization is as a priority. Perhaps a few years ago, sustainability was often driven by a few concerned and knowledgeable individuals within an organization and a lot of education was needed internally. Now, in most cases, we have moved beyond that.”
There is also a difference between larger and smaller organizations. Komenda argues that “generally, larger investors are further ahead because this process takes resources.”
But van Oostrom disagrees: “Larger organizations certainly have more resources which helps with things like reporting, but smaller organizations can move faster, so I don’t think it is necessarily the case that larger investors are always further ahead.”
Targets and pathways are the macro approach to net zero, but real estate portfolios will require a micro approach, which analyses every holding to see how it fits or can be made to fit with an institution’s overall ambitions.
Gibson says: “There’s a discovery process going on amongst investors as they interrogate their portfolios, partners and managers to see where they are on their portfolio’s emissions profile and what they need to do to get to net zero.”
Sustainability is a key consideration for asset acquisition, says Komenda. “We are gearing towards a carbon-neutral, environmentally friendly portfolio, so that is one of the hallmarks we are considering with new investments.
“However, it's not about just buying new assets, but also the hard work on the current portfolio. We need to see either we can transform something into a next-generation asset, or the ultimate solution could also be an exit on an asset, which we would not find appropriate for the future of BVK.”
The concept of carbon obsolescence is relatively new, but will become more and more important as corporate occupiers turn to more sustainable assets in order to meet their own net-zero targets and the demands of their staff. “The velocity of obsolescence is accelerating,” says Gibson. “For an existing portfolio or a building, investors are trying to understand what the net zero transition may look like. That work is ongoing and it's a long journey, as there is a lot of real estate out there.”
Larger European institutions have been asking for more from their partners in terms of sustainability for some time. Komenda says that BVK has “included an ESG questionnaire for more than 10 years in our manager beauty contest process, but this has gained a lot more traction and importance in the past three to four years.
“Three years ago we asked all our managers to participate in GRESB. I think that's really helpful to get better data alignment and to have a good comparison between different regions, different sectors, different geographies, different styles, and get a good overview.”
Technology will be central to the real estate industry achieving its sustainability goals, especially in the field of data. Acquiring carbon data across a portfolio is the first stage of a net zero program, but it is not always easy across asset types and geographies. Komenda says: “One of the hottest topics is data, how best to source it and manage it across a portfolio – do you need an external adviser?”
There is a perception that a greater focus on sustainability will benefit those investors and managers with a long time horizon, as the portfolio work will take time and be costly. “One of the pillars of BVK and an advantage for us is that we have always been long-term investors,” says Komenda. “We always have a long-term horizon, and the bulk of the portfolio is long-term hold.”
Gibson adds: “Technology is a challenge for many organizations because there are many platforms out there and it can be tough to assess them unless you have the knowledge skill-set to do so. Everyone dreams of having one system that can do it all, but in practice investors are having to assess multiple platforms and how they might work together.”
Even as more and more investors are aligning themselves with net zero, the concept of sustainability in real estate is still developing. Most investors comprehend operational carbon as a topic, but the real estate industry is increasingly looking at embodied carbon, the emissions caused by the construction of a building. Factoring in embodied carbon can make ground-up development less attractive compared with refurbishment, for example.
EDGE is one of only a few developers that have pledged to achieve net zero for both operational and embodied carbon in new developments, which will mean greater use of recycled and renewable materials and developing circular economy principals.
Van Oostrom says the pace of change will accelerate and that asset owners need to keep up: “In order to accelerate the decarbonization process, asset owners need to think about entire portfolios, not just take one building at a time. In the future, there will be a greater bifurcation between winners and losers as climate change accelerates.”
Institutional real estate investors are going to need to lean heavily on their partners and investment managers if they are to meet their net-zero targets. Komenda says: “We do see a lot of managers doing more and more; the transformation process is really gaining speed. However, we would like to see managers moving faster in taking on this challenge.”
Despite the size of the challenge, it also presents an opportunity, says Gibson. “We think there's a lot of opportunity in that space, as asset owners undertake this process of discovery about what is needed in their portfolios. There will be portfolios with problems, of course, but we see smart investors saying ‘there is an opportunity for us to lead’ and turning capital towards that.”
This article was first published by PERE in October 2022 and is reproduced here with permission.
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