Shaping the future of investments: The influence of ESG on real estate funds

ESG stands for Environmental, Social and Governance. Among other applications, ESG metrics are used to assess all the non-financial related risks an organisation might face in its daily operations.

• The Environmental Pillar addresses greenhouse gases, air, water, and soil pollution emissions. It evaluates resource utilisation, such as a company's responsible management of water use, preference for recycled materials, and how effectively the company ensures that its products are cycled and fed back into the economy.
• The Social Pillar mandates companies to disclose their approaches to employee growth and development and good labour practices. This includes accountability for health and safety measures, product liability quality, safety reports and access to products and services for socially disadvantaged groups.
• Under the Governance Pillar, companies primarily report on ethics and values, accountability and transparency, shareholder rights, diversity within the board, and the methods used to compensate executives.

We stand at the crossroads of several global issues: climate change, the shift from a linear economy to a circular one and growing disparities. Investors, regulators, and other important stakeholders such as consumers and employees are demanding from businesses not just managing financial capital responsibly, but also uphold their duties towards the environment and society, supported by a robust governance structure. With an increasing number of investors weaving ESG factors into their investment strategies, ESG considerations have become even more critical in attracting both debt and equity capital.

Implications of ESG related regulations on real estate investment decisions

Whether or not they are specifically committed to ESG or sustainability, the Sustainable Finance Disclosure Regulation (SFDR) requires fund managers to disclose, at both the organisation and product (asset) level, how ESG factors are integrated into their investment processes.

ESG has shifted from a “nice to have” to a core part of real estate strategies in the past five years. Data suggests that buildings with an ESG strategy result in a higher yield (~10%), and A+ efficiency constructions reduce the cost of heating, cooling and hot water by 75%. Investments in green and climate-resilient buildings are already profitable, showcasing that ESG-linked real estate investments are not only possible but also beneficial.

ESG considerations for Real Estate Funds

Environmental

• Prioritising the use of timber over steel and concrete for greener building materials.
• Implementing innovative strategies for waste reduction, reuse, and adopting renewable energy sources to minimise property emissions.
• Incorporating PropTech innovations such as smart heating and ventilation into property development for enhanced efficiency.
• Incorporating solar energy systems for efficient and eco-friendly electric car charging solutions.
• Introducing sustainability clauses on waste, energy, water, and emissions into rental agreements. Increase tenant awareness with ESG guidebooks, regular meetings, newsletters, and satisfaction surveys to drive environmental responsibility.

Social

• Fostering diverse, inclusive environments at fund manager level and tenant communities, enhancing integration and success.
• Integrating workplace and residential wellness by incorporating natural light, air quality, and fitness facilities.
• Facilitating homeownership through affordable housing projects.

Governance

• Implementing robust data protection policies safeguarding personal and sensitive data.
• Driving societal impact via environmentally conscious initiatives, philanthropy, and ethical practices.
• Upholding a stringent code of ethics and core values to maintain business integrity.
• Enhancing decision-making through board diversity.
• Ensuring fair, transparent, and performance-tied executive compensation aligned with company objectives and shareholder interests.

A practical method for fund managers to measure their ESG performance is the adoption of Sustainability Scorecards which provide a visually engaging snapshot of the organisation/portfolio sustainability progress. They encapsulate strategic direction, key initiatives, commitments, targets, and related key performance indicators (KPIs). Established in 2009, the Global Real Estate Sustainability Benchmark (GRESB) has become a key indicator with increasing participation from real estate fund managers, delivering standardised and validated ESG data to financial markets.

Closing remark: exploring the Environmental Pillar is a good start for real estate fund managers

ESG related obligations have been recently introduced and real estate fund managers are still in doubt whether the full-scale adoption of ESG considerations will accelerate fundraising or rather increase regulatory costs and lead to capital outflows.

Nonetheless, it is undisputed that the green transition leaves no one behind and the European Green Deal must make Europe climate neutral by 2050. As a result, real estate fund managers need to face reality and initiate their ESG journey starting from the first Environmental Pillar.

The real estate sector, known for its significant carbon footprint, contributes to nearly 39% of global CO2 emissions, making it a major climate polluter. Given that 80% of the buildings expected to exist in 2050 are already constructed, decarbonising the existing stock becomes crucial. Governments and real estate developers shall prioritise energy efficiency solutions and retrofitting sustainable materials to achieve net-zero goals.

The transition to a global net-zero economy will lead to unprecedented capital reallocation, amounting to trillions of euros. This shift presents substantial opportunities for real estate fund managers to optimise returns by aligning with evolving regulations, investor and consumer demands.

Christos Malikkidis, Business & Legal Advisor, Royal Pine