A rising number of cases of greenwashing in the real estate sector offers challenges for asset owners who want properly environmentally friendly property portfolios. However, there are ways for these investors to minimise the risks of cheating, say real estate experts.
Real estate greenwashing – or marketing a property as having a low carbon footprint and being water and energy-efficient when it isn’t – has become increasingly prevalent since ESG (environmental, sustainability, governance) became a popular concept in the investment world.
In its annual letter, the Danish Financial Supervisory Authority’s voiced concerns over the risk of property greenwashing, while noting that a “well-functioning market for green mortgage bonds”, could be difficult to build if there is insufficient real estate to meet future climate requirements, IPE reported.
Asset owners seeking to ensure their real estate investments are both resilient to climate change and genuinely sustainable need to seek information via different metrics.
“Where performance ratings don’t exist, it is harder for investors to do due diligence but the actual energy and water consumption of the buildings should always be examined,” Abigail Dean, head of sustainability of Nuveen Real Estate, told AsianInvestor. Geographies with fewer global tenants also tend to have lower market demand for sustainability standards in buildings, she said.
“It is important that investors consider actual sustainability performance of buildings – such as the Nabers [National Australian Built Environment Rating System] rating in Australia,” Dean added.
Experts consider the US, Europe and Australia to have relatively developed ESG frameworks for real estate investments.
In addition to ensuring that policy and related ESG risks are reflected in a property’s current pricing, investors should conduct due diligence to “differentiate between ‘box ticking’ ESG and a genuine consideration of risks likely to impact future cash flows,” noted Paul Kennedy, head of strategy and portfolio manager for real estate Europe, JP Morgan Asset Management.
This is, however, not just an investment process.
In addition to core variables of a property's potential cashflow - including costs, revenues and risks associated with policy changes - a sucessful and sustainable real estate investment considers also how ESG elements can be applied to the building, Kennedy said, such as helping tenants enhance their environment.
“Ongoing asset management work should ensure that changes in regulations are anticipated and included in business planning,” he added.
ESG PLUS VALUE ADD?
These needs are growing across the region. “Institutional investors in Japan, Singapore and Hong Kong are starting to engage in ESG,” Dean said.
Asian institutional investors are also increasingly interested in value-add properties, or buildings that require some investment to improve but offer a potentially higher renting and re-sale value afterwards. That makes it likely that they increasingly look to add sustainability elements to value-add strategies.
It would also mean that when investors consider a building’s potential rental cash flow they consider the costs of due diligence work to stave off a building’s “greenwashing” risks and post-investment efforts to keep it sufficiently sustainable.
One valid way to mix value-add strategy with ESG principles would be to focus on investing in the energy efficiency, health and wellbeing performance and other relevant elements of buildings that don’t currently perform well based on these benchmarks.
“A specific capital expenditure programme would be put in place to achieve the desired sustainability performance standard,” Dean said.
Other property experts argue that doing so is ultimately worth the time and cost.
“The returns themselves will depend on the asset, sector and market, but good ESG considerations and initiatives will help mitigate risk, better future-proof an investment and increase value-creation,” Shaman Chellaram, a senior director for Colliers International, told AsianInvestor.
There is some evidence that pursuing these efforts is financially worthwhile, too. A 2017 study on sustainability by financial academics found that real estate investment trusts with a more sustainable portfolio had "higher rental income, higher operating expenses, and lower interest expenses, increasing cash flows available for distribution to shareholders".
However, Dean cautioned that investors should be cautious when committing to value-add strategy that consider ESG principles in geographies where market demand for sustainability standards is lower.
“There would be a risk that an investment in the sustainability performance of the building would not be valued by the market,” he noted.
HEIGHTENED CLIMATE RISKS
The importance of considering ESG when investing in property is evident.
While the world has shifted focus to the coronavirus outbreak, the conflagration in Australian is still raging to this day, destroying acres after acres of homes, farmland and natural habitat.
“We are very sad about the bushfire this time ... while Australia has historically had this issue, like in California, this is the worst we have ever seen,” said Elaine Chow, Hong Kong-based managing director of family office Trinity Capital.
The ongoing bushfire once again reminds investors climate risk is not to be ignored. For those with exposure to real estate, these risks can potentially knock off a sizeable chunk of returns, either through damages inflicted to the assets or asset repricing.
In Florida, for example, estimates based on past trends suggest that losses from flooding could devalue exposed homes by $30 billion to $80 billion, or about 15% to 35%, by 2050, all else being equal, according to a McKinsey Global Institute report published earlier in January.
In addition academics have expressed worries over future insurability of properties; Jason Thistlethwaite, professor of environment and economics at the University of Waterloo, believed that climate change will lead to entire beachfront, low-lying or storm-prone neighbourhoods being excluded from insurance policies.
So for real estate investors, it’s increasingly important to review the presence of such risks in their portfolios.
“In all instances, the key questions that investors will need to address are: is the climate risk sufficiently factored into the cost?” Nuveen Real Estate’s Dean said.
By starting to integrate ESG principles into properties, investors could potentially help curb climate change and potentially reduce the vulnerability of their property portfolios to climate risks.