The ULI analysis points at a complex, multi-layered series of overlapping trends, with unpredictable results, rather than a few strong narratives, at least in terms of traditional drivers of value. Unlike traditional, mainstream factors, environmental, social and governance (ESG) trends on the other hand – while also overlapping – may present a stronger, more predictable narrative in the next two to three years, and even further ahead than that. In the wake of concerning developments related to climate change in particular, there has been a renewed focus on sustainability in the building and construction industries. As calls to curb carbon emissions and control environmental impacts can only rise in the coming years, more and more investors and building managers and developers will make sustainable practices a core part of their business.
Real estate has been proactive on sustainability issues for many years and importantly, not just as a matter of self-interest or social responsibility; the sector is moving ahead to advance its sustainability performance, regardless of the direction of national and international policies. And the sector is starting to look beyond climate and energy related issues. The advent of the UN’s Sustainable Development Goals (SDGs)2 and a series of global megatrends may require the sector to think differently about how it approaches sustainability. In turn, investors and analysts in the real estate industry may need to broaden their horizons when developing ESG metrics in order to fully capture these new sustainable development challenges. The executive summary which follows, based on a full ESG trends report produced in partnership by La Française Forum Securities (LFFS) and Global Property Research (GPR) , examines the ways in which sustainability issues and megatrend themes will play a role in shaping the real estate market agenda. The report proposes some key areas of ESG focus, looking first at recent trends and the current state of play, and then discussing how these same trends may evolve over the medium to longer term. What should become clear is that a traditional approach to ESG – with a narrow focus on energy primarily, and related climate change issues, together with an increasing reliance on data driven models – may not be sufficient to understand and analyse future real estate company performance and stakeholder demands in relation to sustainable real estate.
A top-down approach to sustainable real estate analysis
The investment thesis underpinning the introduction of ESG factors into LFFS and GPR analysis of listed real estate companies is intended to reflect the complex and evolving sustainability challenges in the sector in the medium to longer term. We take a top-down approach and build indicators linked to the following aspects of sustainability, which we believe will be among the main drivers of value, risk and opportunity for listed real estate. They represent a series of global megatrends that will shape the future real estate landscape:3
- Urbanisation and town planning: fuelled by both overall population growth and internal and external migration. The UN projects a global urban population of 5 billion by 2030, with 90% of the growth coming from Asia and Africa;4
- A shift in economic centres of gravity and dynamism: from the developed markets of the OECD countries to the rising economies of China, India, and the rest of Asia; by 2050, six of the largest seven economies in the world will be found in emerging markets;5
- Changing societies and demographics: with particular needs for housing, health care, transportation, recreation, and social services;6
- Technological innovation and design: in construction methods and materials, smart cities, smart buildings, energy production and use, and so on. And in addition to green design, the need for healthy buildings will grow;
- Closer collaboration with key stakeholders, notably tenants, employees, local communities and regulators: whether in their capacity as regulators and policy-makers, or as key internal and external partners;
- The globalisation and intensification of real estate competition: The larger real estate companies are both expanding their property portfolios and extending their activities into new countries and regions;
- New market forces affecting ‘strategic governance’: Market trends are also changing, with new ways of shopping affecting retail for example, and diversification in real estate investing with interest in alternative real estate such as data centres. And linked to town planning and urbanisation, local communities want more integrated and sustainable living spaces;
- Rise of ESG standards and regulations: The real estate sector is awash with certification schemes and regulatory controls and targets, especially for climate change and building design, their coverage will continue to grow and new standards will be introduced;
- Growing concerns about sustainability: concerns about issues such as climate change, energy, biodiversity / land use, water and waste, have now expanded beyond government and civil society, and have also become a central preoccupation for institutional investors.
As it happens these nine megatrends intersect well with a number of SDGs that have been identified as highly relevant to real estate. The World Green Building Council has mapped Sustainable Development Goals7 (SDGs) to areas where real estate can make a contribution, and finds that nine of the SDGs can be transposed to the real estate sector. As can be seen in the graphic below, there is a nexus between the megatrends referred to above and the SDGs, with a number of shared themes covering issues such as sustainable cities and modern community / urban needs, global green and social partnerships, occupant health and well-being, and sustainability concerns around economic value, climate, energy, water stress, bio-diversity and waste.
An ESG rating model with a focus on qualitative assessments
Our research model aims at using a series of ESG indicators that evaluate the overall “strategic management quality” and leadership of both real estate investment trusts (REITs) and real estate operating companies (REOCs). REIT and REOC performance on these ESG indicators can reveal important insights about the value drivers listed above, and in turn help to assess a company’s ability to manage sustainability themes, at the strategic and operational / implementation levels. In our view, real estate companies demonstrating sustainability leadership tend to be more forward-looking, agile, adaptable, innovative, and sensitive to changes in the marketplace than their peers. By taking a top down approach to creating ESG indicators, our aim is to focus on the way that sustainable development is harnessed and implemented through a range of primarily qualitative factors such as corporate culture, board diversity (in terms of people and thought processes), management skills and foresightedness, communication, stakeholder engagement and responsiveness to change. While our ESG rating models do take into account data driven indicators, covering energy, carbon emissions, water use etc., we consider that an emphasis on, and analysis of, the qualitative aspects of sustainability has as much, validity than largely quantitative approaches, if not more so. A reliance on ESG data and tick box responses to forms and questionnaires may not provide a complete interpretation of performance on value drivers and risks and opportunities, which are based on SDG and megatrend narratives. Data also tend to be backward rather than forward-looking. In the table below, we link megatrends and SDGs together and then highlight some of the key ESG performance indicators (KPIs) used in our SRES rating model to assess company performance on megatrends and related SDG themes. Some of the KPIs are familiar to typical ESG rating models for real estate, others aims at being more innovative, for example looking to see if a company is responding to a megatrend theme such as health and well-being. For example, real estate companies specialising in healthcare, assisted living or retirement homes may be well-placed to meet a growing social need, which, if provided in a way that takes into account other sustainability themes like sound energy and climate management, could be an attractive investment proposition. Likewise, looking at the goal of sustainable cities, companies which take a holistic approach to ESG management will be ones which understand how their real estate offering can be integrated into a city’s overall urban plan, which may include good access to public transport, electric car charging points, provision of green spaces, modern ambient design and so on.
February 2019 – by Andy White, Senior Sustainability Consultant, La Française Forum Securities
3 IPCM White Paper (2017) – Future Proofing Listed Real Estate, Dr. Matthew Kiernan
4 UN Department of Economics and Social Affairs
5 PWC (2017) Shift of Global Economic Power
6 United Nations (2017) World Population Prospects: the 2017 Revisions