Turmoil creates opportunity for wealthy to invest in green buildings
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Property investors may think they have enough to worry about right now, with the pandemic driving some commercial tenants to suspend rent payments while others consider whether they will need big office or retail space at all in future.
But the bleak outlook has a green-tinged silver lining. The market upheaval is creating opportunities to invest in environmentally sustainable buildings that will not only potentially make investors feel good but also deliver good financial returns. A recent report from property agent Savills cited the positive or neutral correlations that academics have found between sustainable investing and returns, and concluded “this is happening in real estate, too . . . it shows through in values.”
Research by asset manager M&G explains why: environmentally sustainable buildings have operating costs that are 31 basis points above average due to their use of new technologies, but achieve an extra 53 bps of rental yield — which means the cash flows for distribution to investors are 19 bps higher. For a building that would ordinarily have cash flows worth £100m, the increase works out at £190,000 — well worth having in an age of zero and near-zero interest rates.
For wealth managers, then — who have mainly considered carbon emissions when selecting equity holdings — considering environmental, social, and governance issues in property is a growing investment opportunity. Some managers say it will only become more important as the pandemic forces investors to rethink their asset allocation.
“In the post-Covid world, the importance of the environmental qualities of a property and the wellbeing of its occupants will accelerate as key metrics,” argues Zsolt Kohalmi, global head of real estate at Pictet Alternative Advisors, an arm of the Swiss bank. “Creating more environmentally- and occupier-friendly buildings will increasingly not be a plus, but rather a necessity for successful investors. Given real estate’s share of global carbon emissions — estimated at 39 per cent — this could be at least one positive outcome of the pandemic.”
Others agree. In a recent Q&A hosted by the FT’s Moral Money, participants noted that while construction was a major source of emissions in many countries, it was also an economic “multiplier” that could accelerate recovery from the virus — which create opportunities for erecting more green buildings. Similarly, campaigners at the Coalition for Climate Resilient Investment, an international alliance of fund managers and public bodies, have argued that Covid-19 shows the need to make the $90tn of global infrastructure investment required in the next ten years resilient to external shocks, principally climate change.
Investors do not need much persuading. Research carried out by Germany-based asset manager Warburg-HIH Invest this year found that 51 per cent of institutional investors globally now expect higher long-term returns on real estate where environmental criteria have been taken into account. Up to 70 per cent of these property investors said environmental, social and governance criteria were relevant to their decision making, or would be incorporated soon.
Pictet already takes this view. “ESG considerations are fundamental to our investment selection criteria,” says Kohalmi. “We look for opportunities to enhance any asset we buy through measures that reduce the asset’s carbon footprint. We believe that environmentally sound real estate will lead to better performance.”
Damian Payiatakis, head of sustainable and impact investing at Barclays Private Bank, also believes the trend to include ESG criteria is now being driven by returns. “Recent outperformance seen in sustainable liquid funds has provided the first live demonstration of the financial benefits of this approach,” he says.
For wealth managers’ clients, the choice is generally direct investment in low-emission sustainable property, or indirect exposure via funds. Minimum investment levels range from a few hundred pounds for retail managed funds to £25m for specialist private real estate funds.
Kohalmi focuses on buildings and their on-site technologies. “We are looking to reduce energy consumption through a combination of smart sensors, and — where possible — through generating our own energy via solar panels or on-site renewable generators,” he says.
At Swiss wealth management firm Tiedemann Constantia, chief executive Rob Weeber applies a similar approach in the low-cost housing sector. “By way of example, we have invested in private real estate funds focused on developing affordable housing, where the fund enhances returns by adopting energy efficiency measures that reduce energy use,” Weeber explains.
By contrast, Lydia Guett, investment director at Cambridge Associates, which manages portfolios for family offices, prefers to target the technologies themselves, via funds. “Energy management systems, green building systems or the upgrades to existing building stock towards climate resilience are opportunities that we expect to benefit from a transition to a low-carbon economy,” she argues. Investments are identified by incorporating ESG factors in the firm’s fund manager research.
Payiatakis at Barclays Private Bank does much the same but via private equity funds and alternative assets. One private equity fund he selected finances improvements to energy efficiency in real estate developments, industrial buildings, and infrastructure.
Others prefer to avoid equities and invest in other financial instruments, such as debt finance for green infrastructure. This is one way that HSBC Global Asset Management seeks to capture the opportunity. “We actively invest in renewable energy projects and sustainability is a key part of the credit assessments we make in our infrastructure debt investments,” says Melissa McDonald, its head of responsible investing.
Family office Stonehage Fleming thinks even more tangentially, and is considering high-yielding catastrophe bonds that fund insurers’ liabilities if climate events damage property and allow investors some protection for their investments in buildings. “Catastrophe insurance is interesting because it will help society price some of these risks, says Mona Shah, who launched Stonehage Fleming’s global sustainable investment portfolios. “Valuations and pricing in this space are attractive; however, it is a complicated space to understand with inherently unforeseeable risks.”
With the opportunities come challenges, though — not least verifying the sustainability of real estate investments. Cambridge Associates says it relies on proprietary data sources. But as Eduardo Martínez de Aragón, deputy general director of investments at the pension and insurance unit of Spain’s CaixaBank, points out, these can be scarce when dealing with private finance. “[These] investments present the complexity that they are made in non-listed companies and, hence, there is not much visibility of their ESG data.”
Even with managed property funds, the onus is on the wealth manager to check where the money is going. “The conundrum for us is that we can’t rely solely on managers doing ‘good things’ such as social infrastructure,” says Delyth Richards, client solutions group chief operating officer, and head of product strategy at Kleinwort Hambros, the wealth advisory arm of French bank Société Générale. “It has to be quantified by an independent body”. However, she admits that many of the assets are private and don’t disclose information to index providers and rating agencies.
It is therefore the adviser, as much as the real estate developer, who must do the spadework. It is worth it, maintains Kohalmi, as the return comes in two forms: “Both financially and in terms of the productivity and wellbeing of a property’s users.”
Not to mention, a feel-good bonus for investors.
This article is part of FT Wealth, a section providing in-depth coverage of philanthropy, entrepreneurs, family offices, as well as alternative and impact investment.