What did we learn from our first EVORA Insight’s lunch on the topic of how ESG is being integrated into investment decision-making?

The gap in expectations between the leaders and the majority of investment managers is huge. Even the leaders don’t think they are doing anywhere near enough. To be honest, it’s a little disheartening.

Organisational change and capacity building is being hampered by structural changes, which cannot be solved by each firm on their own. For instance, the historically low price of gas as a common fossil fuel, compared to electricity which can be net zero carbon, presents an affordability challenge. Also, the lack of availability of standardised and simplified ESG data to inform investment decisions and to understand the underlying risks. To gather ESG data, particularly for a whole building, is still a time-intensive process requiring active engagement with tenants and other stakeholders, without regulatory support in many countries.

However, there are choices that companies can make to include ESG factors as standard practice. To include ESG representation in the IC and to decide on ESG “red lines”. More often than not, assets are being acquired with little or no considerations of ESG risks and opportunities pre-transition. For some funds, this is the only opportunity to incorporate these factors and budget accordingly, particularly when future income could be compromised. Notwithstanding the need for ESG data to be readily available at the time of the transaction, during a period in the market when there is an insufficient supply of properties to meet the demands of available capital allowing little time to consider non-financial considerations.

We ask our clients to think about ESG over the timeframe of two hold periods – to consider how ESG will be priced into the exit value. There is little room to do this effectively under present market conditions, in part due to the uncertainty of how to interpret financial impacts of climate projections, and because pricing in that risk may result in losing the deal. There is anecdotal evidence of buyers winning and losing deals with risk-adjusted pricing, which most often appears to be through the incorporation of the costs of decarbonisation/adaptation measures or an adjustment to the cap rate at exit as a proxy for perceived future risk. More observational data is needed to understand under what conditions these price adjustments are and are not resulting in winning deals.

Some companies know that the reliance on GRESB ratings and EPC data, which don’t measure actual performance, is insufficient to understand the underlying risks and opportunities. Making the right investment decisions requires technical and operational insights, when there is a shortage of these skills and to get the right experience it requires support from multiple consultancies. However, it seems inevitable that certifications and ratings will continue to be used as a short cut.

With the background of the environmental sciences telling us that we are running out of time to tackle the global issues of climate change, destruction of biodiversity, and pollution of the land, water and air. Social inequalities are generating unrest in our communities. It has left us wondering how do we change the philosophical principles on which real asset investment has been grown on over the last 50-60 years. Is the only way forward a ratcheting up of regulations to force change, which would require proactive involvement from investment managers in policy discussions for finance, sustainability and buildings to be successful?

Over the last couple of years there have been reasons for optimism that real estate investment and finance is starting to change for the better, these include market indicators like:

  • Investor pressure to explain ESG and climate risk policies is increasing and tougher questions are being asked, although how this information is used in unclear
  • More individuals throughout real estate investment firms, and outside of the traditional sustainability team, are being required to take responsibility for ESG
  • ESG and climate risk are showing up on performance objectives for more staff
  • Valuers are starting to query for data on EPC ratings to incorporate into valuations, and market analysts are using this information to review income projections. 

So, looking ahead to 2050. When people look back to this period of change happening today and see what an exciting time we have lived through, will you be one of those who can say that you joined us to push ESG integration forwards successfully or will the transition come too late given the scale of the changes we have to make?