Why real estate investments are uniquely positioned for ESG impact

Head of Hazelview's European office shares how long-term view and regulatory focus drive thesis of sustainable property investing

Why real estate investments are uniquely positioned for ESG impact

While the events of the past year have in many ways brought pain and suffering to humanity, there have definitely been some blessings. Arguably the most significant has been the increased focus on sustainable investing from investors, corporations, and other private stakeholders now awake to the fact that the ills and inequalities in society are not self-resolving problems, and instead must be addressed through collective action.

Of course, sustainable investing is by no means a new movement. As noted by Claudia Floyd of Hazelview Investments, a real-estate investing company whose portfolio spans the world, ESG has been a driving influence behind many decisions in the residential space.

“ESG has definitely been on our radar for quite a long time,” said Floyd, a portfolio manager who heads up Hazelview’s European office. “On the analytical side, where we make our investment decisions, a lot of those ESG factors have become more and more important.”

According to Floyd, much of the action and reaction in ESG through the years has come through regulation in Europe, significantly from the emphasis on reducing carbon footprints driven by the Paris agreements. Regulators across the pond have focused a lot of their attention on the residential space, particularly in countries where a broader acceptance of renting as opposed to homeownership has given real estate companies and REITs a significant level of influence.

“REITS and companies focused on residential real estate have been partnering with the regulators to address some of the issues specifically impacting that space,” Floyd said. “As a real estate investment firm, if your portfolio includes thousands of properties across different countries, you have a much greater ability to explore different ways to improve your operations and processes in a way that supports ESG.”

From the environmental perspective, real estate firms can explore green energy solutions on a per-property basis. That includes managing electricity usage through apps, harnessing alternative energy sources like solar power or heat from data centres, more judicious use of insulation, or measuring the efficiency of lighting within a property. Wastewater and carbon emissions are also data points being measured.

The sustained focus on the environmental pillar has been instrumental in the growth of green bonds over the past few years. As Floyd explained, issuers of such bonds generally are able to enjoy lower financing costs, which leads to an increase in returns on investment.

“Social factors are a bit more complex,” she said. “Within real estate companies, it comes down to opportunities of diversity and labour rights. We’ve also tracked whether they have any social offers, and how frequently people leave, which allows them to retain value as it reduces the costs of training. And the more you know a company like we do, the better you can judge that.”

The value of social factors may also come in with respect to resolving difficulties in rent payments. For some tenants who are unable to make their monthly dues, the problem stems from a language barrier that hinders them from getting government aid they’re entitled to, in which case the landlord can step in and provide assistance, especially in cases where the tenant has been historically conscientious and trustworthy.

Going beyond specific tenant-landlord relationships, Floyd said real estate companies can also reap long-term benefits from becoming established pillars of the community. Embedding themselves and establishing goodwill through local engagement, she said, can make it easier to get approval for projects or rezoning requests from city and local officials, reducing risks and costs to future developments.

“We’re in the earlier stages of putting a number to social factors, but we can already feel or see its value in the returns of the capital market of the companies over long time periods,” Floyd said. “But this is becoming even more effective now. People will be increasingly conscious about putting money into companies that don't consider those concerns. In effect, those who invest in such companies will see them as riskier, which means they’ll have to offer a richer risk premium.”

There are also issues to consider from a governance standpoint. Aside from questions of corruption, executive pay, ownership, and control, real estate companies are feeling the effects of a broader push for better diversity and gender representation at the board level. Diversity regulations are generally applied in Europe, though they aren’t much of a concern; real estate companies in certain Asian jurisdictions, Floyd said, generally require more encouragement.

Tracking ESG data and performance, she added, has become a key concern for European firms who seek to attract institutional investment. The European experience already shows how money flows can be influenced not just by a demonstrated history and potential for returns, but also compliance with regulatory standards defined by non-financial factors. Frameworks such as those established through the Paris agreements, as well as the UN Sustainable Development Goals and the new EU taxonomy for sustainable activities, have quickly become targets to hit for European companies, as well as North American equity and debt issuers who do not want to fall behind.

“That’s the type of data that we hope to track and see in company reports,” Floyd said. “That makes it clear where a company ranks and how they have improved. As of now, we’re seeing data with time periods of three to five years, which is not that long, but long enough to give an idea of trends and the pace of progress.”

The increased diversity in non-financial data, Floyd said, will create a complex balancing act for real estate companies to navigate. While older housing stock may be unfavourable in terms of their energy grade, the decision to tear them down must be weighed against the resulting social impact. In a similar manner, she said property firms must consider taking on the costs of complying with environmental regulations, while at the same time not pushing rental prices up beyond what tenants can bear.

And while there is no universally excepted benchmark for sustainability reporting at the moment, the widely accepted wisdom is that companies should strive for transparency to let investors make fully informed comparisons and decisions. That can be an issue for smaller real estate companies without much experience in tracking non-financial data, which is where large investor partners such as Hazelview may provide assistance and guidance on what frameworks to use.

“We at Hazelview are committed to bring more ESG information into the market and in a pragmatic way, without just relying on a green stamp,” Floyd said. “We want to dig a bit more into the detail.”


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