The arrival of ESG assessments in the last few decades has transformed the industry. So much so, in fact, that a property deal could be won or lost on an ESG scorecard.

“Some investors will tell you that it is a ‘no go’ if a building falls short of a certain ESG standard,” says Etienne Dupuy, managing director of asset management Europe at Invesco Real Estate.

Although the ESG formula has three pillars, the emphasis remains on the green leg. Energy efficiency is often improved by better harnessing a property’s passive design characteristics — its direct and indirect sunlight, natural ventilation, and solar power.

One example of this technique is an office tower refurbishment in Frankfurt, which Benson Elliot recently sold for €155 million after adding floor-to-ceiling glazing and a double-height reception. Another is redesign carried out by Savills Investment Management, which involved the addition of photo-voltaic-ready roofs and rainwater harvesting technology to an industrial property in Oxfordshire, south east England.

The dilemma faced by most owners, however, is how to add value while keeping costs in check. Throwing money at an existing or new building in order to give it a higher ESG rating may add shine, but it can also send the rent bill through the roof.

“Not everything that can be done, should be done when it comes to retrofitting properties. Tenants do not appreciate excessively high leases, after all,” says Tilmann Weeth, head of portfolio management at German property manager Accom.

Staying in the race

Industry benchmarks and best practices are setting the bar on what type of ESG policy to adopt. Real estate owners are also looking at what their peers have done in order to determine their own policy.

This might help them get ahead of the competition, and differentiate their product on the market, but it is also pitting investors and managers against each other in a race to meet the highest ESG standards. Some see this process as being more trouble than it is worth. This is particularly true when it comes to existing buildings. These can throw up some unpleasant surprises in the refitting process, such as the uncovering of hazardous materials that must be then dealt with in accordance with health and safety procedures. Another problem is that many existing structures only allow limited scope for improvement.

“Modern energy and sustainability strategies focus on a passive first approach to reduce thermal and electrical demand,” says Angela Reid, director and environmental engineer at TUV SUD Real Estate. “In refurbishment projects the design elements that can influence the passive performance are often heavily constrained by the site location and existing structure.”

Sometimes a property manager may take the necessary steps for a refit, but later on change their plans if costs get out of hand.

This was the case recently in Milan for Invesco, where the manager had a well-rated building with an automatic smart heating control system, explains Dupuy.

The building’s temperature was regulated by moving shades on the windows, controlling the amount of sunlight entering the area. “It was completely automated but too expensive to run. Ultimately, you want the user to be smart and activate the system when needed. And this is what we did. We shouldn’t get too technical, we shouldn’t believe too much in automation,” says Dupuy.

“The notion is that with smart buildings you can up ESG levels. At the end of the day, however, the best way to do it is with human beings,” he adds.

Although technology plays a pivotal role in ESG, the solutions don’t always have to be complicated and expensive — innovation can go a long way.

Lucy Auden, global head of ESG at Savills Investment Management, explains that one fix could be as simple as adding a bike rack to the front of a building.

“This encourages carbon neutral travel and promotes the health and wellbeing of workers,” she says.

The social element

Although most of the talk on ESG focuses on a property’s environmental impact, there is a growing role for its social element. Tenants are eager to keep employees happy — and their performances high — by demanding features that benefit staff members. Some property managers see this as being the secret to locking in a top-notch tenant.

In Manchester, Hermes Investment Management has developed a 20-acre regeneration project, providing new offices, homes, hotels, retail and leisure as well as urban spaces. Called NOMA, it is the largest development in north-west England. Amazon has leased the six-floor Hanover building in NOMA, its first major hub outside of London. Included in the development is Plant NOMA, an open design studio and exhibition space, which is linked to local schools, businesses, community groups and Manchester Metropolitan University.

“Tenants’ interest in the quality of their office space has grown with the increased awareness from their employees on environmental and health matters,” says Tatiana Bosteels, director, responsibility, and head of responsible property investment, Hermes Investment Management. “Health and wellbeing in commercial buildings is becoming a more important aspect of tenants’ office selection.”

Moving target

Another issue to overcome is that surrounding the rules and practices on ESG standards, which are being constantly updated.

“It is a challenge to stay on top of what is a fast emerging topic,” says Joseph De Leo, a senior partner at Benson Elliot.

There are a number of groups that certify the ESG performance of a property.

In 1990, BREEAM provided the first sustainability assessment for buildings with its certification on new constructions. Since then, the scheme has been updated nine times. These changes have seen a substantial evolution in standards and practices, says Tim Bevan, director at BREEAM operations.

Every two to three years, BREEAM updates its scheme versions in order to keep ahead of standard practice and reflect changes in the industry. The latest round of updates are currently in progress. In 2018, the BREEAM new construction certification scheme was updated and now the standards for its existing buildings and infrastructure scheme are being improved. These changes will come into effect this year.

“What is a very good or excellent rating now, might not be the case further down the track, because standards do evolve and change,” says Bevan. “So if interventions are not completed or targeted to sustain performance ratings, they can fall over time.

“It’s analogous to an old car; eventually it’ll fail an emissions test as the test standards get tighter every few years.”

The introduction of GRESB has provided an extra tool to institutional investors, assessing the ESG performance of a portfolio of real estate, rather than a single building. However, one of the complaints charged at GRESB is that it only provides a limited snapshot of a portfolio’s performance.

Some portfolio managers are complaining that GRESB ratings fail to take into account properties that have been upgraded and subsequently sold, focusing only on current assets they hold. Some of these existing properties may have yet to be improved, resulting in a low GRESB rating for the portfolio. This can put off investors that are demanding answers if ESG scorecards are not up to scratch.

“Some investors are very interested in the ESG performance of portfolios, particularly the Nordic and Dutch investment funds, and will want to understand the reasons for any under-performance,” says Nina Reid, director of responsible property investment, M&G Real Estate.

As a result, the onus is on property owners to better explain their results. Auden says that managers need to “inform the client of the strategy they have adopted, that leaves them with properties that need work to boost ratings.”

GRESB points out that all assets purchased and sold are included in each assessment period that has a 12-month duration. Any asset sales conducted prior to this reporting period, however, are not taken into account.

“The annual GRESB assessment includes all assets that are held during the reporting period, including those that have been sold or purchased,” says Claudia Gonella, GRESB’s marketing and communication director. “For these assets, ESG data is reported for the period of time that the assets were part of the portfolio,” she says.

There are voices calling for improved assessment methods that will boost transparency for industry participants.

Philippe Deloffre, head of real estate debt at BNP Paribas Asset Management, says there is a need for “better coordination of ESG standards” at a European level among investors and asset managers.

“Maybe some sort of uniform guidance that will help investors gain a better understanding of what is being done and what is needed,” he says.

In January, the UK’s Investment Association, a trade body that represents asset managers, launched the first industry-wide consultation on sustainability and responsible investment. The aim “is to bring greater clarity that will help savers and investors navigate and better access this growing feature of the investment industry,” says the group.

Another concern among commentators is the inconsistent pace at which responsible investing is developing.

Scandinavian countries are leading the world with their ESG profiles, outperforming countries such as Germany and the United States, according to data collected by investment firm Robeco SAM. At the same time, some stakeholders appear to have a good grasp of ESG procedures, while others do not. Banks, points out Deloffre, are less advanced than property owners.

“As a heavily regulated sector, the banking system is still in the process of integrating ESG into lending policy. There is more that needs to be done on valuing positive ESG practice within loans,” he says.

“It will take up to a decade or so until there is a uniform policy on this across countries, asset classes and investors,” adds Deloffre.

In the meantime, whether fair or not, the ESG race goes on.

Stelios Bouras is a freelance journalist based in Athens, Greece.