Climate change: Lead or follow, the role for real estate investors 


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Are real estate investors being driven towards investing in green buildings or do they have a leadership role to play in accelerating the sustainability agenda?

I was walking down the street with my young daughter and her friend and her friend started talking about how shocking it was to see the cherry blossom blooming in February. She’s 7-years old,” says Edmund Costello, Partner at Trinova Real Estate.
His is not an unusual story. The attitude of younger generations, the new and future employees of businesses occupying commercial space, is a driver for changing investor behaviour.

Occupiers are looking to occupy buildings that represent their business and the way they see what is important in the world,” says Costello. “It also helps them to attract talent, the type of space they occupy has a direct impact on the people they secure.”

Trinova’s investment strategy means buildings are now assessed on their existing environmental performance and what can be done to improve it. And it isn’t unique.
This approach could prove a canny move as regulations around sustainability are likely to change. It is not beyond the realms of possibility that the current minimum EPC E rating for buildings could be raised to D or even C in the future, rendering a whole swathe of stock unlettable. Given that new-build only makes up a very small proportion of total stock, it presents a huge challenge.
“Investors have to be thinking ahead to whether there is going to be legislation or a change in regulations. Their tenants could turn around and say: ‘When it comes to rent review, if you haven’t met the standards, I’ll expect that to be reflected in the rent you propose’,” says William Clements, Partner at Trowers & Hamlins.
What impact this is having on valuations is unclear. Some valuers are pricing in a ‘green premium’ or the cost of bringing buildings up to standards but not all.
Pressure to act is also coming from other sources. There is FCA consultation underway about climate-related disclosures and various steps have already been taken. But the biggest one that is going to affect institutions and real estate is the 2021 financial institution stress tests when all banks and insurers will be required to include climate-related risk.
The stress tests could, ultimately, result in lenders having to set aside more tier-one regulatory capital to protect their exposure to assets that have a higher climate risk associated with them.” says Katharine Lewis, Partner at Trowers & Hamlins.
They can say we want to see your clear plans to be carbon neutral at worst, carbon positive at best as a corporate entity in the next five years. Or we want to see you publish an annual sustainability audit of your portfolio,” he says.
A tool for measuring the legacy of a project
“This will push up the cost of capital for investors who are looking to borrow money which is potentially going to make a big difference to the industry,” she says.
A lot of institutional investors have signed up to a set of principles for responsible investing set out by the UN. These include incorporating environmental, social and corporate governance (ESG) issues into investment analysis, decision making and seeking appropriate disclosure by the entities into which they invest. Signatories must publicly report on their progress toward implementing the principles.
It’s a good step but for green developer Jonathan Smales, Founder of Human+Nature tougher regulations and a change in Government policies are essential for accelerating action and supporting those who already want to make a difference. However, he also believes that investors have the power to leverage change by their investment choices and the demands they make.
Some investors, such as Legal & General, have had a green agenda for many years and sustainability is part of the assessment process on investment decisions. As such it means that the cost associated with building to BREEAM excellence and making existing buildings sustainable is already priced into the equation.
Pete Gladwell, Head of Public Sector Partnerships at Legal & General says, “I think what has probably changed has been the urgency with which it’s being approached and specifically how we can move the dial more quickly. As an industry, we know more than we did five years ago.”
He believes advances in architecture, technology and the use of materials make it a genuinely exciting time adding, “What was considered acceptable before is no longer considered acceptable and that presents an opportunity to invest in lifting the bar.”
Legal & General is an example of where investors can lead the way. They develop to high ESG standards but also hold the developers they invest in to the same standard. Gladwell admits that having such a weight of capital and being a long-term investor looking for return over 10-20 years is a huge advantage because of the upfront costs associated with building sustainably or improving existing buildings performance.
It is clear that real estate investor priorities towards sustainable development and buildings are changing and for some, it is about choosing to lead and using their influence but even if it isn’t, it makes good long-term business sense.
While occupier demand is helping to drive the shift towards sustainable commercial buildings, with residential the younger generation has less urgency to influence that shift. They are mostly priced out of the market which means they can’t express a preference for the type of home and environment they’d like to live in.
“There is such a disjunction between young people’s aspirations as customers for housing and what the industry offers,” says Jonathan Smales, Founder of Human+Nature.
That offer, he says, is still dominated by volume housebuilders building relatively energy-efficient boxes typically in car-dependent, unsustainable locations.
“Change can’t come from the customer side but it can be led by the investor side, by good people,” he says.
Human+Nature has several projects underway which focus not just on energy-efficient homes but creating a community and environment that supports sustainable living. It is designed so that everything is within easy walking distance but importantly that the walk is a pleasant experience.
He says the economics for developing such a scheme are sound. If designed well you can use density to create appropriate scale, the challenge is convincing risk-averse investors to back such a scheme.
“It’s finding investors that will do everything a little bit differently in terms of urban design, mix of housing etc. when it’s been so easy to make so much money in the market. Why take risks? But I’m sure they will come.” 
Demand for greener homes
"I think there is some appeal for high net worth private investors to invest responsibly in environmentally ground-breaking projects because of a sense that they have a responsibility to give something back,” says William Clements, Partner at Trowers & Hamlins.
Positive legacies may drive change
Views from our Interlaw Partners
Amazon’s CEO Jeff Bezos recently announced that he was going to set up a fund with $10 billion of his own money to support “scientists, activists, NGOs, any effort that offers a real possibility to help preserve and protect the natural world.”
There are a lot of high net worth individuals and family money invested in real estate, could they lead way?
Such announcements as Bezos’ are good press and make people sit up and take notice but privately there might also be the strong compulsion to leave a positive legacy.
But as with a cash-rich individual like Bezos, it is easier to take risks, to put money in untested new models of development or put in more money upfront without worrying about the return.
“They are not going to lose any sleep if they lose money but they will be very happy if in years to come they are looked upon as being the people that paved the way and took the initial pain of weaker returns,” says Clements.

Views from our Interlaw Partners

Our firm is a member of Interlaw – a global elite network of independent law firms with lawyers based in over 150 cities worldwide. This means we are able to quickly draw on the legal expertise and knowledge of members to provide clients with the best international legal expertise.

International viewpoint: Australia
Hasti Kalarostaghi, Hunt & Hunt 
Are you seeing a change in investor priorities with regards to climate change and how is this impacting on their investment decisions?
Whilst climate change is becoming part of the discourse, we aren’t seeing any real change in investor behaviour or their priorities. Investment decisions are still driven by the rate of return and the availability of finance.
What would it take to make environmental impact a consideration?
Based on discussions with clients there would have to be a financial incentive (lower rates or other forms of allowances) that makes investing in environmentally sustainable property more attractive for investors.
There is currently a case in the Federal Court of Australia that may instigate a change in attitude and policy. In Australia, we have a compulsory contribution to a superannuation fund (retirement fund). This case relates to a member of a superannuation fund that has filed a suit against the superannuation fund alleging that the fund violated the Corporations Act 2001 by failing to provide information related to climate change business risks and any plans to address those risks. The case was filed in the Federal Court of Australia in July 2018 and is scheduled to be heard in July 2020. The outcome of this case can be a catalyst for change in the way that investors including super funds invest members’ funds.
Are there any particular types of investors that might lead the way?
Not really, it appears the younger investors such as the super fund member mentioned above might be a catalyst for change.
Do you foresee any further changes which might influence investor priorities in the future?
In Australia, three schemes are used to identify high performing built environments. NABERS (National Australian Built Environment Rating System) measures things like energy efficiency and all new buildings have to meet the minimum rating. Green Star and GRESB are voluntary schemes incorporating social value. These three schemes are intended to be utilised by investors to access green finance, however, there is not enough information available yet to assess how many investors have taken advantage of this.
International viewpoint: Brazil
Tiago Fantini Magalhães, Manucci Advogados
Are you seeing a change in investor priorities with regards to climate change and how is this impacting on their investment decisions?
Investors in Brazil are increasingly interested in funds that have only sustainable companies in their portfolio. In October last year, a brokerage located in the south of Brazil launched the first investment fund in sustainable companies. On the day of launch, there were already 8,000 people interested. The fund uses indexes such as Corporate Sustainability, Corporate Governance (IGC), Carbon Efficient (ICO2) and Social and Governance (ESG), from Reuters, and actions with high environmental scores for a selection of companies.
What would it take to make environmental impact a consideration?
The Canadian magazine “Corporate Knights” compiles and analyses the sustainability of global companies. In 2019, there were more than 7,500 companies with annual revenues exceeding US $1 billion. Four Brazilian companies were listed. From 2015 to 2019, the list of Brazilian companies has hardly changed and probably reflects a lack of attention to issues related to natural capital. But it is not just a Brazilian situation. The Brazilian government has retreated in its role, demonstrated by announcing its withdrawal from hosting the 2019 CoP. The Brazilian authorities view on climate issues was not welcomed by the world authorities.
What do you think could drive the change in priorities?
Coordinating human intelligence, efforts and nature so that business activities remain profitable, but also sustainable remains a challenge. 
Are any particular types of investors leading the way?
There is no clear leadership but there are specific funds for green investments and this has been mobilising entrepreneurs and investors in Brazil.
Do you foresee further changes which might influence investor priorities in the future?
The Brazilian legislator needs to be more forceful in the environmental aspect. There are initiatives, but they are not systematic and organised. It is important to encourage best practices and, on the other hand, to punish those who destroy the environment. The laws and public agencies are attentive, but there is a lack of a systemic structure that can put Brazil on a more adherent level.
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