Sustainable and responsible investment in real estate: a fiduciary duty?

As a prime target for government intervention, investors should look at the environmental impact on property assets.

Real estate, through its construction, use and demolition, is responsible for around 30-40% of global carbon emissions. Indeed, the Intergovernmental Panel on Climate Change identified buildings as offering the most significant opportunity for cost-effective emissions reductions worldwide. With real estate now a key constituent of most institutional investors’ portfolios at around 10% of their overall assets, we believe that there is a very real opportunity for real estate to play a much more significant role for concerned investors wishing to support a reduction in greenhouse emissions. This article examines the argument that it is the fiduciary duty of trustees and investors to understand and consider sustainable and responsible Investment (SRI) issues when looking at investing in real estate.
SRI can be defined as investment decisions and ownership practices that incorporate environmental, social and governance (ESG) issues into their investment decisions and ownership practices. SRI should also meet the investor’s financial goals and fiduciary responsibilities as these principles can affect the performance of their investment portfolios. Conceptuallyit is easy to understand the ethical case for investing in SRI real estate however occupiers and investors that will ultimately make the economic case for this type of investment (e.g. it can create brand value, reputation benefits, enhance capital growth and rental income, lower operating costs, improve tenant retention and lower depreciation costs compared to non sustainable buildings) will want to have the costs and benefits quantified as well as the intangible benefits. Regulation in the sector by policy-makers to act to curb future climate change levels is also increasing and will encourage real estate owners to adapt their assets to SRI criteria. This should mean that by investing in sustainable or “future-proofed” buildings, real estate owners over time have a better chance of securing higher values and better returns.
However, investors need hard evidence in order to justify such investment decisions. Research in this sector is increasing and the evidence supporting the case for SRI in real estate includes:
• A study of 7,488 US buildings that met certain green building standards demonstrated that they generated
higher occupancy by 7.5%; higher rents of 6-9%; and higher selling prices than buildings that did not meet the green criteria of 16-17%.
• Another study found that although there is an initial 2% higher cost of construction for energy- efficient and sustainable buildings, the financial benefits over the lifetime of the asset outweigh these additional costs through reduced operating costs of 8-9%, increased building values of 7.5% and occupancy rates increased by 3.5%
• Other studies found that sustainable buildings can save 25-30% in energy costs compared with buildings that do not meet a green building standard with a payback of three to five years. These buildings can also provide significant health and productivity benefits .
• When surveyed 79% of occupiers in the finance and business service sector said that they would be willing to pay more for a ‘green’ building e.g. through higher rents .

A recent survey also found that 95% of UK real estate fund managers perceived there to be a link between environmental practice and financial returns . Finally, there will be a tipping point which, according to the survey: “…will reach the critical mass when green buildings account for enough of the building stock that tenants have a choice. At this point, the performance premiums for green buildings will flip to a discount for older, less efficient, conventional buildings. We are at or near this point. Ignoring this impending market transformation would be risky and imprudent, and the current recession will provide little cover to ownersfailing to adapt.” We strongly believe that the evidence cannot be ignored, and that trustees and investors need to consider the SRI criteria of their real estate investments in their decision-making. The next question to address is: How can investors access this market? There are numerous ways to invest in SRI equity products, however the investment universe for real estate is much more limited. The market for SRI equity products is well-established. SRI equity products make up 17.5% of the total equities asset management industry in Europe having reached Euro 2.7 trillion in 2007. This demonstrates growth of 102% since 2005 . SRI equity investment has also delivered financial outperformance. The average SRI equity fund outperformed the MSCI World Index by 36% over the last five years. The SRI real estate market, however, is much less mature and the question of what real estate products which incorporate SRI principles are available needs to be addressed. Looking at the UK market there is no real route for retail or high net worth investors to invest and only a limited market for institutional investors. Institutional investors have the choice of a few pooled fund products which include the igloo (an Aviva Investors Fund), Bridges, Climate Change Capital, Carbon Trust and Triodos funds. Companies such as PRUPIM and Hermes have their own internal portfolios which adhere to SRI principles. However these are not accessible to outside investors. Demand for SRI real estate investment is growing; for example the West Midlands Pensions Authority has allocated part of their

portfolio to SRI real estate investment. Their main objective is to invest in assets that generate consistent and strong returns that adhere to SRI and good governance practices. They are not alone. CalPERS and CalSTRS in the US, the Universities Superannuation Scheme in the UK and VicSuper (an Australian A$3.3bn superannuation fund which awarded a direct property investment mandate to a fund manager on the basis of the fund manager’s sustainability credentials) take this type of investment seriously and engage positively within a SRI framework. Developments to date indicate that there will be increasing demand for SRI real estate investment products as investors seek to hold a “future-proofed” real estate portfolio. We currently live in difficult economic times and as a result we need to address the question of whether SRI real estate investment is viable or indeed whether it remains on the corporate agendas of trustees, investors and property companies. There are strong reasons to believe that SRI investment in real estate is here for the long run. Two principal reasons are the political and social will to tackle climate change as well as the potential energy crises. As a result we believe that SRI investment is unlikely to be sidelined by short-term economic difficulties. Real estate will remain a prime target for policy action e.g. the UK’s carbon disclosure project will increase institutional investors’ awareness of their fiduciary responsibilities to address climate change risk in the built environment. There isalso pressure on tenants and investors to behave in an environmentally and socially responsible way. This has not diminished in the current economic environment and may have actually increased, for example by increasing pressure on reductions in energy usage. In addition as governments find that their resources to tackle these issues are finite, they will increasingly look to the private sector for assistance. Therefore there is strong evidence that SRI in real estate is here to stay. In conclusion, pension schemes, trustees and investors with interests in real estate have a vested interest in the long-term health of the world and its resources. If SRI investment in real estate can deliver equivalent or superior returns, or at the very least, future-proof one’s investment, then it is the fiduciary responsibility of trustees and investors to understand the implications of these issues and to seek economic ways to improve the sustainable assets and funds they buy and hold . Trustees and investors should seek to divert capital towards investment in sustainable real estate (e.g. through a pooled fund with SRI characteristics) and can help set the agenda of long-term
sustainable investment. By doing this they will be undertaking their fiduciary duty to protect the long-term financial futures of their members and investors.
Hoong Wey Woon is a Fund Manager at Aviva Investors.