While the decarbonisation efforts of Real Estate Investment Trusts (REITs) have advanced reasonably well in the last five years, it’s what happens next that could be most meaningful for investors.
The investment opportunity for real estate is quite real and tangible when it comes to environmental considerations. We think this is only going to get more important as REITs align with higher standards expected of them by the communities and regulators.
The global property sector’s continuing alignment on Taskforce on Climate Related Financial Disclosures (TCFD)1 is an example of the kind of higher standard property companies are being held to.
Then there’s the standards investors like us are creating as we wait for official standards and benchmarks – including the World Business Council Green House Gas Emission Protocols – to catch up.
Operational carbon (scope 1 and 2) is now mostly measured across the listed REIT sector2. It’s the so called embodied carbon emissions (scope 3)3 that may end up surprising investors that haven’t assessed the impact of emissions in the full life-cycle of an asset when more stringent regulations are put in place.
We believe there is a direct link between Environmental, Social and Governance (ESG) alignment and long-term value for investors in listed property. And while we have been pleased with the developments made by the property sector to date, the work ahead on the environmental side is likely to be more meaningful for investors than ever.
Where the rubber hits the road
Think about modernisation programmes, for example. As renovations and upgrades continue, upgrades in technology and materials can lead to major improvements in a portfolio's energy and carbon efficiencies.
Modernisation can equate to lower ongoing tenant costs of occupation when viewed through the investor lens. Energy savings through modernisation programs typically get shared between landlords and tenants.
Improvements in energy efficiency through modernisation can also increase the “rentability” of buildings, leading to more secure cash flows.
Tracking and measuring the effectiveness of modernisation programmes and how these programmes translate into better cash flows and greater tenant demand can directly relate to investor outcomes.
Beyond modernisation, another emerging area of materiality for property investors are carbon offset programmes.
We expect carbon offsets to be a significant risk mitigating factor in coming years as carbon regulation gets rolled out.
Landlords with established high-quality offset programmes will be at less risk of increasing financial liabilities associated with the rising cost of carbon credits.
ESG has progressed, but there’s more to come
Overall, we consider ESG adoption to be a positive development in the property sector. Social disclosures have been improving, whilst corporate governance evaluations have been a mainstay for investors already now for many years.
We have had ESG considerations embedded in the investment process for a decade now and it’s clear to us there is a high correlation between these considerations and shareholder returns.
We believe there are no losers, broader society and the environment benefit, corporate culture strengthens, and so do employee and executive and shareholder outcomes.
We expect to see higher returns in the property sector attributable to the progress REITs are making on their energy and carbon efficiencies, as carbon emissions reduction programmes become more and more prevalent.
- https://www.unpri.org/infrastructure-and-other-real-assets/tcfd-for-real-assets-investors/7495.article
- Operational carbon is the carbon released from the ongoing operation of the building, including from sources such as power, heating, cooling, lighting, ventilation etcetera.
- https://ghgprotocol.org/standards/scope-3-standard
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