In our view, real estate is the asset class with amongst the strongest reasons for incorporating sustainability into investment decision-making. This stems from the strong link with financial performance, developments in the areas of investor requirements, government policies, tenant demand and the growth of smart data technologies. An ESG real estate strategy can preserve and enhance risk-adjusted returns and strengthen the investment process. With growing investor allocations to real estate, we examine the drivers that are strengthening the case for incorporating ESG in the real estate sector.
Compared to other asset classes, Deutsche AM’s (2015) extensive review of academic evidence in this area reveals that real estate has the strongest positive link between financial performance and ESG. As investor requirements for ESG integration continues to grow, real estate investors have rapidly adopted Global Real Estate Sustainability Benchmark (GRESB) for evaluating their portfolios’ approach to incorporating ESG in the investment process. We estimate that the global commercial real estate sector will need to make at least EUR 850 bn investment to reduce the energy use of their buildings over the next 15 years in order to play a fair role in implementing the Paris Climate Agreement (Deutsche AM analysis Dec 2016, IEA Nov 2014).
This article also undertakes a comparison between Deutsche AM’s recommended global geographic real estate portfolio allocation with a ranking of countries’ green building policies. We conclude that 29% of a model portfolio allocation is to countries with the strongest green building policies and 35% is to countries with the second strongest ranking of policies (Deutsche AM analysis Dec 2016).
Low-carbon policies covering buildings continue to expand and strengthen as governments seek cost-effective ways to reduce energy consumption for reasons of energy security, job creation and reducing carbon emissions. Government policies could accelerate low-carbon technology investment in commercial real estate by reforming building energy labels to include operational performance of buildings.
Energy labels should essentially become electronic building passports. Governments may increasingly set deadlines after which inefficient buildings will not be able to be sold/leased. Investors will have to invest to improve or sell their most inefficient buildings.
Tenant requirements are amongst the most important drivers for sustainability in the real estate sector.We expect this trend will continue, particularly as research shows that better indoor air quality can improve worker productivity by between 8 to 11% (World Green Building Council 2014).
From section 5 of this article, we conclude with a discussion of ‘new horizon’ issues that are growing in importance for the sector: