ESG is the acronym for Environmental, Social, and (Corporate) Governance, the 3 broad areas, of interest for what is termed “socially responsible investors.” They are investors who consider it important to incorporate their values into their selection of investments instead of considering the profitability and/or risk by an investment opportunity.
ESG and real estate
Once upon a time, real estate embodied the epitome of capitalism. The trend, however, is growing quite the opposite way. The application of ESG standards on real estate (notably by governments and developers in many developed countries) has shown that this asset class is also relevant when these guiding principles are being applied. Awareness is growing that real estate can have a significant social impact either through the form of rehabilitation of public spaces (indirectly attributing value to existing real estate), affordable housing, social housing, and care centers, or through an environmental focus investment on new buildings such as green buildings.
Vital for investors
The correlative appetite that investors have for ESG, closes the loophole where more (long term) value is attributed to real estate assets. Medium-to-long term profit is therefore considered and kept with the usual lower risk volatility of a real estate asset. Sustainability has become increasingly vital to real estate investors. ESG is therefore here to stay and will increasingly shape and influence real estate valuation, and therefore real estate investment, as investors wish to allocate their commitments under this banner.
Impact on the community
However, the impact of ESG on the real estate industry goes beyond what is mentioned above. ESG, aside from fostering eco-friendly buildings, also allows space to include considerations about the impact of properties on the community, covering aspects like diversity. The real estate industry must respond to this challenge by creating opportunities through social impact investing, like multitenant shared spaces or the transformation of underutilized buildings into enthusiastic venues. In practice, the major obstacle is that investors will need to reinvent their traditional investment models to match the needs of the local community.
Environmental, Social and Governance as a value driver
ESG and infrastructure
Obviously, real estate and infrastructure are closely related. For example, the real estate industry is a major consumer of energy. Therefore, the construction of more sustainable buildings, e.g. by means of new eco-friendly materials or smart technological heating or ventilation, not only helps the environment, but it also boosts the return of the respective real estate investment, improving investment performance. Governments around the world are increasingly fostering these new construction methods to improve the carbon print of cities and emissions mitigation. Overcoming new infrastructural challenges
Implementing an efficient ESG-focused infrastructure system is vital for undeveloped countries – it provides access to the most basic services like energy and water for the community. Also, for developed countries, it may help to face new challenges, such as the increase of population in urban areas and the environmental concerns. Additionally, ESG standards are already proving to be decisive in infrastructure closings.
Smart cities
Another expression of the ESG impact on infrastructure is the so-called “Smart cities” initiative, which refers to urban areas for which different innovative technological methods are designed. The output generated by such methods can assure that city infrastructure is managed and organized more efficiently. Most of these methods are nowadays designed to allow ESG guidelines to span across the life of a city, in the respective assets, community services and resources, including better (and greener!) transportation, improved communication networks, optimization of energy consumption, water supply, crime detection and waste.
The backlash from COVID-19
It is relevant to understand how these concepts will develop in the midst of a worldwide pandemic. There is no doubt that the current pandemic has so far has affected how stakeholders look at vested assets and has slowed down further (real assets) investing. COVID-19 has severely impacted real estate valuations. At the same time, many transactions were put on hold as this pandemic seems to be shifting people’s demands for use of real assets, such as an increase in the search for bigger houses with gardens outside the urban areas, due to working from home). As much as the pandemic has slowed down economies and the real estate industry activity, the positive side of it is the wake-up call for investors to prioritize sustainable investments. The environmental factor
COVID-19 has brought out the environmental factor by enhancing the urgent global need to decrease pollution and improve precarious sanitation systems. In fact, the initial slow start of the adoption of ESG standards was probably built on the erroneous perception focusing on positive social impact would reduce financial return. It is becoming evident that it is indeed the opposite.
The social factor
However, the major spotlight is on the social factor: COVID-19 seems to be reshaping how the community should interact and behave from now on, which also calls for a revaluation of the current transport, technology and health infrastructures. This said, more than ever, it is key that millennial investors - as well as governments - not only focus on traditional financial metrics but also on their ESG performance in order to create a positive long-term impact.
Recent global developments
This reality brings us also to the consequent topic of a global increase of guidelines and regulations related to ESG investments. The United Nations have outlined 17 sustainable development goals in the UN 2030 Agenda for Sustainable Development, which must be achieved for a more global sustainable future. Also, these goals represent the current challenges worldwide: poverty, inequality, climate change, environmental degradation, peace and justice6. By adopting the Paris Agreement on climate change and the UN 2030 Agenda for Sustainable Development, the European Commission developed an Action Plan in March 2018 on different measures regarding financing sustainable growth. Transparency
As part of the Action Plan, Regulation (EU) 2019/2088 on sustainable Finance Disclosure regulation (SFDR) was published, which aims to provide more transparency on the degree of sustainability of financial products, to channel private investment towards sustainable investments while preventing green washing9. Its phase-in implementation will start on 2021. As a complement of this Regulation, the European Supervisory Authorities have developed a Joint Committee draft Regulatory Technical Standards (RTS) on ESG disclosures, for which a Consultation Paper was published in April 2020, seeking input on proposed ESG disclosure standards for financial market participants, advisers and products. Luxembourg is already taking relevant steps in this respect, such as the recent CSSF communication issued on 16th December 2020 on regulatory requirements and fast track procedure in relation to the SFDR Regulation. European Commission
Also as part of the Action Plan, last November the European Commission launched a public consultation on some of the criteria for determining which economic activities can qualify for the classification system for sustainable economic activities under the European Taxonomy Regulation that focus on climate change mitigation. Furthermore, the European Union published a Directive back in 2014, which requires big companies to disclose certain information about how they operate and manage social and environmental challenges. More developments
Some countries are exploring the green bonds market, such as Luxembourg and Germany. In this respect also note that the European Green Deal Investment Plan of 14 January 2020 announced that the Commission will establish an EU Green Bond Standard (GBS). Finally, the European Union is currently reviewing the regulation for the collective investment vehicle, the European Long Term Investments Funds (“ELTIFs”). ELTIFs are funds that attract institutional and private funding to channel their investments into long-term assets, including real estate assets such as nursing homes, schools, prisons, and social housing.
A successful “sustainability-proof” business
This said, it is expected that the regulation around ESG should continue to increase in detail. Investors will probably be impacted by ESG-related legal and regulatory disclosures, for which proper advising from experts may be needed. Also, there is no doubt that the global real estate market is already aware that ESG principles are key for sustainable investments.
