In recent years, there has been a proliferation of new funds across broader shares and fixed income with a Socially Responsible Investing (SRI) or Environmental, Social and Governance (ESG) focus.
However, to date, there has been seemingly little innovation within the listed property sector with no overtly dedicated ESG/SRI property funds yet to launch into the Australian market.
This begs the question from investors: Can listed property form part of an ESG aware, diversified multi-asset portfolio?
Simply put, we believe the answer is yes. However, investors need to be aware that in property, the extent to which asset owners and operators are active in ESG related issues looks visibly different to many other asset classes such as general shares.
There are three fundamental factors within a broader ESG framework:
Environmental – includes an assessment of a company’s current impact on the environment or potential to damage the environment through current operations.
Social – focuses on a company’s current impact on society. For example, does the company operate in
an industry that benefits the community? Does the company have a strong health and safety track record?
Governance – focuses on how the business is managed by assessing the company’s board structure,
ownership structure and whether staff are appropriately incentivised.
Differences in approaches arise from the extent to which different managers focus on each of these ESG factors and the fund’s objectives relating to these factors. These approaches can be broadly summarised as follows:
The presence of physical assets and their active management is the driver of REIT returns. This focus on physical operations is a key reason why we view REITs as differentiated to general shares on an ESG basis.
To understand how our active REIT managers consider ESG, we have looked separately at the physical assets, and the behaviours and policies of the REITs themselves in actively managing their properties. These activities have been further divided between those specific to asset owners, managers, developers and the corporate considerations common to both REITs and general shares which are largely governance-related.
Conceptually, the purpose of considering ESG factors is to encourage responsible corporate behaviour, which results in firms reducing negative externalities. While the magnitude may change depending on several factors, it is widely accepted that physical properties attract a ‘green premium’ when they have attributes like favourable resource and energy efficiency. This premium can be reflected across several factors including:
Given that the presence of physical assets and their active management is the driver of REIT returns, property owners, managers and developers are increasingly economically motivated to act on these environmental factors, this, regardless of an investors’ environmental views. As such, the environmental externalities are somewhat reduced, and these considerations are reflected in the economic value of the assets.
With these factors in mind, from a physical asset perspective, real estate owners are already increasingly aware of and acting on, a range of ESG factors. While these factors are often different to those commonly used in negative ESG screens for general shares such as tobacco, controversial weapon manufacturers and heavy green-house gas emitters, they are nonetheless important tools in minimising negative impacts from a real estate perspective.
Governance has for many years been a significant consideration for all share investors. REIT managers are no different, taking their role as proxy owners seriously. Many managers seek guidance from proxy advisers, rather than taking a passive approach, with analyst and portfolio managers making the voting decisions on governance-related factors, like remuneration, independent boards, diversity of boards and ESG linked compensation are becoming increasingly important considerations.
Managers are also taking an active approach to engage with REITs outside of formal voting. This is where a considerable amount of the current ESG effort from fund managers is being implemented. Increasingly, analysts and portfolio managers are engaging and lobbying boards and management of REITs on a range of considerations with disclosure of environmental performance and adherence to ESG reporting standards becoming commonplace.
The Global Real Estate Sustainability Benchmark (GRESB) is an internationally recognised standards body responsible for the annual assessment and benchmarking of ESG performance of real assets around the world.
Australian property fared well in GRESB’s 2018 Real Estate Assessment, which covered 903 property companies, REITs, funds and developers. Within the assessment listed real estate respondents covered approximately 61% of the major REIT indices worldwide, including 75 of the top largest REITs by market capitalisation. Based on the high ratings in the latest GRESB scores, A-REITs are well placed to be leaders in ESG issues.
Given the Australian commercial property market is currently more advanced on ESG issues (at least when viewed through the GRESB framework), we believe that Australian based managers are fundamentally more ESG aware than their global counterparts.
While there are many sources of ESG data, there are challenges in using this information in a systematic way due to the difference in reporting standards across the ratings systems and countries. Also, the presence of smaller capitalisation stocks and ESG laggards across REIT markets means ESG disclosure is not as widespread as investment managers would like.
While the data sources provide a good starting point, they still often require further bottom-up research for verification purposes. In recent years, many asset management firms have been building dedicated ESG research functions to support investment teams across various asset classes. While viewing this as a positive, we do not think this precludes managers without specialist teams from influencing ESG outcomes in their funds.
While investors appear to have no readily available ESG/SRI options in property, we believe many A-REIT and G-REIT funds may potentially be included in an ESG aware, multi-asset portfolio. The overt identification of positive ESG attributes is difficult and it may appear that little activity is occurring. However, this belies the high level of action that is occurring along the value chain within real estate as an asset class.
By Dan Cave, Investment Analyst.