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ESG in real estate

INTERVIEW: Shared Accountability Crucial For A Sustainable Change in the Property Sector (Magazine)

INTERVIEW: Shared Accountability Crucial For A Sustainable Change in the Property Sector (Magazine)

June 21, 2021- Globally, climate change and environment risk are making their impact felt on asset valuations. Long term investors have started to consider climate change risk in their strategies. In particular, insurers are looking at flood risk from rising sea levels, while sovereign wealth and pension funds are pricing in carbon risk.

According to a CBRE report last year, 51 buildings, totalling about 20.8 million square feet (1.9 million square metres) of office space in Singapore’s Central Business District (CBD) are in high flood risk areas.

Against this backdrop, in December 2020, the Monetary Authority of Singapore (MAS) issued guidelines on environmental risk management for asset managers.

These guidelines outline the government’s expectations on environmental risk management for fund management companies and real estate investment trust (REIT) managers in the country. They include governance, strategy, research, portfolio construction, portfolio risk management, stewardship and disclosure of environmental risk information, among other aspects.

Cherine Fok, KPMG
Cherine Fok, Director of Sustainability Services, KPMG

REITAsiaPac caught up with Cherine Fok, Director of Sustainability Services and KPMG IMPACT for KPMG in Singapore, on the current climate of environmental consciousness in the property market and how the green revolution will change the investment strategies of asset managers and real estate investment trust (REIT) managers.

Q: How will the new regulatory measures revolutionise the investment strategies for asset managers?

A: The MAS guidelines require asset managers to review their portfolios and to be a lot more conversant on the topic of climate-related risk. This means that asset managers have to actively identify possible exposure of climate-related risk in their portfolios and manage the risk accordingly.

Physical climate risk involves elements that affect the physical infrastructure of the building. It hinges largely on where the building is located, the types of materials used, the structural foundation and whether the design and architecture have been adapted to address possible climate events. Some building designs across the world do incorporate climate considerations, but this is currently not a pervasive practice across the industry.

If a building has a high risk of exposure to climate-related risk, and has insufficient adaptation and mitigation measures to deal with severe weather events, there could be a risk of asset value depreciation or concerns around insurability.

The second component relates to transition risks, which include regulatory and market risk. We expect to see shifts in regulations for green buildings and the behavioral patterns of tenants, consumers and visitors. For example, visitors to a mall may expect the building to be environmentally friendly in terms of energy usage for lighting or air conditioning. Increasingly, visitors are also paying attention to a mall’s indoor air quality.

REIT managers will have to monitor both climate-related risk and climate-induced behavioural trends closely. Collectively, these will impact investment decisions and strategies. In that respect, REIT managers will have to consider and review the environmental, social and governance (ESG) criteria of new and existing buildings. This is in addition to other due diligence work required on the financial and commercial viability of assets. The scope of ESG due diligence typically consists of a review of ESG governance and performance. For example, such work may include ensuring that the necessary environmental impact assessments are performed satisfactorily or resolving issues relating to compliance with environmental and social regulations.

In view of the increased oversight required, REIT managers can opt to consult independent advisors such as KPMG to carry out ESG due diligence work on new and existing buildings. Advisors can help to raise red flags such as missing approval documents from the government for the construction of a building or possible discrepancies in soil erosion analysis that could impact the foundation of the building or other climate-related risk exposures due to the building’s location.

The findings from such due diligence process can have a direct impact on the asset’s value and potentially influences the transaction price of the building. It will also allow asset managers or risk managers to make more informed decisions about their investments and determine whether there is a high risk of stranded assets in their portfolios.

In general, the MAS guidelines are meant to encourage REIT managers to holistically assess how climate change impacts business models going forward and to prepare them to proactively mitigate any risks.

Q: Given that KPMG has a unique view in the industry in the sense that you’re on the ground, how are real estate companies or REITs implementing ESG? Is there a material difference in how developers now approach ESG?

A: Definitely. The understanding and knowledge around ESG-related topics has increased significantly over the years. The built environment industry contributes nearly 40 per cent of greenhouse gas emissions globally, as such there is an expectation for the built environment to contribute to a low-carbon economy. 

In the last couple of years, building owners and real estate players have become more sophisticated. Forward-thinking real estate companies have taken a leadership role, applying technological or digital solutions in ESG management  for disclosure reporting and sustainable finance assessment. These solutions may include data analytics using real-time information gathered from building sensors and the Internet-of-Things (IoT); companies may also leverage simulations that provide carbon profile insights of portfolios and blockchain technology that captures emissions data from the source. Companies with strong governance structure and oversight around sustainability would also have a steering committee. The committee members look after various parts of the business and may have ESG performance scorecards tied to their remuneration.

Small and medium sized real estate firms are increasingly responding to ESG as well, in part due to commercial pressure. These firms are realising that they are becoming less competitive when putting in bids for big tenants with sustainability mandates. For example, if a multinational corporation or a Singapore company has a climate neutral pledge and reaching the target involves being housed in an efficient building, a provider who is unable to support these specifications will be eliminated in the selection process.

The other impetus driving small and medium sized players to consider ESG factors are MAS incentives as well as preferential rates from banks on sustainability loans. However, these benefits could taper off once ESG practices become mainstream.

Q: What metrics do investors care most about ESG investing?

A: In Asia, the focus is a lot on energy consumption, water usage, and carbon footprint. However, in KPMG’s work to help financial institutions develop or enhance sustainability through financing or investing frameworks, we have observed an increasing number of investors  inquiring about investee companies’ climate-resilient strategies. Investors are interested to find out and know more about the governance structure and the best practices that investee companies could adopt.

Q: As people are growing more and more conscious of green investing and ESG, there’s mounting pressure not only on investors, but also on stakeholders to get themselves involved in ESG. In the world of real estate, to what extent is ESG just greenwashing versus actual change?

A: Companies have been cautious about putting out commitments that they cannot fulfill. They face two major challenges.

First, measuring returns on sustainability. Being able to quantify the returns on sustainability is important because it drives economic and commercial decisions around how much to invest in going green. Yet these calculations are not easily done.

Second, most industries lack a critical mass. We require more companies to be on board the sustainability journey. Such mass support will motivate solution providers to create new technologies and approaches of going green. To achieve that, the entire ecosystem has to come together to address climate-related risk and not just the real estate players. Case in point: developers need green materials that are cost effective. Yet, many options in the market do not provide the capabilities or cost effectiveness that developers seek.

To mitigate some of these issues, industry players are now working alongside key business partners towards shared goals and commitments. This coordinated approach helps reduce the risk of greenwashing since responsible behaviors will now need be applied across the value chain.

Furthermore, progress can be measured by applying or establishing a certain type of matrix among the partners.  For instance, a real estate developer can work with its business partners to ensure ESG factors are incorporated into procurement and supply chain decisions and operations.

Q: Can you give us the current state of play of ESG investors now?

A: In the last few years, ESG investing has grown enormously. The focus now is on the rigour of sustainable investing.

Many investment managers are building up internal capabilities for climate change. They are also persuading management to prioritise ESG for growth and for risk management. Ownership and accountability have become the biggest and most important drivers for this entire movement.

Investors have also started to refine their screening criteria. They have more specific criteria and a more rigorous matrix to assess ESG elements. Investors are also asking more qualitative and in-depth questions, and together with their steering committees, verify the credibility of the claims made by investee companies.

To that end, we are also seeing a move away from exclusion. Exclusion in investing policies are perceived as less effective because climate-related risk is simply being transferred to another party in the ecosystem. Hence, more investors prefer combining exclusion with inclusion, transitory investing or financing. In a way, this demands investee companies to have a roadmap for ESG actions. For instance, in the coal industry, investors with ESG capabilities are working with professional firms to offer coal companies solutions that will give them access to funding. This helps coal companies transit to a low-carbon economy.

There has also been a growth in funds solely focused on ESG impacts. Included in the prospectus of some of these funds are ESG metrics and measurements that are given the same importance and focus as financial returns. These funds have been doing very well and are typically oversubscribed with a premium attached.

Q: How has the pandemic changed the path of ESG investing in the property sector?

Everything is still very much a work in progress. Companies are struggling a lot with managing profit and loss, especially with reduced footfall to their properties due to the pandemic. Safe distancing and work-from-home measures are also cutting carbon footprint.

Among the ESG elements, the stronger emphasis has been on ‘S’ – the social lens and its alignment with governments’ goals related to COVID-19. This is also why industry players are increasingly cognizant of the fact that ESG involves not just green technologies, but to keep buildings safe and to consider the wellness of tenants and visitors.

Q: What kind of growth trajectory does KPMG foresee in terms of demand for these sustainable and green assets?

A: Contrary to pessimism as a result of the pandemic, we are seeing rapid growth in sustainable and green assets. This growth is evident in Singapore and also in other parts of Asia.

In terms of sustainability finance, the Singapore government will issue green bonds for up to S$19 billion worth of infrastructure projects, with some of these covering financing for the real estate sector.

There is also greater interest in lowering the risk of greenwashing. In KPMG’s interactions with industry players, we are seeing companies apply baseline standards in managing sustainable assets. Along with this, companies are pushing for ESG commitments to happen across the value chain, instead of just by individual developers. This creates scalable new demand for green services, encouraging greater innovation and commitment to the sustainability cause. For example, developers and owners can appoint agents who use eco-friendly products and services to clean and maintain facilities, as part of measures to support green initiatives. This in turn, encourages agents to start offering eco-friendly products and services.

Q: How do you see the balance between demand and supply of sustainable assets in the market?

A: The real estate sector has been embracing green building certifications over the years. Hence in terms of sustainable assets, the demand from investors remains robust, with developers well able to meet demand adequately.

However, we do see a gap in sustainable infrastructure assets for bigger projects such as airports, railway trains, terminals and ports. The complexity here for ESG is that growth for sustainable real estate in the future will depend on whether the market is willing to start paying a premium or to share the costs of green initiatives.

For example, in some countries, buyers are more ESG conscious and are willing to pay a premium for sustainable assets. In the long run, if the real estate sector is going to be successful in the ESG journey, developers will need to be fairly compensated for their efforts. In other words, they should get an appropriate or fair return on their investments, and this is dependent on whether the market is willing to pay for it.

Q: ESG sustainable assets have been gaining a lot of traction but a lot of analysts are saying that there’s still a lot of work left to be done. What is the biggest challenge to ESG investing, especially in the property sector?

A: The biggest challenge is the lack of data points. There are certain baseline measures, but these may not always be consistent; the quality of disclosures could also be further improved.

For example, when measuring energy intensity, the standard denominator used is gross floor area. However, gross floor area can be measured in various ways by different players. From an investor’s point of view, this makes it difficult to compare data although the data points can give some reference to where the company is headed.

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