What Investors Really Want…

Saturday, November 21, 2015

…is high returns at low risk (volatility). Sure, that’s the starting point and so-called fiduciary duty of pension funds, insurance companies, and the investment managers that invest their capital. But increasingly, investors also want the companies and funds that they invest in to show what these investments do when it comes to environmental, social and governance (ESG) issues.

This week I moderated two panels in two related, but quite different orbits. Not just because the REITWorld conference took place in the Wynn in Las Vegas and the Greenbuild conference in the Washington Convention Center in Washington DC, but also because the Greenbuild crowd is so deeply engaged when it comes to sustainability, and sometimes so disconnected when it comes to finance, and vice versa for the NAREIT crowd. However, it seems like these two worlds are slowly coming together, which should be good news to those REITs and fund managers that have embraced sustainability, and worrisome to those real estate investment managers that are still of the view that “sustainability is not for me.”

The amount of capital that has an interest in ESG data on REITs and property funds is significant. During the equity panel of the Greenbuild GRESB Investor Track, CBRE Clarion Securities, a USD22 billion REIT investor, alluded to their engagement with publicly traded property companies on ESG issues. It’s still in its infancy, and the conversation is mostly focused on those REITs that do not yet report on sustainability (through GRESB). But having actionable sustainability data on all equity REITs is the goal. Another panelist, the Townsend Group, is predominantly focused on private equity funds, with a scary USD170 billion in assets under advisement, all in real estate (Townsend advises clients on where to allocate their capital). Townsend already has clients that will not invest in funds that refuse to disclose their sustainability performance (again, GRESB is the measurement), but that represents the minority of investors. A dozen of Townsend clients are actively asking for the ESG performance and profile of their fund investments, and Townsend reports to those clients based on GRESB’s Portfolio Analysis Tool. And increasingly, Townsend is looking for more granular data – think asset-level information on consumption, green certification, etc. There are also pension funds that have direct investments in real estate. The third panelist, Oxford Properties (with a portfolio value of USD34 billion) is such an example, fully owned by OMERS, a large Canadian pension plan. Interestingly, Oxford sees the current market conditions, where real estate has become pricey (in my view overpriced) as another reason to deploy capital in its large portfolio of existing assets, increasing the net operating income (NOI) at returns that exceed cap rates on new acquisitions. Oxford Properties is an owner of prime office, retail, multifamily space, and sees strong demand for their “green” assets. An example in case is a recent LEED Platinum development in Torono for EY (aka Ernst & Young), where the war on talent (and the quest for productivity) drives demand for better buildings. The average age of EY employees in Canada is…28 years! These youngsters do not want to work in a Park Avenue-style cubicle space deprived of natural light. (And rightly so.)

The REITWorld panel was themed “Sustainability in REIT Investments: Where Are We? And What’s the Investor Point of View?” Again, an impressive lineup. Dutch pension fund PGGM Investments, a >EUR200 billion investor with EUR20 billion (over USD22 billion) in real estate (both REITs and private funds) is moving to set actual targets for its investments (see also my recent blog) – 50% carbon reduction in 5 years is the goal. The pension fund, driven by its 2.5 million trustees that are healthcare workers, does not shy away from difficult discussions with its investments if no or limited progress is made. The second panelist, Cohen & Steers, is truly the gorilla in the REIT room, with USD53 billion in assets under management, all of it invested in “liquid real assets,” of which the largest chunk is REITs. Initially driven by clients, but increasingly by the realization that ESG and good management are strongly correlated, Cohen & Steers has expanded its definition of governance to include “environment” and “social,” allowing for these factors to influence the growth rate and discount rate in their REIT valuation models. Small changes to these variables can have considerable effect on pricing, and thus on overweight or underweight decisions by the firm. With all sophistication came the honest conclusion that Cohen & Steers should still do more to engage with REITs on the topic of ESG. Interestingly, Wellington Management, the third panelist, has engagement as a core part of its strategy. Wellington manages almost USD1 trillion (!) in assets under management, of which “a couple of billion” is invested in REITs. As a preparation for the panel, Wellington had asked a number of REIT management teams about their views on “how climate change may affect the portfolio, and what to do about that.” In all but one case, the response was an awkward silence. Work to be done – Wellington’s view is that ESG will affect pricing of REITs, and the ability of REITs to raise capital.

I often get the question from REITs and fund managers what investors want when it comes to sustainability. And why they never hear from investors directly. The panels this week provided some part of the answer: investors expect their real estate investments to actively develop and implement a sound ESG strategy. That’s simply part of good business, so don’t expect a pat on the back for running a proper sustainability program. However, for those that don’t, expect more and more questions. And for all: be prepared for the bar to be raised, business as usual won’t do a couple of years down the road. In the meantime, put that ESG slide in the quarterly investor briefings, and prep your fund-raising and management team for the ESG questions in case they come. Nobody wants to look a (potential) investor in the eye, laugh sheepishly, and answer that sustainability is something that the company is not actively considering.