By Fong Yee, senior product manager, sustainable investing
Carbon intensive sectors are facing unprecedented scrutiny from governments, regulators and markets. Since this can have a significant impact on liquidity and asset values—indeed, the effects are already becoming visible—it is a factor that investors cannot afford to ignore. The real estate sector, which is characterized by long-lived and energy-intensive assets, is one such target.
The U.N. estimates that buildings account for over half of global electricity usage, about 28% of global carbon emissions and over 10% of potable water consumption. To keep global warming below 2 degrees as mandated by the Paris Agreement, the real estate sector alone will need to reduce total CO2 emissions to 36% by 2030.
As policy makers try to accelerate emission reductions across entire economies, building stock with poor environmental performance is a likely target for new policy measures. This creates significant policy risk for real estate investors who, in a worst-case scenario, could see substantial reductions in asset values and liquidity.
This is happening now: UK landlords can no longer let residential or commercial buildings with F- or G-rated energy performance certificates. New York City’s Building Emissions law (Local Law 97) aims to cut emissions from buildings by 40% (by 2030) by placing a cap on carbon emissions for buildings over 25,000 sq. ft. (2,300 sq m2). The UN-backed Principles for Responsible Investment (PRI) expects decisive government policy measures globally by 2025 and has highlighted how these measures will have a clear impact on businesses and their investors.
It’s not necessarily bad news, though. In contrast to other carbon intensive industries, the real estate sector benefits from a range of cost-effective, well-understood solutions to reduce energy use and achieve carbon savings. Furthermore, there’s also is a growing body of evidence suggesting that strong sustainability performance contributes to better branding and higher asset values in the sector. Several recent studies see a correlation between greener buildings and higher occupancy rates, higher rental values and reductions in operating costs.
Our own analysis suggests that investors can be exposed to green real estate portfolios while limiting downside risk. The performance of the FTSE EPRA Nareit Green Real Estate Index Series, for example, suggests green real estate has provided increased exposure to real estate portfolios demonstrating strong sustainability performance while minimizing tracking error versus the market cap benchmark.
Challenges remain at the portfolio level as investor-focused tools for real estate have been limited. Unlike listed equities and, to a lesser extent, bonds, property investors have lacked comprehensive data that allows them to systematically factor climate concerns into real estate investment portfolios. Ultimately this is a problem of disclosure, and whereas listed companies increasingly provide information on ESG issues to investors, real estate companies lag other sectors.
Market leaders often disclose third-party assured data across a range of sustainability considerations but most do not. As an example, less than half of the largest 50 constituents of the FTSE EPRA Nareit Developed Index, which is designed to represent general trends in eligible real estate equities worldwide, report their carbon emissions. Disclosure levels will have to improve as investors demand better data. The industry will also need to develop innovative, alternative approaches to assessing real estate portfolios where data gaps remain.
Pressure for change, therefore, won’t just come from the policy angle. Investors are setting increasingly ambitious sustainability targets across their investment strategy and asset allocation and capital is starting to shift towards more sustainable assets/mandates. This will accelerate as data and financial products become more available.
© 2019 London Stock Exchange Group plc and its applicable group undertakings (the “LSE Group”). The LSE Group includes (1) FTSE International Limited (“FTSE”), (2) Frank Russell Company (“Russell”), (3) FTSE Global Debt Capital Markets Inc. and FTSE Global Debt Capital Markets Limited (together, “FTSE Canada”), (4) MTSNext Limited (“MTSNext”), (5) Mergent, Inc. (“Mergent”), (6) FTSE Fixed Income LLC (“FTSE FI”) and (7) The Yield Book Inc (“YB”). All rights reserved.
FTSE Russell® is a trading name of FTSE, Russell, FTSE Canada, MTSNext, Mergent, FTSE FI, YB. “FTSE®”, “Russell®”, “FTSE Russell®”, “MTS®”, “FTSE4Good®”, “ICB®”, “Mergent®”, “The Yield Book®”, and all other trademarks and service marks used herein (whether registered or unregistered) are trademarks and/or service marks owned or licensed by the applicable member of the LSE Group or their respective licensors and are owned, or used under licence, by FTSE, Russell, MTSNext, FTSE Canada, Mergent, FTSE FI, YB. FTSE International Limited is authorised and regulated by the Financial Conduct Authority as a benchmark administrator.
All information is provided for information purposes only. All information and data contained in this publication is obtained by the LSE Group, from sources believed by it to be accurate and reliable. Because of the possibility of human and mechanical error as well as other factors, however, such information and data is provided “as is” without warranty of any kind. No member of the LSE Group nor their respective directors, officers, employees, partners or licensors make any claim, prediction, warranty or representation whatsoever, expressly or impliedly, either as to the accuracy, timeliness, completeness, merchantability of any information or of results to be obtained from the use of the FTSE Russell Indexes or the fitness or suitability of the FTSE Russell Indexes for any particular purpose to which they might be put. Any representation of historical data accessible through FTSE Russell Indexes is provided for information purposes only and is not a reliable indicator of future performance.
No responsibility or liability can be accepted by any member of the LSE Group nor their respective directors, officers, employees, partners or licensors for (a) any loss or damage in whole or in part caused by, resulting from, or relating to any error (negligent or otherwise) or other circumstance involved in procuring, collecting, compiling, interpreting, analysing, editing, transcribing, transmitting, communicating or delivering any such information or data or from use of this document or links to this document or (b) any direct, indirect, special, consequential or incidental damages whatsoever, even if any member of the LSE Group is advised in advance of the possibility of such damages, resulting from the use of, or inability to use, such information.
No member of the LSE Group nor their respective directors, officers, employees, partners or licensors provide investment advice and nothing contained in this document or accessible through FTSE Russell Indexes, including statistical data and industry reports, should be taken as constituting financial or investment advice or a financial promotion.
Past performance is no guarantee of future results. Charts and graphs are provided for illustrative purposes only. Index returns shown may not represent the results of the actual trading of investable assets. Certain returns shown may reflect back-tested performance. All performance presented prior to the index inception date is back-tested performance. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back- tested data may reflect the application of the index methodology with the benefit of hindsight, and the historic calculations of an index may change from month to month based on revisions to the underlying economic data used in the calculation of the index.
This publication may contain forward-looking assessments. These are based upon a number of assumptions concerning future conditions that ultimately may prove to be inaccurate. Such forward-looking assessments are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially. No member of the LSE Group nor their licensors assume any duty to and do not undertake to update forward-looking assessments.
No part of this information may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without prior written permission of the applicable member of the LSE Group. Use and distribution of the LSE Group data requires a licence from FTSE, Russell, FTSE Canada, MTSNext, Mergent, FTSE FI, YB and/or their respective licensors.