Alongside ‘self-isolating’ and ‘social distancing’, one of 2020’s buzzwords (or more accurately, an acronym), especially in the commercial property world, is ESG and it stands for environmental, social and governance. Some have called it ‘conscious capitalism…’
Traditionally, investment decisions have been made using the ‘head over heart’ model but more and more, ESG, by definition a ‘heart over head’ model is becoming increasingly front and centre when it comes to investment decisions. The built environment is responsible for around 40% of EU energy consumption and is under a constant magnifying glass on how to manage – and reduce – that number.
In an article from nasdaq.com, it suggests that ESG considerations are becoming more relevant. Much more than just a feel-good factor, investments ‘are now being evaluated on non-financial metrics alongside more common financial metrics’ and it’s not just investors who are looking at ESG as a determining factor, occupiers are too.
What Are Investors & Occupiers Looking For?
In a June 2019 article, Ruslana Golemdjieva at Knight Frank said that there was ‘strong evidence that investors are increasingly seeking buildings that are committed to sustainable practices’ however there was a concern that commercial property that has incorporated high levels of sustainability measures (low carbon emissions, uses of renewable energy, green technologies and infrastructure, environmental reporting etc) incurred higher operational costs. However, the negating factor is that rents are higher, compensating for the rise in operational expenditure.
In addition, sustainability measures and ‘future-proofing’ staves off the notion of built-in obsolescence and can add real-time value to an asset.
It’s not only environmental benefits that investors look for. S for Social means the impact that businesses have on society. Does the company promote health and safety at work, is there a fair pay, benefits and perks system in place, are there diversity and inclusion practices, is the business actively involved in charity work or social justice projects and do they have a focus on product or service integrity?
G for Governance is about how the business is run from a holistic standpoint. Is there transparency from the C-Suite down, is there diversity on the board, are the compensation packages overly excessive, where is the accountability?
More so than ever there are a lot of questions that need to be answered before an investor puts their hand in their pocket.
Why Should Investors Care? Isn’t It All About Returns?
Yes and no. Any investment requires a return, it’s been like that since time immemorial, but now there are other factors that come into play, known as ‘extra-financial’ variables.
Many investors are now concerning themselves with the impact of their investments and the role their assets can have in the promotion of social and environmental issues such as diversity and climate change.
‘Responsible’ investors* evaluate investments (and as landlords, the business that occupy the space) using the ESG criteria to a greater or lesser extent to screen possible targets and to assess risk in their decision making.
*For the avoidance of doubt, it’s worth noting that when we refer to ‘responsible investors’ we mean specifically those who actively apply ESG criteria in their decision-making processes. It most certainly doesn’t mean that those who choose not to are in any way irresponsible.
Why Do ESG Investments Work?
New York-based wealth management firm Glitterman Wealth outline a strategic pattern for investors, remarkably similar to the way football clubs at the top end strategise the buying of new players.
The Investor will identify a collection of interesting investments based on his or her traditional selection criteria.
The Football Manager will identify up to four players for the same position based on their traditional selection criteria.
The Investor will then apply an ESG lens to the investments – do they fit in with a more specific investment criteria taking in extra-financial variables? Does it constitute a responsible investment? Does a potential investment have the social, environmental and governance impact the investor is looking for? The original list will shorten.
The Football Manager will narrow down the search in similar ways. Will the chosen players have the on and off-field impact the club is looking for? Do they fit in with the manager’s style of play? Is the player a good fit in the dressing room? The original list will shorten.
The Investor will then select the investment that is anticipated to generate a profitable impact in terms of ROI but also a positive E, S and G impact.
The Football Manager will choose the player who fits in with the club’s overarching buying strategy of system fit, culture fit and cost fit and has a potential sell-on value later down the line.
Commercial property investment is slowly adjusting to a new normal that’s not purely about returns.