Responsible Investing in Real Estate - ESG Screening

Posted by Whitehall Capital on 6th March 2023 -

Investing in real estate presents unique Environmental, Social, and Governance (ESG) considerations when compared to other asset classes. This is due to the long-term nature of real estate investments, which allows for a greater period of time for material ESG issues to manifest and affect investors, the environment, and society. As well, many ESG issues occur at a local level, from habitat protection to community relations such as planning concerns and local objection. The impacts can be huge and play out over a long timeframe. As they the finished products are experienced by the members of the communities they’re placed in, ESG considerations are particularly important for the asset class.

Screening

To ensure that ESG factors are taken into account during the investment process, there are several key steps that should be followed. The first step is in deal sourcing. At this stage, potential deals can be eliminated from further consideration for obvious reasons, such as significant and warranted community opposition or a poor ESG track record by the developer. Investors may also screen new deals for commercial tenants with ties to industries such as fossil fuel production. If a deal passes these initial checks, formal due diligence can commence.

Due diligence

The next step is due diligence, during which ESG issues can be more thoroughly investigated. This includes evaluating the potential for improvements, classifying climate risks and identifying habitat destruction. At this point the due diligence process becomes aligned with commercial interests in many ways, as low energy performance ratings (for example) directly affect expected future values and will necessitate remediation costs. Due diligence can be tailored to specific portfolio goals. For example, if an investor wishes to maintain carbon neutral status, sponsoring a project that requires heavy construction may be automatically prohibitive, depending on the carbon intensity of the subject project relative to others in the portfolio net of offsets.

Development Projects

Major renovations provide opportunities to achieve higher ESG standards for existing assets. However, additional factors present themselves for consideration such as carbon costs implicit in sourcing materials through the supply chain. To maximise impact, ESG considerations should be integrated into the project as early as possible, and investors should ideally have some influence over design and construction methods – the investor may be able to request specific components as part of the financing arrangement such as heat pumps in place of gas boilers, for example.

Investment Committee

Finally, the investment decision should be informed by the ESG risks and mitigants. This information should be included in the investment paper and considered carefully by the investment committee. To ensure that all ESG considerations are properly addressed, those sourcing and screening potential investments should have a thorough understanding of the investment committees ESG objectives well in advance of this stage. Feedback loops should occur naturally between the first and second lines involved in the investment process, and any commercial incentives should be aligned.

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