Heitman’s Laura Craft weighs in how ESG data guides investment decisions
2020 saw a record influx of money poured into funds with strong ESG performance. From January through November 2020, investors in mutual funds and ETFs invested $288 billion globally in sustainable assets, a 96% increase over the whole of 2019. And a recent study by Morningstar revealed that most sustainable funds have actually beaten traditional funds—even excluding 2020’s unusual market conditions.
Given this heightened interest in ESG (Environmental, Social Governance) performance, building managers and owners might find it eye-opening to see this transition in the way top global real estate investors decide where to put their money. Once relegated to the “nice-to-have” or supplemental, the ESG performance of a target acquisition has now become increasingly central to the decision to invest—or divest.
Laura Craft says ESG data is helping her firm mitigate climate risk and build resilience into their portfolios. Craft is Senior Vice President, Head of Global ESG Strategy at Chicago-based investment management firm, Heitman, with $42.5 billion in assets under management. The firm has embedded ESG considerations into its investment and management processes.
Sounding the alarm on climate hazards
“For every investment opportunity, we analyze deals on a range of ESG metrics. If the investment goes above our risk threshold, we alert our in-house due diligence team to determine whether there are real hazards or if the risk has been mitigated,” says Craft.
Heitman uses physical climate risk data to detect climate exposure and to assess risk from multiple angles, at the asset-, market- and portfolio-levels. Identified climate risks can be factored into valuations through investment sensitivity analysis and economic modeling to calculate how the risk may impact investment returns. She uses the metrics and financial models to screen investment opportunities, build resilience in properties Heitman owns, and reduce the firm’s risk to the impact of climate change.
Investment managers can use ESG data to evaluate and monitor real estate investment risks and opportunities. Property databases, climate data, geographical reports, and proprietary analytics can provide scoring at both the portfolio and property levels. By analyzing the data, investment managers can monitor the threat of climate risks such as rising sea levels in low-lying regions, gain a better understanding of the impact of storms and wildfires to investment risk and align reporting with TCFD disclosures.
“For years, investors have used online databases to identify what properties were for sale, but there was often no transparency beyond financial data—sale price, market averages, and the like. The transparency wasn’t there for ESG factors which can help you make your decision,” says Craft. “We’re always looking to buy and underwrite assets better than our competitors and see value where value may not easily be seen. ESG metrics help us identify additional threats and opportunities that the financial metrics alone cannot do.”
Craft says both the capital and debt markets now take keen notice of ESG criteria—and are placing a heavier weight on ESG in valuations, lending rates, and insurance premiums.
ESG metrics help us identify additional threats and opportunities that the financial metrics alone cannot do.Laura Craft
“We’ve started to see lenders charging different rates, depending on criteria such as the market’s risk of flooding,” says Craft. “Some insurers have been upside down with paying out more in damages than premiums collected in recent years, thus have been steadily increasing policy premiums to account for potential hurricane and wildfire threats. These represent additional costs directly correlated to climate and need to be priced into investment decision-making. As both the costs related to climate and awareness of climate risk increase, demand for investments at-risk could soften resulting in less appreciation in asset value and lower tenant demand and rental revenues,” she says.
“Revenues can fall while at the same time operating expenses can rise due to climate risk. It’s important to be aware of the potential climate financial impacts to property values and net operating incomes.”
Why ESG and sustainability criteria are leading indicators of investment success
As real estate investors searched for better ways to understand an asset’s health in the wake of the 2008 global financial crisis, the effects of sustainability and energy efficiency emerged as a crucial consideration.
“As investment managers struggled to maintain investment values during the financial crisis, they realized that by lowering energy usage, they lowered energy costs and increased net operating income and property values,” says Craft. “From that commonsense viewpoint, sustainability began to look very different. It became obvious that companies which addressed energy efficiency and sustainability issues had a much better chance of surviving long term.”
Fast forward to 2020: As the world dealt with the COVID-19 pandemic, health and safety rose as another factor to consider in a property’s viability as an investment.
It now can be a dealbreaker if you can’t keep your building healthy and safe.Laura Craft
“Buildings need to ensure there’s suitable indoor air quality, ventilation and cleaning protocols in-place to maintain health and safety. Before entering commercial spaces, occupiers want to know and see that there are procedures and protocols to limit unhealthy environments and the spread of Covid,” says Craft, adding that, “It now can be a dealbreaker for occupants and visitors of retails spaces if you can’t keep your space healthy and safe.”
Other factors are also increasingly coming into play, says Craft.
“We’re starting to look in a more concerted way at satisfaction ratings at our assets—how satisfied are our tenants—so that we can increase desirability of asset and retention rates because if you can increase retention rates, you lower downtime and turnover costs. And that increases the profitability of an asset.”
Start with the right resources
“For investors and asset owners alike, the first thing to do is understand that ESG metrics are impacting valuations, so they’re going to be increasingly important,” says Craft.
Urban Land Institute (ULI) Greenprint Center,” recently published “Blueprint for Green Real Estate,” which helps real estate owners and investors create or accelerate a sustainability program, and developers looking for ways to integrate sustainability into their overall development strategy. The resource is focused on real estate addressing environmental areas—energy, water, waste, and greenhouse gas (GHG) emissions—while acknowledging that the role of a real estate sustainability program is much broader than it once was, now encompassing topics like resilience, health and wellness, and social equity.
“For investment managers, a great place to start would be joining an association like the Urban Land Institute (ULI) Greenprint Center,” says Craft. “These are places where managers come together to share knowledge and learn how better to apply ESG and sustainability measures in their decision-making.”
The broader organization, Urban Land Institute (ULI) is the oldest and largest network of cross-disciplinary real estate and land use experts in the world. ULI is its members—delivering the mission, shaping the future of the industry, and creating thriving communities around the globe.
In the past few years, Heitman has co-authored two reports with ULI—Climate Risk and Real Estate Investment Decision-Making and Emerging Climate Risk and Real Estate Practices for Market Assessment. These reports are publicly available and meant to move the industry forward on evaluating and pricing climate risk into investments at the asset- and market-level.
“There are a lot of industry resources that people new to ESG can use to get their grounding,” says Craft. “There’s no reason to do it alone. This is a space where even competitors come together to brainstorm solutions.”
Real estate is rising to meet the climate challenge—backed by robust data and good decision-making
Over the years, Craft says she has seen the real estate industry come a long way in developing strategies to identify, understand, and manage the impact of climate risk.
Previously, the industry relied on insurance to price and cover shorter-term risks. But insurance doesn’t protect you from devaluations or reduced asset liquidity, says Craft.
Today, there are many new methods for identifying and mitigating risk—including mapping the physical nature of assets and candidate acquisitions and adding mitigation measures for at-risk assets (like improving drainage in flood-potential areas).
“Data is at the heart of all these measures,” says Craft. “The industry as a whole needs to understand the impacts of physical climate risks on pricing and how climate change will impact valuations in the future. Big data will help investors, asset owners, and property managers alike improve the resiliency of the real estate sector as we face the impact of climate change head-on.”