featuring Peter Martenson
March 29, 2017
Private real estate fund managers face a rising tide of investor interest in environmental, social, and governance criteria and greater expectations on reporting, but observers say many smaller and mid-sized players may have to play catch up on ESG matters.
Larger global private real estate managers have incorporated ESG into their businesses in recent years, but most of the U.S. market hasn’t matched the pace, says Nils Kok, chief economist at GeoPhy and former CEO of GRESB, which runs a sustainable real estate data measurement system. Part of the reason is that U.S.-based institutional investors have not yet pushed the same expectations for ESG reporting and results in real estate as they have for private equity firms, he says.
"It’s fair to say a lot of the [U.S. real estate fund manager] market is more at the beginning stages of ESG, where private equity was a few years ago," he says. "There’s definitely general awareness and no more denial of the importance of ESG, but now we get to the phase of implementation."
Investor questions on ESG topics have grown steadily in volume over the past decade, but especially in the past five years, and in particular for larger managers with global client bases, says Bohdy Hedgcock, senior v.p. at Clarion Partners, a $44 billion private fund manager acquired last year by Legg Mason.
"More fund managers are participating in reporting, and it’s becoming almost a requirement," he says.
While a recent Preqin survey found that 59% of private real estate fund managers are taking ESG factors into account for "at least some of their deals," that global sample underscores a clear difference between managers in Europe versus North America. For instance, 38% of European managers consider ESG in all their deals, while only 10% of North American managers do so, according to the survey. And only 3% of European managers never consider ESG, but 34% of North American managers fit into that category.
European managers in many cases have gotten ahead of the ESG factor tracking and reporting curve because of regulations requiring such information, Kok says. In the U.S., by contrast, the pressure is more from the end marketplace, with real estate developers increasingly turning to sustainable construction and property management techniques as a way to keep up with demand from tenants and buyers in certain markets – leading to much more scattered adoption across the country, he adds.
Use of ESG criteria – and actively reporting on it – also varies by other measures, including investment strategy and firm size. It’s definitely much more on the radar of big funds, says Dan Krivinskas, managing principal at Chicago-based Alignium, a newly formed real estate investment consultant composed of a breakaway RVK team.
"For the larger funds, it is a priority, and now you see it spreading to smaller or mid-tier funds," he says.
ESG is also clearly well entrenched in core real estate strategies, but not as much in opportunistic investing, Kok says. "It’s 95% of the core U.S. private equity managers looking at ESG, with various degrees of adoption," he says. "When you get up to opportunistic, it’s more hit or miss."
Even among managers that do track ESG and report with GRESB tools, there is wide differentiation in their level of activity, Kok says. Some are just "ticking the box, reluctant to go beyond corporate investor relations storytelling," while others are integrating these policies deeply into their operations, he says.
GRESB has a wide range of reporting categories to measure the ESG performance of real assets and funds. More than 70 North American real estate managers use GRESB, including most of the real estate arms of big traditional managers and stand-alone players such as Bentall Kennedy Group, CBRE Global Investors, Colony NorthStar, and LaSalle Investment Management.
The range of private real estate managers actively tracking ESG criteria has significant overlap with another factor: the presence of European institutional investors in their client base.
Investor pressure generally has influenced how firms have developed their programs, Clarion’s Hedgcock says.
"Investor interest has helped us to formalize these policies and do them in a much more comprehensive and holistic way," he says.
The European investor contingent is a clear driver for more reporting, says Abigail Dean, head of sustainability at Nuveen affiliate TH Real Estate, in an e-mail.
"The interest in this area from institutional investors has significantly increased over the past few years, with investors asking much more articulate questions about our approach to sustainability and expecting us to demonstrate improvements," she says. "I would say that European investors are pushing hardest on this, although a number of U.S. pensions, such as [the California Public Employees’ Retirement System] and the New York State Common Retirement Fund, are also quite progressive in this area."
The typical U.S. institutional investor is well behind its European counterpart in terms of the number and depth of ESG questions, however, Kok says. "If you were to talk to the average private equity fund manager in the last year, all of the European RFPs will include something substantial on sustainability, but in the U.S., it’s the exception rather than the rule," he says.
The biggest area of ESG interest for investors in real estate tends to be around reducing the use of natural or energy resources and increasing operational efficiency of buildings and properties, Hedgcock says. Investors also often ask for the manager’s GRESB score as a basic metric in assessing sustainable performance, he says.
That underscores how investors are asking managers to not only use ESG in the deals due diligence phase but also as part of the long-term asset management effort, says Peter Martenson, partner at Eaton Partners, a placement agent firm.
"Investors want to monitor ESG during the lifecycle of the fund," he says. "Are you lowering the amount of water you use? Are you lowering the carbon footprint?"
Clarion’s ESG reporting tracks a range of elements across energy and water consumption, resource cost, greenhouse gas emissions, renewable energy generation capacity, and hazardous waste handling. It began developing its program a decade ago, adopted formal policies in 2011, and has been adding more full-time staff resources to track ESG since then, spreading the application beyond its main funds, Hedgcock says.
Every potential investment now has to go through a routine element of ESG review, according to the firm’s policy.
"It’s embedded in what we do now," says Michelle Levy, Clarion’s COO.