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Real estate

Investors, tenants demanding that managers go green

Jacques Gordon said market forces, not regulation or politics, are behind the sustainability clamor.

Investor and tenant demands are pushing real estate managers to make their properties more sustainable.

Commercial real estate contributes 30% of global annual greenhouse gas emissions, a recent report noted, despite early and continuing efforts by real estate managers to make their properties more environmentally friendly.

Many investment managers now are accelerating those efforts, notwithstanding the Trump administration's moves to loosen environmental regulations and drop out of the Paris climate accord.

But the sustainability movement in real estate is driven more by market forces than regulation or politics, said Jacques Gordon, global head of research and strategy at real estate money management firm LaSalle Investment Management, Chicago.

"The overwhelming majority (of real estate managers and property owners) desires to have green buildings or sustainable buildings … It's true of big companies. It's true of small companies … it's true of Jones Lang LaSalle (LaSalle Investment's parent company) and LaSalle and most Fortune 500 companies," Mr. Gordon said.

Executives at these companies believe the best and smartest workers prefer to work in healthier, more environmentally friendly buildings, Mr. Gordon said.

"That's not just in the U.S. but it's global," he added.

LaSalle has approximately $60 billion in assets under management.

While many managers began focusing on the environmental impact of their real estate portfolios after the financial crisis, their efforts have not been enough to stem global real estate's affect on climate change.

Real estate greenhouse gas emissions continue to grow rapidly and could reach 50% of CO2 emissions by 2050, according to the UNEP Finance Initiative, a partnership between the United Nations Environment Program and the financial sector.

Needed improvements to existing properties aren't cheap. Should the industry decide to embrace the goals of the Paris agreement — keeping the global temperature rise this century well below 2 degrees Celsius above pre-industrial levels — the building sector's energy consumption would have to decrease by at least 30% through building highly energy-efficient new buildings and a deep renovation of the existing stock of buildings by 2050.

That would cost roughly $11.5 billion between 2015 and 2050, according to the UNEP Finance Initiative.

Investor pressure

Investors are increasing pressure on their real estate investment managers to make investments more sustainable.

In 2017, the $324.7 billion California Public Employees' Retirement System's real asset managers, including real estate, were required to begin reporting into GRESB, formerly the Global Real Estate Sustainability Benchmark, an organization committed to assessing by environmental, social and governance factors real asset performance globally.

CalPERS' real asset portfolio has a net asset value of $31.8 billion and accounts for 10.8% of CalPERS' total assets.

The GRESB results are expected to be reported as part of CalPERS' real asset review in November, said spokeswoman Megan White, in an email.

CalPERS adopted carbon footprint reduction goals as part of a five-year strategic plan for ESG approved in 2016. That includes reducing its carbon footprint by 50% by 2021.

CalPERS is not alone. Sixty pension plans worldwide are GRESB members.

Officials at the $20.3 billion Los Angeles Fire & Police Pension System consider ESG a financial issue, but "the bonus is that it is better for the planet," said Tom Lopez, chief investment officer, in an email.

"Buildings use a lot of power," he noted. "Since building energy usage directly affects cash flow, all building owners had a financial incentive to be green."

What has changed is improved technology that allows greater energy savings, "and the new attention that is now paid to water usage," Mr. Lopez wrote.

Investment officials at the roughly $192 billion New York State Common Retirement Fund, Albany, also keep an eye on environmental factors in the various asset classes, including real estate.

"We consider ESG factors in our investment process because they can influence both risk and return," said Brian Butry, pension fund spokesman.

In March, pension officials took steps to expand the New York fund's ESG program from focusing on public equities — where ESG practices are more mature — to the rest of its asset classes, including real estate.

Pension plan officials recognize "that different ESG policies and factors are relevant for different asset classes and will evaluate accordingly," Mr. Butry said.

Managers are responding. For example, PGIM Real Estate, Newark, N.J., has been working to incorporate sustainability practices into its real estate investment process and the management of its $65.9 billion global portfolio since it started the program in 2008, said David DeVos, global head of sustainability, in an email.

"We have expanded our (ESG) program to include more assets, more funds and more stakeholders globally," he said.

In 2016, PGIM Real Estate launched an environmental data management program, got 80 buildings with 27.4 million square feet worth $13.8 billion, LEED certified and 67 properties amounting to 22.7 million square feet worth $12.9 billion Energy Star certified.

(LEED-certified buildings use less water and energy and reduce greenhouse gas emissions; Energy Star is a joint program of the Environmental Protection Agency and the Department of Energy to increase energy efficiency of products and real estate.)

In addition to financial benefits such as reducing costs, PGIM Real Estate's initiatives have reduced greenhouse gas emissions by a combined 11.6% at 467 properties from 2011 through 2015.

Benchmarking efforts

As part of its data program, PGIM executives start out by benchmarking building performance as it relates to sustainability, Mr. DeVos said.

Currently, PGIM benchmarks energy, water and waste at more than 900 portfolio properties in 13 countries.

"With this data, we can focus our efforts on those assets with the greatest potential for savings," Mr. DeVos said.

PGIM executives then share the information with their property managers, who, in turn, "offer sustainability tips for our tenants to help them reduce resource consumption and better manage their operating expenses," he said.

In addition to benchmarking, PGIM executives improve their properties to make them more sustainable, including lighting retrofits, mechanical equipment upgrades and water efficiency projects such as irrigation controllers, Mr. DeVos said.

"Depending on the market, simple returns for such projects can be from one to four years, frequently reducing maintenance costs, improving the tenant experience and adding value to the asset," he said.

There are a number of steps managers can take to make their properties more sustainable, according to a recently released LaSalle paper. Indeed the paper contends that sustainability of properties will be a secular driver of demand over the next decade.

Environmental factors that can contribute to improvements in real estate investments' risk-adjusted performance include: energy conservation, carbon footprint reduction, water and waste recycling, and green-building ratings to certify sustainable building design and operations, the paper noted.

However, investments in sustainability "need to be customized for specific markets and sectors" because regulations and "green building" rating systems vary greatly around the world, said Eric Duchon, LaSalle's global head of sustainability. Mr. Duchon joined LaSalle in January to take on the new post.

It's not just the big real estate managers that are increasing the sustainability of their portfolios. Denver-based real estate manager Northstar Commercial Partners has been moving toward making investments in sustainable real estate that also have an ESG impact.

Good sense

"It makes good social sense and corporate sense," said Brian Watson, chairman and CEO of the real estate firm that has $1 billion in assets under management.

"With all of our assets, we consider ways to make them more environmentally friendly for the employees that will eventually locate in our buildings and for the companies (tenants) as well," Mr. Watson said.

There is a demand from tenants for buildings that use technology to be more efficient and create a healthier environment for tenants, he said.

Mr. Watson estimates that Northstar's funds have reaped double-digit cash-on-cash savings from sustainability efforts. Making a building more energy efficient by adding solar panels, for example, can bring down utility charges about 30%. These efforts also help to retain existing tenants and attract new tenants, he said.