Real estate ESG AUM is material, but path to net-zero is uncertain

Investors and tenants are paying attention to environmental, social and governance issues in real estate, putting the onus on managers to take action.

A good chunk of real estate managers' portfolios are currently managed under ESG principles, according to data from Pensions & Investments' annual real estate money manager survey. ESG assets accounted for $372 billion, more than half (51.2%) of real estate assets managed for U.S. institutional, tax-exempt investors as of June 30. For worldwide real estate, ESG made up 43% of assets at $841 billion of managers' worldwide assets, and 24.8% of global real estate investment trust assets at $120.7 billion.

This is the first year P&I has asked real estate managers to quantify the amount of assets they manage under ESG principles.

For many real estate managers, incorporating ESG into their investment processes is a work in progress, industry executives say.

"Step one is to say, 'Look it (net-zero) matters,'" said Martha Peyton, Irvine, Calif.-based managing director and global head real assets research at multifamily real estate manager Aegon Asset Management, which has $25 billion in real assets under management and under advisement. "Step two is more complicated."

A number of countries, municipalities and real estate managers have made net-zero pledges and those pledges have made their commitments real, Ms. Peyton said.

For example, in November, Aegon Asset Management committed to a goal of net-zero greenhouse gas emissions by 2050 or sooner, and its parent, European insurer Aegon, also pledged to transition its €156 billion ($153 billion) general account investment portfolio to net-zero by 2050.

"How do owners of property ... managers in the real estate sector, how are they going to get there? That is the question that is on the table now," Ms. Peyton said. "There are not a lot of answers."

But managers are taking some incremental steps, mainly collecting various metrics, she said.

"You cannot address what you can't measure," Ms. Peyton said. The data give managers the "raw material" to make strategic plans for decreasing their carbon footprints and getting to net-zero, she said.

Another question is how to incorporate climate risk into real estate managers' analysis, Ms. Peyton said.

"But, I think the extreme climate events of recent years and the focus on ESG has advisers (real estate managers), property owners also focusing on the question of what to do about climate risk," she said.

One factor playing a role in managers and property owners' climate risk measurement is rising property and casualty insurance cost, Ms. Peyton said.

It will be interesting to see what the impact of the devastation brought by Hurricane Ian has on property owners' property and casualty costs, she said.

Still, while there are tools, most notably from GRESB, a global ESG benchmark for real assets, that help measure energy usage and carbon footprint of properties today, none of them are useful in the real estate investment process, which has a long time horizon, Ms. Peyton said.

"Given the reality of the investment, what manager wants to be the first one to start pricing climate risk 20 years out? Who wants to raise their hand to do that?" she said.

Among managers reporting ESG assets in P&I's real estate manager survey, Nuveen topped the lists for worldwide and U.S. institutional, tax-exempt assets with $143.5 billion and $105.8 billion as of June 30, respectively, and came in second for REIT assets managed under ESG principles with $12.1 billion as of the same date, P&I data showed.

ESG is not only an investment risk but can enhance performance, said Carly Tripp, Charlotte, N.C.-based CIO of Nuveen Real Estate, in an emailed response to questions.

"Tenants continue their 'flight-to-quality' to the top assets in the market that offer modern amenities and that have lower carbon emissions than legacy assets, a point that will only amplify in importance in the coming years as more firms look to their real estate to improve their ESG performance," Ms. Tripp said.

"And as tenants reduce their overall space needs, they can actually afford significantly more on a per-square-foot basis resulting in many to consolidate into these higher-quality assets," she said. In the office sector, for example, Nuveen expects there will be a roughly 15% reduction in office demand over the next few years as a result of hybrid office and remote working that started due to the pandemic.

New construction and assets that can be effectively renovated to compete in the "amenities arms race" will continue to outperform, Ms. Tripp said.

Real estate managers are increasingly adding ESG-related investment strategies.

Earlier this year, Man GPM launched a joint venture focused on net-zero energy homebuilding, said Anthony Cazazian, New York-based managing director and head of U.S. residential real estate.

"We drew a line in the sand and were fortunate enough to have like-minded joint venture partners," Mr. Cazazian said. "Our goal for the JV is to build up to 1,000 homes across a handful of projects across metros."Man GPM's joint venture partners include Dutch real estate manager Bouwinvest Real Estate Investors and global technology company ZF Friedrichshafen.

Man GPM had $3.4 billion in global real estate assets, including $267 million in worldwide real estate assets managed under ESG principles as of June 30.

While the real estate money management industry is still dominated by white men, P&I's data shows that real estate managers are making some progress on the "S" or social part of ESG. As of June 30, women made up 22.2% of senior management, up from 18.5% from a year earlier and people in minority groups accounted for 15.7% as of June 30, up from 12.7% in the year-earlier report.

Close to a fifth of real estate investment professionals (19.5%), were women and 18.9% were minorities as of June 30, up from 17.6% and 15.1%, respectively.

And only four firms that responded to P&I's annual real estate money manager survey are women- or minority-owned as of June 30. They are REIT manager Adelante Capital, with $1.8 billion in total REIT assets, multifamily manager Cityview with $1.6 billion in global assets, TerraCotta Group with $513 million of global real estate assets and REIT manager Phocas Financial with $45 million in global assets as of June 30.