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Sector Reports - 26/11/2019

ESG performance difference in the Real Estate sector: Addressing Climate Change and Urbanisation Risks with Resilient Buildings, Green and Social Projects and Smart cities – Leaders are shaping the trends but most others still lack resources to follow suit

Vigeo Eiris awarded an average overall score of 29.1 to companies in the Real Estate sector, on a scale of 0 to 100. The sector’s performance improved slightly since 27.2 registered in our previous analysis.

  • The sector ranks 29th of Vigeo Eiris’ 39 sectors, which cover a research universe of 4,850 companies. The sector gained five positions from the previous assessment.
    Sector leaders are concentrated in Europe, whilst laggards are mostly listed in North America and Emerging Markets.
  • The Real Estate sector reporting rate is 53%, slightly below the universe average (58%), with European companies being more exhaustive in communicating on their ESG policies, practices and performances. This can be explained partly by the different effects of national regulations that, in Europe, successfully set ambitious and credible targets on energy efficiency.
  • ESG risk mitigation scores are weak and slightly above the universe average in relation to reputation (29/100), operational efficiency (31/100), human capital (25/100) and legal security (30/100).
  • The capacity of the sector to tackle climate change and support the transition to a low-carbon economy remains weak (24/100). European companies lead the sector in efforts to integrate climate risk management into their strategies. 66% of companies within the sector have shown a weak energy transition performance while only 9% have shown an advanced performance. The best performer here is GPT Group.
  • The sector faces 62 controversies, affecting 14.1% of the companies: 6.5% are involved in high severity cases, 6.9% in significant cases, 6.2% in minor cases and only one company is involved in critical cases. The most recurrent controversies concern internal controls, customer relations and prevention of corruption.

SectorReportRealEstate

Key Takeaways:

  • Physical and transitional risks associated with climate change presents an urgent and complex challenge to real estate which must be addressed but for which the industry does not yet have a clear strategy.
    There are multiple factors that contribute to making the real estate sector highly sensitive to the physical risk of climate change. A real estate asset is immobile in nature, has an average lifespan of 80 years and real estate investments are made usually with at least a 10-year time horizon; even small variations in the assumptions on future cash flows could lead to an abrupt re-pricing of real estate asset values. Physical risks, such as catastrophes, can lead to increased insurance premiums, higher capital expenditure and operational costs, and a decrease in the liquidity and value of buildings. In this framework, real estate companies are expected to find the optimal balance between transition and physical risk to manage effectively their overall exposure to climate change risk. Apart from a minority of pioneer companies that show proactive behaviours and best practices, only weak (24/100) and limited (30/100) scores are respectively achieved by real estate companies on their contribution to the energy transition and on energy efficiency measures adopted on their property portfolio, demonstrating the low strategic importance attributed to adaptation measures aimed to reducing exposure to the physical risk of climate change. A significant geographical bias has been however observed on companies’ performance, with European players displaying better scores than their peers, robust and advanced in absolute terms representing the 29.7% of the sample.

 

  • Real estate companies have limited capacity to tackle corruption and money laundering, which may have important socio-economic consequences on the economy and populations
    Land scarcity, price fluctuations, escalating asset value due to increasing demand from urbanisation have given rise to kickbacks, bribery and corruption in the real estate sector. In addition, favourable tax conditions for real estate companies as well as high financial returns to investments and additional earnings from rentals make the sector vulnerable to money laundering risks. Vigeo Eiris’ assessment reveals an overall limited performance in corruption prevention (34/100) and internal control system (47/100) in the real estate sector. Corruption control score distribution across all regions has a standard deviation of 12. Meanwhile, there is a more significant gap in the internal audit and control capacity with a standard deviation of 17: European companies achieved an average score of 53/100, companies in the Asia Pacific obtained 44/100 and those in Emerging markets only 36/100. This can be partly explained by a higher level of centralisation and convergence in regulation in Europe. Noteworthy, internal control and corruption are among the most recurrent issues of controversies in the sector. Some cases involved real estate developers bribing local authorities and regulators while others are closely connected to internal control leaks, due to a lack of procedure and due diligence process.

 

  • Investment in green certification, smart infrastructure, and flexible workspaces could be key competitive advantages for the Real Estate industry
    39% of the Real Estate companies have green building certifications covering more than 30% of their portfolio. In terms of the evolution in the green certification, the market is composed of more than 600 sustainability certifications for products and buildings. Each certification comes with its own methodology, making it difficult for potential customers and real estate companies to have a clear understanding of all the differences. BREEAM (564,000 certifications in 77 countries), HQE (HQE realized 530,227 certifications in 24 countries) and LEED (108,779 certifications in 164 countries) are the most used ones. Cumulative green building certified space went from 650 million square meters to 3500 million in 2018 and will keep growing, mainly driven by countries like China and India. Although the improvement of buildings’ isolation can be considered as the most efficient measure to reduce buildings’ energy emissions and reach 2030’s objectives, only 27% of the Real Estate sector report has implemented this measure in their portfolio. Furthermore, reduction in energy use could be achieved through a combination of passive design combined with the monitoring of thoughtful building technology. Those technologies contribute to the concept of Smart Cities, by gathering numerous information of the building itself connected to the ones surrounding it to improve energy efficiency and develop the neighbouring communities.
    Vigeo Eiris awarded in the promotion of accessibility of buildings on average limited scores (35.9) to companies in the Asia Pacific region and (47.2) in Europe, on a scale of 0 to 100. As defined by The International Telecommunication Union (ITU), “A smart sustainable city is an innovative city that uses information and communication technologies (ICTs) and other means to improve quality of life, efficiency of urban operations and services, and competitiveness, while ensuring that it meets the needs of present and future generations with respect to economic, social and environmental aspects.” According to IHS Technology, by 2025, Asia-Pacific will account for 32 smart cities while the European Union (EU) classifies 240 of the 468 cities concentrating on large cities. Hence, the promotion of connectivity of properties could be considered as an emerging challenge in the Asia Pacific compared to Europe.
    With the emergence of smart buildings, real estate companies are rethinking their workspaces as well. In 2017, the Smart Building Alliance for Smart Cities (SBA) has highlighted the importance of considering health and well-being as a major topic in the development of Smart Building. Limited scores (41/100) are registered by European Real Estate companies in the improvement of health and safety conditions. Thus, more European companies are experimenting with flexible office space to cater for 21st-century work-life and better position themselves in a fast-paced business environment. Europe’s flex space market is growing rapidly up by as much as 35% a year over the last three years. According to a report by real estate company JLL, almost a third of corporate real estate could be flexible workspace by 2030, with major implications not just for underlying costs, but for their ability to attract and retain talents.

 

  • The rapid growth of urbanisation represents risks and opportunities for the real estate sector, however a majority of companies fail to rise to the challenge
    Currently more than half of the world’s population are residing in cities, and the UN Department of Social and Economic Affairs estimates that this will increase to 66% by 2050. The rapid growth of urbanisation represents a significant challenge for the Real Estate sector, with huge demand for properties in cities, contributing to rising house prices, a lack of affordable options and a growing stock of inflexible buildings which are increasingly at risk of becoming obsolete. Research shows a strong correlation between connectivity and real estate values, with fluctuating prices representing a significant risk for the sector. Further, escalating demand for real estate in urban areas has put mounting pressure on existing infrastructures, highlighting an urgent need for modernisation and repair. Vigeo Eiris’ assessment shows a weak overall performance from the sector (20/100) regarding the social accessibility of properties, with European companies performing better than their counterparts, with a limited score of (35/100). With intensive urban growth, comes a risk of increased poverty, due to job shortages and insufficient services, therefore social and economic development is key to ensure the longevity of communities and maintain stability in real estate values. However, the sector performance regarding the promotion of social and economic development was weak overall (28/100) and geographically heterogeneous, with European companies again performing more favourably, while North American companies delivered the poorest performance in this area, with an average score of (16/100).

 

  • Investor appetite for Green Bonds is growing, but most real estate companies seem unable to catch this opportunity
    Market transformation to a more efficient, more sustainable real estate sector will require an astounding amount of capital, and green bonds have emerged as a potential and promising financing source. The bonds help real estate companies raise finance while allowing tenants to rent office space and buildings that are energy efficient. Eligible green projects can span a range of construction and real estate investment activities to include new development projects, land preservation easements, the retrofit of underperforming buildings, and the refinancing of existing high-performance buildings. Companies have therefore a significant interest to integrate environmental considerations in investment processes and to developed comprehensive methodologies to assess environmental risks in their due diligence process for all new acquisitions or developments. However, the sector displays a limited performance on Environmental Strategy (33.7), with only the 23.8% on the panel achieving robust or advanced performances. European players achieve the best performances in absolute terms (42.5/100), while companies based in emerging markets achieve a weak average score of 23.7/100. Finally, a very low score of 17.5/100 is registered on the companies’ cooperation with tenants on the reduction of environmental impacts from the use of buildings, since a large majority of the panel do not report on measures such as green leases, formalized partnerships and awareness raising for tenants.

 

To view an excerpt of our 2019 Financial Services Real Estate sector report, download the document below

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