The construction and operation of commercial property is a significant contributor to the UK’s carbon emissions. The quantum of this contribution enables institutional investors and managers to have a significant impact on the process of decarbonisation.
Professional Pensions assembled a panel of experts to discuss how professional and pension investors can achieve net zero in their property portfolios - assessing how they can work with active managers to achieve real-world reductions in whole-life carbon emissions.
The panel - chaired by PP editor Jonathan Stapleton and held in association with Columbia Threadneedle Investments - The Townsend Group partner Oliver Hamilton; MJ Hudson managing director and head of research Joanne Job; The Association of Real Estate Funds managing director Paul Richards; and Barnett Waddingham principal and senior investment consultant Pete Smith in addition to Columbia Threadneedle Investments co-head of UK institutional real estate James Coke and client relationship & sales director Moira Gorman.
This roundtable assessed some of the issues faced by the real estate industry - including how responsible investment practices should be embraced, and how they can be reported to comply with an increasingly demanding regulatory environment.
The roundtable also explored the merits of differing approaches to property management and the impact each have on delivering tangible change.
Let's start with a big picture view and the role commercial property can play in a pension scheme portfolio. Does commercial real estate have a role?
Pete Smith: It has a role, especially for schemes that are moving from a growth phase to focusing on income and investing in assets that have real contractual income streams.
What are some of the key things pension schemes are looking at when it comes to real estate?
Joanne Job: The Local Government Pension Scheme (LGPS) and a lot of other institutional investors have moved to invest a lot more in real assets, including infrastructure, as a diversifier and an alternative to fixed income, given the low yields we have seen in the last few years. There is, of course, now the appeal of ESG, which transposes itself quite well to real estate; for example, if you take the "E", there are buildings using energy-efficient materials that can help reduce carbon emissions; therefore, real estate can appeal to investors not only looking for diversification and higher yields but also to help achieve their ESG objectives.
How are ESG and sustainability factors affecting asset allocation decisions?
Pete Smith: The reality of addressing the problems we face is that we need to put money to work to help transition to a low-carbon economy. In relation to the type of properties you are wanting to own in the longer term, it is the ones that are lower emitting and more efficient from a carbon point of view.
Moira Gorman: The tangibility of property means trustees are often more engaged with the asset class than other parts of their portfolio. Property is a large emitter of carbon and by talking to their manager and making sure they are taking an active approach, they are able to make a significant direct impact in the reduction of real-world carbon emissions.
Oliver Hamilton: Interestingly, we are seeing pension scheme sponsors, not just trustees, starting to look at this as well. If they are a large corporate, they have their own sustainability goals and targets. Sponsors are engaging with trustees to help ensure that pension schemes portfolios are aligned with their own goals.
Moira Gorman: As an industry, we have a big job to do to educate schemes and trustees. We need to make sure they understand sustainability in the context of the asset class and ask for the right data to make their assessments of progress (or otherwise), and that we are providing the qualitative background.
Oliver Hamilton: One of the key issues is defining what is meant by ‘net-zero carbon', because there are different definitions. Does it include the property's embodied carbon? Is it just emissions the landlord has control over or does it include the tenant's operations? Ensuing the data that managers present are on a like-for-like basis is one of the challenges for trustees and advisors to overcome. Currently, we see disclosures on different basis which can be misleading and confusing.
Paul Richards: We have been pushing back to the FCA and the Treasury about standards and they are listening. They want ideas as to how we can put in place reporting standards that incentivise doing the right thing, which is quite heartening.
How are you addressing these challenges and straddling that balance between the embedded carbon impacts of old buildings versus the carbon cost of constructing a new and efficient building?
James Coke: The industry is starting to work out that it is carbon inefficient to knock old buildings down and build back new. What we are starting to do on our refurbishments is quite a wholistic whole-life carbon assessment. Is it more whole-life carbon efficient to demolish it and rebuild it? In most cases, it is far more carbon efficient to refurbish. At a portfolio level, there will be a balance between which buildings you keep and improve, and which you think are economically and environmentally obsolete.
Pete Smith: I listened to a presentation from a steel company which is trialling lower-emitting steel production. I am conscious there are similar developments in the concrete world. For some of those decisions around the buildings that are no longer fit for purpose, and may need to get flattened and rebuilt, there is therefore a question around the timing of doing that. Let us say it takes five years for these new materials [to become available for use]. Is that too far in the future to focus on in today's decision-making?
James Coke: That is a pertinent point because the timing of interventions is going to be key. The analysis we have done on the fund I run is an operational net-zero pathway to 2040. The reason we ended up at 2040 is because that gives us the right balance of allowing technology to improve to the point that it is cost efficient, as well as technologically resilient enough to have a material difference.
How are pension schemes approaching this?
Joanne Job: They face a number of challenges. One is to understand the challenges of reporting, frankly. And the lack of standardisation across the industry is a major hurdle. But you also cannot look at the metrics in isolation.
Then from the schemes' perspectives, they also want to have a holistic view of their entire portfolio and where it stands in terms of carbon footprint. The dialogue with managers to come up with solutions that make sense in terms of transparency and tangible results is very important, as well as with their investment consultants.
How big a challenge is reporting the carbon impact of commercial property and property in general? As an investor, can I get a single number from a building to work with?
Paul Richards: You can get a number, but the concern is what that tells you, if anything. There is a tension because an investor - whether a multi-manager or pension trustee - has so many considerations. If [the investor] can reduce that to a reporting standard or a number, that is attractive. The concern is it becomes a tick-box exercise and not knowing what is going on behind it.
Can and should real estate investors be looking to influence landlord and tenant behaviour?
James Coke: Through positive engagement with our tenants, we try and drive positive corporate behaviour. We have seen that working in some instances, but it is by no means universal. In the same way that different investors and pension schemes are dealing with their own agendas, the occupier community is [experiencing] the same thing. We have had prominent retailers trying to get to net zero, but [at the moment] they want to do it independently of landlords.
Oliver Hamilton: Ultimately, with open ended funds, if investors do not believe in what their fund managers are doing they can redeem. If you are a larger scheme, you can engage with your managers and be more prescriptive on the mandate's ESG policies and reporting.
To what extent is social and affordable housing is becoming increasingly important in scheme portfolios?
Moira Gorman: We have a lot of engagement with the LGPS, which is looking to allocate to social and affordable [housing]. There is the regulatory risk associated with social housing, as there is with any asset that attracts government subsidy. Focussing on affordable build to rent without government subsidy, ensures private capital is not in direct competition for sites with housing associations and other organisations delivering social housing stock, for example those under s106 agreements, that ultimately just drives the prices up for the social sector, also results in much less regulatory risk. We will see increased capital allocation to affordable housing in the very near future, primarily through the LGPS. Hopefully, it will also generate interest for corporate DB schemes too. For DC, it is probably still [some] way off.
Oliver Hamilton: Investing in social housing is an area that some of our clients inquire about, but accessing the asset class harder than most appreciate because for many larger housing associations it is expensive to finance themselves via inflation-linked leases compared to accessing fixed debt. It is also an area that has reputational and regulatory risk that needs to be carefully considered; we have seen for example the fallout in the residential ground market over onerous leases and replacing dangerous cladding.
Moira Gorman: Yes, but through owning a property fund, the fund owns the housing and you are leasing to the end tenants with an affordability criteria. When you are working with a housing association as a delivery partner, this means they can use that cheap debt to fund other crucial activity such as bringing existing housing stock up to standard.
Joanne Job: Also, in terms of Section 106, it can also be something like having a play area and a community area. These are just a couple of examples.
How is the industry responding to the deluge of reporting? Are we at peak regulation?
Paul Richards: The industry is saying, ‘can we please just have a single standard or, if not a single standard, some standards that do not clash with each other?' That is quite an ask, because the European Commission, the FCA, the Treasury and the SEC each want their own regulation. The spirit of the conversation is, ‘we should probably do something that is consistent'."
James Coke: Our primary focus is on understanding our portfolios, what the energy performance is, and then we look at how to report it. Hopefully, the regulators will coalesce and make our lives easier, but even in the event they do not, the building blocks for understanding carbon performance are broadly similar.
This roundtable was held on 9 June in association with Columbia Threadneedle Investments