Why ESG is important to AREIT investing

ESG investing continues to grow at a rapid rate. This is driven by investors wanting their investments to be aligned with their beliefs, to mitigate investment and reputational risk, or in many cases to deliver better risk-adjusted returns.

We have long held the view that ESG investing is not only good for the environment and for society but also makes good business sense.  In the property sector, ESG issues manifest through a range of factors such as energy efficiency, health and safety, pollution, community relations, as well as corporate governance issues such as board structure and shareholder rights. In this article, we will explore some of the investment benefits associated with superior Environmental, Social and Governance practices.

Environmental

Pleasingly within the real estate sector, Australian REITs are at the forefront of best practices for compared to global standards.  Most AREITs benchmark their assets against standardised ratings systems which help both investors and occupiers measure energy and water efficiency.  While carbon reduction efforts may not seem to directly generate higher investment returns, they play a prominent role in attracting high-quality tenants and preserving asset values.  More efficient buildings reduce the running costs for tenants and help to maintain higher occupancies, often on more favourable terms.

The building and construction industries account for almost 40% of annual global carbon emissions.  Targets to reduce waste to landfill and the procurement of renewable energy are key for companies seeking to achieve net zero carbon emissions.  Mirvac Group (MGR) has managed to reduce its carbon footprint by 80% through constructing greener buildings and reducing waste to landfill since 2014.  They have also constructed an industry-first apartment made from waste!

Social

Positive interaction with employees, suppliers, customers and the broader community is particularly important for real estate business like shopping centres or residential developers that are closely integrated within communities. In addition to the obvious benefits associated with increased support, we have seen numerous examples of businesses with diverse and inclusive cultures attracting superior talent and ultimately producing superior outcomes through delivering products that are designed to suit the community in which they operate.

Manufactured Homes Estates, Land Lease Communities and Built to Rent are all potential solutions to the increasing challenge of housing affordability  These communities also promote social inclusion and reduce the risk of negative mental health outcomes for retirees.  There are several very compelling investment opportunities in these sectors including Ingenia Group (INA), Lifestyle Communities (LIC) and Mirvac Group (MGR).

Governance

The importance of good governance cannot be overestimated. Issues such as executive pay, management diversity and structure, audits, internal controls, and shareholder rights are critical.  Governance also relates to a company’s values, ethics and “doing the right thing”.  By creating a strong ethical and social framework, companies can strengthen operational resilience and be better positioned to withstand any crises and disruptive competitions. Good governance is the key in delivering good “E” and “S” outcomes.  If we don’t trust management, we simply don’t invest but we always prefer REITs that have an independent board; incorporate ESG measures for each business unit and are internally managed.

Not only do ESG factors directly impact on operational earnings, they can also play an important role in capital management for landlords as greener buildings have access to more favourable debt structures including potential access to the green bond market.

Our approach is qualitative.  We incorporate ESG factors alongside financial factors to provide us with a complete risk return profile of our investments.  Our ESG research is conducted internally, allowing us to engage directly with management and have more insight into how a company incorporates ESG into its business. With a better understanding of ESG issues specific to each company, we are better placed to identify quality companies that are able to generate sustainable earnings and returns for our investors.