On the occasion of PERE’s special issue dedicated to sustainable investment, Sunita Mahant, Head of Social Impact and Inclusion, Sustainable Investment, and Simon Lauzier, Chief Financial and Business Performance Officer, examine the ESG-related challenges and opportunities facing investors, and identify the cutting-edge practices being developed to help them deliver their environmental, social and equity goals .They also stress the need for full alignment of interests with all stakeholders to make progress on decarbonization and social impact.
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Why must investors integrate carbon pricing into their asset valuation and financial decisions?
Simon Lauzier : The built environment is responsible for 40 percent of global greenhouse gas emissions and, at a city level, buildings produce 60 percent of emissions on average, so the sector is an obvious target for carbon reduction policies.
As a long-term business, real estate investment is therefore heavily exposed to the effects both of climate change itself and of the changes in regulation and stakeholder expectations that will derive from it. To align with a Paris-agreement compliant pathway, we will have to undertake a deep retrofit of 80 percent of the existing stock by 2050.
However, research by the Urban Land Institute shows that only 4 percent of European real estate investors capture or use a shadow pricing model for carbon in their underwriting. Too often, carbon is not priced in, while still representing an increasing risk factor for investors.
As an industry we need to be better at anticipating the future carbon risk that will materialize and pricing-in this externality. That means being proactive and examining transactions through the right lens to make sure we are buying and selling at the right price.
What challenges do investors face in doing so?
SL : Access to reliable investment-grade data relating to energy use, energy efficiency, carbon emission estimates and the capital cost needed to retrofit properties is a challenge for the whole industry. For example, in most jurisdictions, lease terms do not require tenants to share energy consumption with their landlord, and some of them do not want to.
The current market environment represents another challenge. Inflation and high interest rates make it more expensive to invest in retrofits, and underwriting the impact of decarbonization is more difficult to estimate than it would be in the context of a stable market situation. We need to develop a deeper knowledge of our portfolios, as well as create better alignment of interest with our external asset managers, property managers, GPs, lenders and tenants to deliver ESG improvements and better decarbonization outcomes through linking ESG performance with financial performance.
At Ivanhoé Cambridge, we have implemented a green IRR (internal rate of return) metric, which is essentially a shadow price on carbon, so we can assess how sensitive projected asset cashflows in each region will be to a future in which carbon will have a value. It accounts for a price on carbon during the investment period, the holding period, and also a carbon impact on value creation at the exit.
The green IRR will help us better identify and capture the value created when we invest capex to upgrade a property. For example, we renovated Place Ville Marie, a five-building office complex in Montreal, to achieve the highest energy performance standards, reducing the asset’s carbon emissions by 40 percent, and improving the green IRR by 130 basis points. Some of our peers are also interested in the green IRR concept, and we participate in industry groups aiming to refine it and encourage wider adoption.
That does not replace traditional financial metrics, but it sheds additional light to help us make better decisions. It helps us to activate a ‘brown to green’ strategy because we will be able to better differentiate pricing between brown and green assets and calculate the value we can create by turning one into the other.
What progress have you made on implementing social impact and inclusion into your due diligence processes?
Sunita Mahant : We live in an age where we are facing major impact on communities. The world is increasingly unequal, with 1 percent of the richest people owning 46 percent of its wealth, and vulnerability of low-income households.
The population is also aging; by 2100, 24 percent of the global population will be over 65. People are more focused than ever on their health, aging well and quality of life. Cities are denser, busier and more diverse than ever before.
As real estate investors we have a unique role in shaping cities. To respond to those challenges, we need to adopt a long-term, inclusive and sustainable approach. Inclusion and social impact are integrated into our performance objectives and represent a strategic priority for us.
When we analyze a prospective transaction, we look at factors like health and safety, wellness, access to services, public transportation and community engagement, and we have created a system of accountability that links social performance to financial incentives. The managers that we partner with are rewarded according to how they deliver on sustainability KPIs through the “promote,”
We are now putting that system into operation, and in the last 12 months we have evaluated our first investments on that basis and tied that performance to the payment of fees to the manager. We have also initiated supply chain.
How does creating a more inclusive culture within a company contribute to better investment performance?
SM: A more diverse workforce leads to better corporate decisions, fosters innovation, increases resilience and makes you better equipped to navigate uncertain times. We have a broad range of DEI (Diversity, Equity and Inclusion) objectives embedded within our company’s annual KPIs. We have set up a team in charge of social impact and inclusion.
In the past 12 months we have achieved EDGEplus, a global certification for gender equity and intersectional equity. There are also three employee resource groups at Ivanhoé Cambridge, which drive inclusive changes: Pride (LGBTQ2S+), BIPOC and Women IC.
Last year, we became a signatory to the Institutional Limited Partners Association ‘Diversity in Action’ initiative. It encourages the adoption of best practices in diversity and inclusion, the reflection of those priorities in corporate culture, and the collection and analysis of demographic data. We actively encouraged our partners worldwide to join us by signing up too. To date, 20 percent of them have already responded to that call, and a further 8 percent are in the process of becoming signatories this year.
We are now taking a closer look at how our buildings are designed and operated, and this, with an inclusive lens. For example, thinking about lighting not just in terms of improved energy efficiency, but also in the way it impacts people of different ages. Our priority is to improve the overall experience and comfort, in terms of wellbeing and inclusion.
Last year we also became an early adopter of the WELL Equity rating. It sits under the WELL certification and gives organizations a framework for action to validate their commitment to improving health, wellbeing, access and diversity. We are currently applying that to our headquarters and hope to obtain this rating by the end of the year.
How are the governance structures against which investors measure ESG performance evolving?
SL: We don’t have a separate bucket for impact investing. Instead, we want to be more systematic about how our whole portfolio improves on material ESG factors, and that is where governance comes into play. It is the glue that makes everything possible because it provides accountability and protects against falling into greenwashing or social washing.
For our external partners to do business with us, we must share a common vision on how ESG or sustainability will be integrated into the business plan. We have made progress on setting expectations which create a better alignment of interest both financially and on ESG metrics.
Certifications and benchmarks such as LEED and BREEAM are still necessary, and we will continue to use them, but they are probably no longer sufficient in themselves to monitor and demonstrate sustainability performance. Investors are becoming more sophisticated, and they are demanding more specific performance indicators such as energy use intensity, or forward-looking carbon intensity estimates.
To do that we have adopted CRREM, the carbon risk real estate monitor, to assess the extent to which our assets and portfolio are aligned with a Paris-compliant carbon pathway. GRESB is still very relevant in terms of benchmarking for ESG performance, meanwhile, and for global investors like us it remains the go-to solution. We are influencing our external managers so that they make more and better use of these tools in the way they manage our assets.
Another way of creating better alignment of interest throughout our value chain is by working with our lenders when we borrow money on financial markets. We have taken out C$18 billion ($13 billion; €12.3 billion) of sustainable financing since 2017, about C$15 billion of which is sustainability-linked loans where the cost of the debt is tied to whether we have achieved targets such as reduced carbon intensity or amount of low carbon investments. In May 2023 we issued a C$300 million sustainability bond, which will help finance green assets that we own as well as affordable housing projects.