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Driving ESG in real estate and construction: A foundation for impact investment

Changes to the cultural and regulatory landscape have accelerated the progress of the ESG agenda. But impact investing for social and environmental good could become something of a dark art if we cannot reach a consensus on what constitutes "impact".

Sander Scheurwater, Head of Public Affairs – AEMEA, RICS
3 February 2021

Kate Raworth’s Doughnut Economics: Seven Ways to Think Like a 21st Century Economist may become one of the defining economic treatises of our time. The titular doughnut is “a safe and just space for humanity.” Into the doughnut’s hole fall those people abandoned by the “social foundation”. The doughnut’s outer circumference, meanwhile, represents the “ecological ceiling” through which we cannot break without dire consequences for the life of the planet. Notably, research suggests that no country is currently capable of meeting its citizens’ basic needs without crashing through the ecological ceiling.[1]

Though Raworth’s book was published in 2017, her economic model arguably came of age in April 2020. Then, as COVID-19 was first supplanting Western certainty with doubt, the Municipality of Amsterdam formally adopted the doughnut as the foundation block for all future policy decisions. At the time, the city’s Deputy Mayor, Marieke van Doorninck, expressed her hope that the move would help the city to “overcome” the shock of the pandemic. The theory, she said, is more than “just a hippy way of looking at the world.” Nonetheless, the sceptics will not be persuaded until this brave policy approach begins to yield results. So how might that happen?

Driving ESG in Real Estate and Construction – A Foundation for Impact Investment

There is no doubt that demand for ESG-linked real estate investment is increasing. With a wide range of global sustainability challenges and complex risks on the rise, investors are starting to re-evaluate traditional portfolio approaches. As public pressure builds for industries to adhere to environmental, social and governance standards, the real estate and construction industries are no exception. Numerous regulations and cultural shifts are changing the course of the European ESG landscapes. How exactly is ESG affecting the real estate and construction industries? How does the European ESG landscape look right now? Will these industries be changing its portfolio strategy (more) towards ESG?

Overperformance of ESG funds has provided much-needed optimism through bleak recent months; ESG reporting and investing may provide the tools by which the doughnut model can be implemented.

“The wallet is a powerful way of transforming comprehensive industries,” says Tina Paillet, Chair of RICS Europe. As we sail perilously close to the ecological ceiling, nothing less than transformative action is required. Carbon neutrality pledges, increasingly popular with governments and corporations alike, are hard to realise and verify without accepted taxonomies and comprehensive reporting protocols. What use are statistics on emissions from the built environment, if the figures do not include embodied carbon? Words may be the means by which we signpost intentions, but they have limited value if not accompanied by impactful action.

Few people can be better qualified to make that point than Tanja Volksheimer, Senior Portfolio Manager for Europe, at Nuveen Real Estate. For 30 years, Ms Volksheimer has monitored the successes and shortcomings of a practice that has come to be known as impact investment.

Impact investment, she notes, is not separate from ESG, but rather builds on the ESG concept to go beyond traditional responsible or sustainable investing. It is not an exercise in philanthropy and must deliver worthwhile commercial returns. And while the industry is growing in both size and sophistication, a consensus on what constitutes a genuine “impact” remains frustratingly elusive. The IRIS+ framework developed by the Global Impact Investment Network is a clear step towards the resolution of this issue.

Global Impact Investment Network (GIIN) defines impact investment as “investments made with the intention to generate positive, measurable social and environmental impact alongside a financial return.” GIIN further cites three qualifying criteria:

  • Intentionality – identifying the intended outcome and necessary steps needs to be part of the strategy;
  • Additionality – the intended outcome (impact) could not have incurred without the investment; and,
  • Measurement – the ability to compare the intended outcome with the starting point, a challenging and hot topic for the impact industry.

Sebastiano Ferrante, Head of Germany and Italy at PGIM Real Estate speaks to this frustration when advocating for the creation of quantitative impact metrics. Investors must be enabled to demonstrate “impact returns” alongside more traditional profit measurements. He stresses, too, that the profit motive does not compromise the virtues of impact investment, but rather underscores them. A bankrupted pension fund cannot explain away its losses by cataloguing its ethical achievements. It is noteworthy, he says, that the absence of a strong paternalistic tradition in North American politics has created a space in which impact investment has been able thrive. To a degree, the opposite has thus far been true in Europe. This is not intended as a criticism of regulatory stringency, but rather an acknowledgement that investors face a differing array of challenges according to prevailing local policy conditions.

Another, as yet unresolved, tension in the practice of impact investing is that markets and asset classes primed for positive impact are often subprime for financial returns. Markets with weak income structures, high unemployment, poor infrastructure, lower educational density and other social stressors are those that stand to benefit most from targeted deployment of capital. They are also, by their nature, the markets most freighted with risk.

Markets with weak income structures, high unemployment and poor infrastructure are those that stand to benefit most from targeted deployment of capital. They are also, by their nature, the markets most freighted with risk.

Susanne Eickermann-Riepe, Chair of the RICS Advisory Board in Germany, believes that investors have to accept that such challenges come with the territory. The climate emergency and COVID-19 pandemic are alike in posing the greatest threat to already vulnerable societies. Failure to finance impactful projects in these communities will have increasingly dire consequences in the long run.

Encouragingly, ESG-focused investment has an increasingly influential cohort of backers. A November 2020 report released by PwC Luxembourg showed 77% of institutional investors plan to stop purchasing non-ESG products by 2022.

The evidence base for ESG has grown to the point that it now verges on the mainstream. Investors appear ready and willing, and have the power to instigate substantive change. But without shared metrics and rigorous verification procedures, real “impact” will remain slippery – understood in theory, but sparingly realised in practice.