You Asked Us: A foundation for impact investment in real estate

WBEF expert panel:

Tanja Volksheimer, Senior Portfolio Manager – Europe, Nuveen Real Estate

Tina Paillet, Chair, RICS Europe

In our current circumstance, is it realistic to expect investors to prioritise anything other than financial return on investment? How can we drive culture change at this most challenging of times?

Tina Paillet: Bottom-up public opinion on responsible investment and top-down environmental regulations are applying pressures not seen prior to this cycle. Investments that do not consider and pre-emptively tackle their impacts and externalities on wider society will become increasingly undesirable and will lose value. I think the real estate sector will soon see a division between “investment grade” sustainable and desirable assets, and all others. This latter group of assets will be considered second class at best. At the extreme end of the scale, they will become stranded assets – stranded either by their failure to conform to environmental legislation, or by simple unattractiveness to end-users. That is a pretty convincing argument for cultural change!

Tanja Volksheimer: Impact will mutually co-exist with financial return. This is especially important and in-demand at times like this, where we are more aware than ever of inequality, political instability and public health. The consequence is a re-imagining of capitalism. Capitalism is about investing according to market demand; well, the market currently demands solutions to these pressing challenges. Cultural change is already happening, regulation is doing its part, companies are doing theirs and employees are driving change too. We can drive this further by highlighting inspiring examples of what the real estate industry is doing. We must throw a spotlight on examples of new approaches and technologies, new construction methods, functioning urban spaces and smarter urban density.

How fit for purpose are Discount Rates and Net Present Value on driving the right investment decisions? Can they negatively influence whole life value decision making?

TP: This is a great question which needs to be approached from two distinct standpoints: investment timelines underwritten by business plans are typically between five and 10 years. The timeline for long-term sustainable investment returns and, notably, most carbon targets stretches out to 2050. This is a mismatch. Investment returns in the CBDs of Europe’s capital cities for core office product, typically top out at 3%. They continue to be dragged by prevailing low interest rates and government bond rates, and by an influx of investment capital increasingly positioning itself towards real estate investments. This does not leave much room for budgets of capital improvement over time, which will be required to transition even recent assets towards carbon near-zero targets. If investors ignore these imperatives, the mismatch in investment underwriting and real returns will leave assets stranded or investors scrambling to justify higher-than-planned investments to sustain values. A path to reconcile investment drivers may be found in the consistent measurement and disclosure of the social and environmental returns achieved through good impact investing. Any such measurement must take into account the social cost of externalities – both negative and positive – of each investment.

TV: There is, perhaps, a related question here: “How much does a return say about an investment that looks at the true value of a building?” We still need discount rates and net present values to make an investment decision as they reflect the asset´s income and the general state of the market. But it is true that there is another factor that must be taken into consideration. This added factor has been termed social return on investment (which you may have seen expressed as SROI) or, alternatively, impact return. At Nuveen we condense the financial aspects into one number and then do the same for impact. This helps us to see the investment holistically and make the two perspectives comparable – giving a “true” value. This practice is becoming ever more sophisticated; we can look forward to impact soon being added to risk-return profiles. Currently each company has its own approach, but in the future we must surely adopt a common methodology. I am encouraged by the fact that the industry is already working on that.

What will be the sustainable investment model for future offices if, as expected, more people will be working remotely in the future?

TV: Overall demand for office space should not be affected too dramatically, although the balance of arguments suggests it could reduce moderately over time. Corporates will probably restructure their portfolios and accept greater flexibility regarding remote working. Demand for supplementary flexible space is expected to rise accordingly, although the model of provision will need to change. Serviced office operators will need to consult their customers on what constitutes “acceptable” densification. One trend appears inevitable: landlords, property managers and tenants will interact more closely and effectively in the future. They must come together to enhance the experience and value of the office, accelerating a trend that was in its infancy prior to the pandemic. Additional new services will be provided to tenants, with associated income streams for landlords – this will speed the migration to a partnership model. Office values will be reinforced and ultimately underpin a healthy long-term demand for space. The workplace environment needs ‘actively animating’ with an enhanced focus on collaboration, community, hospitality, health and wellbeing. Meanwhile, new technologies will emerge which allow for workplace data collection, contributing to a better work experience in the new normal.

TP: There is a new war for talent already underway. The office of tomorrow will need to adjust to new design, technology, amenity and operational expectations in order to attract knowledge workers. Landlords will become a productivity or space-as-a-service operators, catering to increasingly diverse and individualised workforces. Smart buildings and building management systems which harness the data produced in and by buildings can create a virtuous feedback loop, enabling responsive improvements for the end-user. It will be key that office operators embrace these systems. Lease lengths will be shorter and rents will be partially based on experiential criteria – not to say productivity!