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Kempen Real Estate Update: It is not easy being green

16 July 2019

Our clients are increasingly seeking green or ESG flavoured strategies. We fully support this quest even though as our friend Kermit the Frog once said: “It is not easy being green”.

Real Estate

Since the launch of our investment philosophy in 2011 ESG criteria (Environment, Social and Governance) are incorporated in our investment framework. To be precise, ESG determines 25% of the warranted valuation that we calculate. We strongly believe that sustainability features can have a paramount impact on the value of real estate companies. An energy efficient building will normally incur lower costs for heating, cooling, lighting and ventilation. This should lead to reduced operational costs and maintenance requirements. Therefore Energy Performance Certificates (EPC) labels give a good indication as to the capital expenditure we should model in our real estate valuation for each individual company.

Green it is

Regulation will be a key driver going forward, with increasing impact. For example, in England and Wales it has been unlawful since April 2018 to let properties with an EPC label of F or G. In the Netherlands, legislation was passed last year stating that office buildings with a D energy label or lower will be illegal to let as of 2023. According to research conducted by the Economic Institute for Construction and Housing [1] (EIB), approximately 52% of the total office stock in the Netherlands needs to be upgraded from the existing energy label to be compliant with the new legislation. EIB estimates that additional investment between €867 million and €942 million is needed to obtain the compulsory C label by 2023.

Investments are needed to help the Real Estate industry in its transition to become more sustainable and comply with the climate goals as set by the UN. At Kempen we feel a fiduciary responsibility to encourage companies in this transition. We do not exclude companies owning lower labelled buildings from our universe – it is precisely those companies that need the investment and support the most to refurbish the buildings they own. They have the biggest upside from improvement. As Olivier Elamine, CEO of Altria Office REIT, said once: “The most sustainable buildings are those buildings that have never been built”. We fully agree as most carbon is created in the construction phase of a building. This supports our core belief that everything has a price rather than only investing in best in class companies. Most value can be unlocked for all stakeholders through identifying where the most upside is, engaging, sometimes guiding and encouraging management to start their journey. Allocating capital to only those companies that already own highly sustainable buildings is, in our opinion, irresponsible as it incentivises companies to sell less sustainable buildings that need upgrading and buy newly developed sustainable buildings.

“It is extremely difficult to give a manager a CO2 budget. ”

Carbon intensity

It is extremely difficult to give a manager a CO2 budget. It would be relatively simple to reduce the carbon footprint of a portfolio: sell all companies that have a high carbon intensity as they own older buildings (with most upside in case of redevelopment) and buy all low carbon intensity companies with newly developed buildings. A second drawback of allocating capital to best in class, is that for an investor the re-rating potential, and hence alpha could be lower.

In addition, an important driver of the carbon intensity of a listed real estate company is the typical energy mix used in the country the company operates in. In Australia coal is still the main source for electricity production whilst in France some 70% of energy is produced through nuclear power plants. By rebalancing between France and Australia one can steer the carbon intensity. A “like for like” comparison for carbon intensity would be ideal however we have not yet found a way to produce this for a portfolio that owns different companies over time which own different properties over time. You get what you measure. Setting a CO2 target at portfolio level, will earlier see a shift in portfolio composition than an improvement in the underlying company’s CO2 footprint. To achieve the latter, active managers like Kempen use a more engaged approach by encouraging laggards to improve.

The role of ESG data and proprietary analyses

The quest for more green and more ESG has resulted in a large amount of data providers emerging in this area. Each data vendor collects different data points and applies different methodologies, views and weightings to come up with a final score for each company. When comparing these scores for the same company they can lead to different conclusions. The correlation between MSCI ESG ratings to ISS ratings is roughly 0.5. We found these final scores less useful as they leave no scope for us to apply our own views. They can, however, flag different risks and opportunities.

In addition, we feel most data vendors currently lack the ability to judge materiality of issues, instead relying on a one size fits all approach. This does not allow for exceptions in cases where a material factor can overrule everything else. This is why Kempen has own ESG scores for each company. We combine our own observations from meeting management, raw data from different data vendors and our forward looking views on what we believe will become increasingly important, to determine the ESG score of each company. This is time consuming, but as it determines 25% of our warranted valuation we believe it adds value.

In our opinion ESG criteria can be thought of and implemented in a number of different ways and every investor should choose their journey according to their set of beliefs. However, excluding ESG criteria from your investment considerations, despite the complexities around it, is no longer an option given the material impact it can have on your portfolio.

[1] AKD and JLL. “Manage your EPC risk. The upcoming EPC regulation for buildings in the Netherlands” June 2018.
Important Information

As at 30 June 2019, the Kempen Global Property Strategy held no shares in Alstria Office REIT. As at 30 June 2019, the Kempen European Property Strategy held shares in Alstria Office REIT.

The views expressed in this document may be subject to change at any given time, without prior notice. Kempen Capital Management N.V. (KCM) has no obligation to update the contents of this document. As asset manager KCM may have investments, generally for the benefit of third parties, in financial instruments mentioned in this document and it may at any time decide to execute buy or sell transactions in these financial instruments. 

The information in this document is solely for your information. This article does not contain investment advice, no investment recommendation, no research, or an invitation to buy or sell any financial instruments, and should not be interpreted as such. This document is based on information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such.

The views expressed herein are our current views as of the date appearing on this document. This document has been produced independently of the company and the views contained herein are entirely those of KCM. 



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