Kempen Real Estate Update: The Social in ESG is there to stay and will become increasingly important…
Among the traditional Real Estate subsectors the residential market is likely to be most at risk of government intervention through regulation. In a business to consumer model (“B to C”), the consumer in general needs more regulatory protection than a business in the same setting. For all businesses but especially for businesses operating in the B to C channel, reviews, customer satisfaction and adapting to the latest trends is more important than ever before. Unhappy customers nowadays have more options to make their case, find likeminded people and team up when they feel they are not the only ones encountering a problem.
A customer standing up to a big organization can feel helpless, especially when it touches one of the core necessities: a place to live. Finding people with the same experience gives comfort and potentially an opportunity to collectively change the situation. One way of doing that is via politics. When a significant part of the electorate is renting it is worthwhile for politicians to support what a large portion of voters wants. Studies show that people want an affordable rent and a nice place to live with a mixture of neighbors or neighborhoods that do not change too much in composition. Gentrification of cities and neighborhoods has at times been applied by local governments to push out the poorer and was considered something positive. Nowadays politicians on the back of their electorate consider gentrification a cause of segregation, destroying social cohesion and the sense of being part of a community.
What can be seen happening globally is that people feel their rents are unaffordable and that the landlord is reaping the benefits. As more and more tenants start to feel this way they will start to mobilize. We see this already happening in Hong Kong, New York, California, Paris and Berlin. In Berlin, the left wing parties proposed new legislation to freeze rents for the next five years. In our view this does not address the true issue of a lack of available housing. Nevertheless, it is a move widely supported by tenants and enhanced the popularity of these left wing parties.
“A traditional Real Estate investor will seek to optimize the balance between risk and return for a potential investment. ”
Residential, a skewed risk-return profileA traditional Real Estate investor will seek to optimize the balance between risk and return for a potential investment. The property level return that can be achieved can be broken down into multiple components of which an important part is the market rental growth and how easy it is to capture this growth. Residential property is known to be an asset class where it is tougher to capture market rental growth because of more regulation due to increased tenant protection. The potential return might be lower but, as mentioned above, we should also consider the risk profile. An important part in considering the risk profile for Real Estate is the volatility in the property level cash flows. The Residential sector is less sensitive to the economic cycle than other sectors such as offices or retail. In general we observe that in place rents are below market rents. One can argue that this could provide a safety margin for future market rental decline. Therefore residential is often seen as a less risky sector but also with lower expected returns as rental growth is more muted.
With the tenant uprisings across the globe and the traction that these tenants have with the politicians, we can see residential markets moving in similar directions globally. Stakeholder management is getting increasingly important especially as social benefits to society are winning over financial benefits to landlords. We increasingly hear management teams say that part of the return should be given back to society to create a more sustainable future in which not only the rich can live.
We believe those companies who find the right balance between all stakeholders will drive the most sustainable value. We award these companies the highest ESG score in our framework and hence the highest warranted valuation. In our process, ESG determines approximately 25% of our warranted valuation. We believe the market continues to underestimate the importance of ESG and often fails to truly link it to returns and risks. The recent concerns raised by residential tenants across global cities again shows us that it will impact risks and returns going forward and can’t be neglected. ESG factors expose market inefficiencies that we can benefit from.
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