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Funds Raise the Bar on ESG Strategies to Attract HNWIs

Real estate investors across the board are showing more interest in sustainable platforms.

ESG may not yet be in the lexicon of high net worth investors (HNWIs) when it comes to their real estate plays, but the same focus on environmental, social and governance issues that is gaining traction among institutional investors is starting to resonate with HNWIs and family offices as well.

People want to invest in things that have a decreased footprint and more of a conscious approach to environmental, social and governance best practices, says Michael Underhill, chief investment officer at Wisconsin-based Capital Innovations LLC. “When you look at ESG investing, we’ve moved from just checking the box to more of an active analysis in terms of the component of investment portfolios. It’s now a must have for all portfolios,” he says. That increased interest is spanning across different demographic groups from baby boomers through Gen Z, he adds.

The growing appetite for ESG-friendly investments is sparking a shift among sponsors that ranges from greater emphasis on disclosing ESG policies and practices  to dedicated sustainable and impact funds. Capital Innovations is preparing to launch a new Sustainable Real Assets Interval Fund in June 2021. Although the real assets investment firm has managed sustainable portfolios in the past that have included real asset securities, including REIT stocks, this is its first interval fund that also includes private market investments. In all, 70 percent of the fund is expected to be invested in private market real estate, infrastructure and natural resources. Specific to real estate, the fund will target investments such as green buildings, affordable housing, urban housing and other real estate projects that focus on reducing carbon emissions, energy and water consumption.

“The COVID-19 pandemic and all of the extensive aftershocks have put a spotlight on the importance of ESG issues, and I think now more than ever individual investors, as well as the financial advisors that oversee the portfolios for these investors, are focusing greater attention on ESG issues,” says Underhill. Going forward, ESG issues are going to differentiate companies to a much greater extent than they have in the past, and there will be winners and losers, he adds.

Underhill, a 26-year veteran of the real estate industry, co-founded Capital Innovations in 2007 to help investors migrate to a more sustainable investment philosophy. In addition to a resume that includes major investment firms such as Alliance Bernstein, Invesco and Lehman Brothers, Underhill is chairman emeritus of the United Nationals Principles of Responsible Investment (UNPRI) Infrastructure work stream. “We want to make sure that we are not only being socially responsible when investing on behalf of our institutional clients, family offices and individual clients, but also to make sure we are managing to better outcomes,” says Underhill. The Sustainable Real Assets Interval Fund has a target return in the mid-teens.

Growing scrutiny on ESG policies

Industry experts agree that investors across the board are showing more interest in sustainable platforms. People have a lot of choices on where to invest, and they are becoming more and more selective in evaluating ESG credential and criteria, notes Allan Swaringen, president and CEO of JLL Income Property Trust. “We are definitely seeing accelerating interest from the high net worth side of the world, and it continues to be an important criteria for screening and selecting investments,” says Swaringen. JLL Income Property Trust, which currently owns a $3 billion core real estate portfolio across nearly 80 properties, achieved a three-star GRESB Rating in the 2020 Real Estate Assessment.

At JLL Income Property Trust that interest is manifesting itself in due diligence questions and questions within RFPs. There also are more in-depth inquiries into practices, policies and results across the ESG spectrum. Investors are taking a closer look at LEED certifications and EnergyStar  ratings, as well as looking at what managers are doing to reduce carbon footprints and optimize energy efficiency. From a socially responsible component, investors want to know about things such hiring and diversification practices and community involvement, as well as good governance. “That broad spectrum of ESG investing is critically important with a number of the wealth management firms that we work with, and it is especially showing up with the wirehouses and the larger clients within those wires and the registered investment advisors,” says Swaringen.

Investors may not be calling it ESG, but they are asking questions about sustainability, such as whether a building has solar panels or energy efficient lighting, adds Zack Otte, senior vice present at Plante Moran Real Estate Investment. “Especially on the private real estate side, it is much more of a qualitative assessment of just asking what is the ESG approach,” says Otte. Having more benchmarks and more quantitative data is starting to trickle into the market. However, that piece is still evolving generally, and that quantitative approach is not a big part of the discussion with HNWI and family offices at this point, he adds.

Raising the bar on ESG strategies

Despite a growing number of examples of dedicated funds from the likes of Capital Innovations and SoLa Impact, pure play sustainable and impact funds are likely to remain a relatively small niche within the real estate industry – at least for now. However, growing interest in environmentally and socially responsible funds is expected to elevate ESG platforms more broadly across the real estate industry as table stakes to attract investors. For example, GRESB has become the leading ESG benchmark for real estate and infrastructure investments across the world. Participation in GRESB’s 2020 Real Estate Assessment grew by 22 percent to encompass 1,229 real estate portfolios worth more than $4.8 trillion globally, including reporting from REITs, property companies and non-listed portfolios.

“For the majority of our clients, it is a hot topic that comes up in conversations quite a bit. But I would say the discussion is more around what fund managers are doing with their ESG program versus an entire fund where that is the focus,” says Otte. People are still highly focused on the return on investment. How does that energy efficiency or social impact strategy drive things such as operating costs, tenant retention and lease renewals? he adds.

One of the challenges is that ESG is not the same as discussing an apartment strategy or a core plus strategy. It’s a bit of its own animal that is harder to understand and harder to underwrite, notes Otte. Investors or their advisors have to have confidence that a fund is hitting its ESG targets, and also making reasonable financial returns based on the risk the manager is taking in the portfolio, he says.

In addition, many HNWIs are still fairly under-allocated to real estate. Oftentimes, initial allocations tend to focus more squarely on the real estate strategy. It is when those allocations get larger, as with institutions, that a portion of that real estate allocation may be invested in an impact or green fund, adds Swaringen. “In the high net worth space, folks are trying to get access to income-producing, diversified real estate, but they want to do it with managers who are focused on all of the components and criteria of ESG,” he says.

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