Institutions find themselves in a commanding position when it comes to taking a lead in the development of sustainable property investment. Richard Lowe investigates

It is not often that pension funds find themselves in a unique position of power to significantly change the status quo in the world. Their activity is more likely to be compared with the behaviour of herd animals, seeking safety in numbers and following safe, tried and tested investment strategies. Their fiduciary responsibility means they are naturally averse to being too pioneering or ‘being the first in the queue'.

But it is becoming clear they might well have a lead role to play in what is likely to be one of the most significant global issues of the 21st century: climate change. Amid all the intellectual debate, political wrangling and proliferation of confusing acronyms, it was a pension fund that effectively threw down the gauntlet.

Danish public pensions giant ATP pledged €1bn to a new climate change fund to invest in emerging economies, inviting other institutional investors to join. Chief executive Lars Rohde was reported as saying it was a way of making "ourselves heard", and he recognised how difficult it was for institutional investors to be "the first in the queue" on these sorts of issues.

Paul McNamara, head of research at Prudential Property Investment Managers (PRUPIM), was at the summit, as co-chair of the property working group of the United Nations Environment Programme Finance Initiative (UNEP FI), and was greatly interested by ATP's announcement. Speaking to IPE Real Estate, he says it linked into some of the thinking behind the scenes at PRUPIM, which has launched an "internal improver portfolio" to learn what parts of the asset management process are most amenable to reducing environmental impacts. While ATP's proposed climate change vehicle is not a real estate fund, it is intended to include infrastructure. McNamara says a real estate equivalent could in theory be launched on similar principles.

He says the ATP fund is essentially a fund to finance infrastructure in developing countries in an environmentally conscious way. A ‘lookalike' fund could be developed which would pursue a similar strategy for property developments. Such a vehicle could fund energy efficient refurbishment and asset management projects, he adds.

ATP Real Estate, the property investment arm of ATP, preferred not to comment on how or whether it might adopt such an approach for its investments, but head of real estate Michael Nielsen revealed it would be formulating "a strategy, vision and action plans to be incorporated into our asset class" during 2010.

Picking up the gauntlet
As investors and owners of real estate, pension funds are in a strong position to spearhead progress in increasing the energy efficiency and reducing carbon emissions in the built environment. This is because they have long-term investment horizons, as well as often environmental, social and governance commitments. In other words, endeavouring to help address climate change and generating investment returns for their members (their ultimate aim) are not mutually exclusive.

A growing body of research is leading investors to believe that the sustainability and energy efficiency of buildings will in the long term have a direct effect on investment returns. A research report published in March 2009 by the Royal Chartered Institute of Surveyors (RICS), Doing Well By Doing Good, found evidence to suggest that upgrading a building to a recognised ‘green' standard would directly increase its capital value (although this would be offset by any capital expenditure involved).

Another piece of research last year by PRUPIM showed that 80% of UK pension funds believed sustainability to be "important" or "very important" to real estate investment performance over the next five years. But McNamara says individual interviews conducted for the research revealed that while many understood it was important, some also admitted to not knowing enough about the issue.


Many large European pension funds have integrated sustainability concerns into their investment processes for some time. The UK's Universities Superannuation Scheme (USS), for instance, has been of the belief for several years that it can affect investment performance.

David Russell, co-head of responsible investment, explains that USS has taken the view that measures such as reducing energy consumption, reducing waste production and increasing recycling in its directly held properties are "bottom line savings to both us and our tenants". The pension fund has put a lot of focus on identifying how to monitor and best manage environmental and social issues in its direct portfolio with the end objective of generating a better investment performance.

The role of the fund manager
Most of the focus at USS has thus far been on its direct holdings (these make up roughly 85% of its real estate exposure), but it is now beginning to look at the behaviour of its external fund managers. As Russell explains, this process has been started through a collaboration with Dutch pension giants APG and PGGM to produce a major study into the sustainable credentials of 700 listed property companies and fund managers.
The report, carried out by Maastricht University (see pages 58-59), has enabled the pension funds to create an Environmental Real Estate Index. But the survey results themselves reveal that the vast majority of fund managers are not actively managing environmental issues in their portfolios. Only a select number of organisations from Australia, Sweden and the UK were found to have come close to attaining the top score in the new index.

This finding does not seem out of step with the views held by Hermann Aukamp, managing director at German pension fund Nordrheinische Ärzteversorgung (NAEV). He says the pension fund has always taken sustainability issues into consideration with its direct investments and developments, but he is not convinced fund managers can claim to have the same long-term interests as NAEV.

The pension fund has in the past requested managers of commingled real estate funds to assess their portfolios with regard to sustainability. Aukamp says that all fund managers are willing to respond to such requests, but the level of proactivity varies from manager to manager.

"We see no manager who is not willing to respond on this issue now," he says. "What they are actually delivering is quite different: we see some deliver information and work with consultants in this field and make it an issue; the others just reply."

That said, there is another way of looking at the issue. Fund managers may well have shorter-term interests than pension funds, but then perhaps the onus is on the end-investor to communicate and press their interest and priorities, and for the fund manager to respond to these.

"It certainly helps enormously if the end-investors are calling for this," says McNamara. "If it doesn't seem important to the clients then I guess fund managers might delay ‘getting the issue', which would be a pity."

But Aukamp is also concerned about the rise of the so-called ‘green fund'. He has seen several products launched in Germany that market themselves in this way and he is particularly cynical about them, claiming they are approaching the issue from a marketing standpoint and not one of real estate fundamentals.

"We see a lot of products that are green now but it is only labelling. We've always liked sustainable buildings even if we don't talk about it too much," he says. "We don't like to label it green or sustainable. These green funds offered by fund managers often have mediocre properties in some way."

According to this year's Investment Intentions survey by INREV, only 3% of European real estate fund managers have actually launched a vehicle "clearly marketed as being sustainable" in the past year. In addition, only 7.1% of fund of funds managers and 5.7% of end-investors said they had made an investment in such a fund during the same period. That said, approximately a quarter of fund managers surveyed were planning to launch a sustainable fund in the future, while one quarter of fund of funds managers and (a surprising) 37% of investors were planning to invest in sustainable products in the future.

But Aukamp's concerns about "green labelled" funds raises a critical question: what is the principal way pension funds should be seeking to gain exposure to sustainable real estate? Should it be through allocating to specifically sustainable funds or should the issue of sustainability considerations and policies be integrated into its entire property portfolio?

McNamara admits it is a difficult question and understands the logic of cynics who might ask a fund manager: ‘If you believe in a sustainable real estate strategy, why not do it in all your funds?' However, McNamara says that green real estate funds might be a necessary way of moving the issue forward, at least in the short or medium term. He cites the existence of socially responsible investment (SRI) funds in the equity markets and how they have driven forward the issue of responsible investments. "My guess is every fund manager house is wrangling with this issue. I think it is genuinely, conceptually a difficult thing to work your way through," he says.

Sharing responsibility
Russell at USS believes the onus for driving sustainability forward in real estate does not fall squarely on pension funds. "I believe the onus is shared. We as pension funds do have part of the responsibility to make sure that the assets that we own are taking these issues into account, but then the rest of the chain does as well," he says.

He cites the work that RICS is doing in helping valuers incorporate sustainability into their appraisals. In November 2009, the organisation announced it would provide advice, guidance and green standards to the industry as part of its Global Climate Change Strategy.

Then there are the tenants. It is estimated that 80% of emissions from the buildings come from the tenants using them.

"Both investors and tenants have a huge part and responsibility to play," McNamara says. "I wouldn't want to say that absolves institutional investors of their responsibility. They need to encourage and work with each other and tenants."

The West Midlands Pension Fund in the UK will be in communication with its numerous tenants over the next 12 months as part of an assessment of its large, directly held UK portfolio. Its external property manager ING Real Estate Investment Management has recommended adopting the so-called Eco-Ledger, an environmental performance benchmarking service developed by International Property Databank (IPD), based on its Environment Code.

The service will allow West Midlands to assess its real estate holdings against a benchmark. "All the direct property holdings we have we will run through this process over the next 12 months and we will see what actions are necessary out of that," says Brian Bailey, director of pensions at West Midlands.

One of the exercises in the process will be to work with tenants to seek to agree a standard format. "A pilot programme shows an increasing appreciation from tenants in wanting to improve the environmental management from their side as well. So I am hoping we will get a strong response," Bailey says.

And then there are governments and regulators who are also vital in pushing the issue forward. McNamara says he did not expect real estate to feature in the final communiqué that came out of the Copenhagen summit last year. But he believes that the UNEP FI property working group and a number of other real estate-related bodies made their presence felt.

"There was a feeling that there is still quite a lot of work to be done to push property in its appropriate place, which is in the spotlight," he says. "Post-Copenhagen, I don't necessarily think anything has changed. For those who are active in pushing this forward at an international level it is more of the same really."