NAEV is planning to ‘green' its entire residential property portfolio in Germany. Hermann Aukamp tells Richard Lowe why and how the issue becomes more complicated for commercial and international real estate

Sustainability in real estate will be driven primarily by tenants rather than investors or regulators, says Hermann Aukamp, CIO for real estate at Nordrheinische Ärzteversorgung (NAEV), the €9.8bn German pension fund for doctors. The risk for investors that fail to anticipate a change in tenant demand for sustainable buildings, and do not future-proof their portfolios accordingly, is that their assets will become obsolete.
However, the picture is not the same across all real estate sectors. Aukamp believes the residential sector in Germany is further ahead in this regard, compared with commercial segments of the market. "There is tenant demand," he says. "Tenants want to move to [sustainable] buildings and in my view residential tenants also pay for this."

For this reason, NAEV is embarking on a comprehensive ‘greening' of its residential real estate portfolio in Germany. Its investment strategy will restrict the pension fund to building new developments with joint venture partners that meet the highest levels of sustainability; it will not be making acquisitions of existing assets. The move also aims to keep NAEV ahead of regulatory developments in Germany that seek to push through energy efficiency improvements in the housing sector.

"When we do residential we only concentrate on new sustainable buildings," Aukamp says. "For the time being it is only on the residential side. Of course, when we do developments and buy into office and other sectors, we also look at it, but for residential investments we do it 100% now."

Tenants in German commercial property are in a position where they will willingly pay more for sustainable buildings. "It is a different situation for the landlord on the residential market," Aukamp says. For this reason, NAEV does not have an "overall programme" to improve its commercial real estate portfolio in Germany, although it is endeavouring to make improvements through a natural process. "We mainly try to improve buildings when we've got a tenant change or when the lease is renewed," he says. "We do it building by building and lease contract by lease contract."

Improvements invariably fall into the category of ‘low hanging fruit' - that is, measures that have low or zero cost but lead to significant sustainable results, such as improvements to air conditioning, building facades and lighting systems.

All these examples apply to NAEV's directly held domestic real estate portfolio. When it comes to international property investments the pension fund is one step removed, investing through third-party funds targeting markets in Europe, Asia and the US. For this reason, the approach to sustainability is somewhat different and the onus is effectively on individual fund managers.

Aukamp says he wants managers to consider sustainability in their investment strategies and he would not want them to invest in "high-yielding, [energy] inefficient stock". He adds: "We would oppose [that] and ask different questions to fund managers who want to invest in buildings that might be obsolete in a short time because they are not efficient or sustainable. We put this discussion on the table and discuss it with the managers and fellow investors."

Manager responses to this vary, Aukamp reveals. "It is very different, but not only by fund manager company, it also depends on people, and by individual fund managers who really work on these issues," he says. "Certainly, there are fund managers which put a bigger emphasis on this, which are a little bit more advanced on the learning curve than others."

He adds: "But it is also a problem of the fellow investors. Not all fellow investors are on the same track." For this reason, Aukamp admits that it can be very challenging for fund managers to do the right thing - that is, to address sustainability issues prudently and to please all investors, who often have varying priorities and agendas.

"In this environment there are often quite different views in the investor base of many funds," he says. "We are all on a learning curve. Green buildings are much more in the focus of many investors than they were 24 months ago."

One of the biggest difficulties for institutional investors when it comes to sustainability is the fact that their principal fiduciary responsibility is to protect capital and to achieve the best possible investment returns. For this reason, sustainable practices and measures have to make sense financially, rather than be driven by socially altruistic reasons. Most investors agree that the incentive behind integrating sustainability into investment strategies has more to do with future-proofing against changes in regulation and market behaviour rather than quantifiable boosts to short-term returns.

Aukamp admits that "for the time being there is no defined link" between sustainability and investment performance. He says: "We can only say in the long run you will better off. But on the other hand, a lot changes quickly. It's very difficult to say." He cites offices as an example where it is currently difficult to identify this link with any certainty. "The only thing you can say is this building will be let when it is efficient and sustainable, and the other one will not be let. But it does not say anything about price and whether you get a higher yield or not."

Of course, the way forward is to begin measuring sustainability and corresponding investment returns. But here there is another obstacle: a proliferation of different measuring systems, regulatory regimes and organisation across global property markets. "With all these standards, it is very difficult. So we need more transparency," Aukamp says. "I think we will get better transparency in the future. All these standards will not be the same in every country and for every sector, but we will get better transparency in the long run."