A potential office building investment on West Palm Beach in Florida was scrapped by AEW due to its flooding, tropical cyclone and extreme heat risk, likely to be exacerbated by climate change in the future.
These kinds of processes are how AEW Capital Management approaches its real estate investments where ESGR (for Resilience) criteria form the base framework for the firm and its global outlook.
“It’s not just that the long term value of this asset could be impaired by physical damage caused by climate change,” Lily Kao, senior portfolio manager, US Core Property at AEW, said at the Investment Magazine Real Estate Investment conference in late February.
“But there’s an economic impact in that there’s a higher insurance or debt cost or a reduced buyer pool who are also aware of the climate risks.”
Environmental Social and Governance policies are commonplace in global investment firms, but addressing the physical risks to physical assets like property mean AEW’s teams have deepened their due diligence and studies of investment risk.
Tanya Do, portfolio manager, Asia Pac Core Property at AEW, said sometimes it’s worth building an entirely new project from scratch to take advantage of ‘best in class’ technology, but improving an existing asset is also a viable option.
“There’s a high carbon cost in developing a new property, particularly the greenhouse gases used in construction,” Do said.
“Whereas improving an existing asset can have a large impact too, like changing LED lights, automatic sensors, and adding solar panels.”
Rather than just passively invest, AEW will push vendors to upgrade facilities to achieve five star ratings.
Do pointed to a recent Australian new build core investment, where her team worked with the vendor to implement drip irrigation systems and other simple things to increase the building’s credentials from a four to a five star.
Identifying climate risk takes many forms, but Kao said increasing policy intervention gives investors like AEW parameters to work with.
“Things like the Paris Agreement can tell us we need to reduce emissions in the portfolio by five per cent a year,” she said.
“That gives us a framework to approach how we future proof assets and reduce risk.”
California, where AEW has an office in Los Angeles, requires net zero construction for new buildings and organisations are able to cheaply buy carbon offsets to help achieve this goal.
“But the long term goal for us is to remove processes that are carbon intensive,” Kao said. “That kind of transition risk is being factored into how we make investment decisions.”
While the environmental component of ESG receives the most attention, Do said the pandemic has shined a light on how much social work companies still have to do.
“Covid19 showed us how important it is to embed social understanding into how we manage our properties and investment process,” she said, adding how much space people need is a major consideration going forward.
“These kinds of social criteria mean we’re pivoting towards different kinds of assets and it is changing how we manage them.”
Diverse workforces are proven to outperform, though it’s difficult to find diverse candidates.
“After forming a committee, we realised most of our employees came from a small handful of private schools in the Los Angeles and Boston areas,” Kao said.
“So we made a conscious effort to widen the net of potential candidates.”
AEW has implemented policies requiring one new diverse candidate for every role, and has developed a speaker series to educate staff on unconscious bias.
“It’s about retaining people too, through fostering an environment of inclusivity,” Kao said.
And while it’s important to inject new and different ideas into the firm, AEW has also pushed diversity initiatives through their vendors and partners by including ESG requirements in contracts and across various agendas.
“Increasing transparency for investors and stakeholders is critical, and it’s good to see regulators getting on board with that,” Do said.
While Europe and parts of the United States are leading the way, Do said Australia is a highlight in the APAC region where developing nations are still focused on improving their own country’s economics.
“Emerging markets have a lot to think about when getting on board with ESG, so it’s difficult to apply the Australian view point to everyone,” she said.