Covid-19 has turned what tenants need from a building on its head, with sustainability, health and wellbeing now firmly at the top of the agenda. Environmental concerns are acute and need to be addressed before regulation forces the hand of the landlords.
For SKAGEN m2, ESG considerations have long been one of the key metrics we look at when investing. It is not just the wish to contribute to a better planet; we also see it as increasingly important to avoid unnecessary company specific risks. A company's most elevated risks are those linked to reputation, regulatory change, change in consumer preferences and corporate governance.
The inability of consumers to make use of rented real estate during the Covid-19 lockdown has resulted in tenants demanding increased flexibility of contractual terms and alignment of interests from their landlords. There are several positive examples in SKAGEN m2 of landlords having voluntarily facilitated tenants' rental payments. This desire for flexibility may alter the balance between tenants and landlords. Reputational risk may exist for those landlords not willing to offer such flexibility.
An increasing regulatory burden can raise costs and/or constrain revenue growth. Environmental legislation passed by many European nations (e.g. MEES in the UK) require measures such as limits on acceptable levels of emissions and mitigation technologies associated with these. There measures are likely to result in increased development costs within the sector, by requiring adherence to sustainable building standards. We have previously commented with regard to our holding in German residential operator Deutsche Wohnen on how government regulation targeting housing affordability within the residential sector (e.g. rent controls) may also impact the sector.
Changing consumer preferences
Increased emphasis from tenants and investors on companies to align with environmental standards may result in pressure on demand and occupancy levels. This may be the case, specifically for those companies deemed to fall short of compliance. Rent premiums are not yet paid to landlords for "Green" buildings, however downside risk may exist for those companies without such an offering. The pressure from tenants and investors may also accelerate the sector's adoption of environmental standards.
Alignment of management and shareholder interests through pay structures and anti-takeover measures is a consideration for the sector. A good corporate governance structure is crucial to any company to ensure long-term value creation. Transparency, responsible board/management, and alignment of management and shareholder interests through pay structures are key pillars of a sound corporate governance strategy. SKAGEN m2 has a 100% voting record at AGMs, demonstrating our engagement and active management. If necessary, we engage more deeply either to create long-term change, or to discuss specific events.
These are mainly risks involving climate, weather and extreme events that affect assets and people. A common example is the increasing number of floods taking place around the world.
Sustainability as an investment theme
Sustainability is one of the main investment themes for SKAGEN m2. Our long-term thesis is simple: the more sustainable the asset, the higher the occupancy and the rent that tenants are willing to pay. We are convinced of the positive direction of this trend, and we believe the penalty for doing nothing will be material.
The E (environment) is the most dominant ESG factor from a real estate perspective, with buildings accounting for more than 33% of global greenhouse gas (GHG) emissions and global energy consumption. It is therefore reasonable to state that real estate is heavily accountable for contributing to global warming and climate change. Looked at another way, real estate has the scope to drive positive change, not just in terms of leading by example, but also in terms of reducing global emissions.
The significant potential within the real estate sector to improve energy efficiency is well known and real estate companies opt for a variety of innovative solutions. One example from the m2 portfolio is the Finnish residential rental operator Kojamo, which deploys AI to optimise the energy consumption of its residents and generate increased awareness of their consumption of water, heat and electricity. Improved data gathering and user-awareness also leads to lower costs for residents and companies alike.
Paving the way in logistics
Meanwhile, in the logistics real estate industry, landlords are paving the way towards energy consumption optimisation, improving both the environmental footprint of their properties as well as reducing costs for their tenants. Our portfolio holdings Prologis and Catena are two good such examples. Prologis offers more than 200MW of solar energy capacity in ten countries and customers only pay for the solar energy they use. They have also led the way in making LED lighting the industry standard. Lighting accounts for up to two thirds of electricity use in the logistics real estate space and LED lights can deliver better light at a lower cost. Catena have gradually been implementing an energy-tracking system since 2015 which provides great opportunities for identifying problems and savings potential. Heating and electricity are the largest operating cost for their tenants, so optimising their energy consumption not only improves their environmental footprint but also has a positive financial impact for both Catena and their tenants. They take advantage of geothermal energy where possible and deploy photovoltaic cells on the roofs of their properties.
Tackling energy-intensive data
The data centre industry is another good example of a real estate segment where there is a high need to tackle the energy intensity of data and the internet – the internet industry contributes to emissions in line with the aviation industry on a global basis. Data centre providers have increasingly realised the importance of sourcing renewable energy to run their operations – not only because it is the right thing to do, but because it attracts new clients.
SKAGEN m2 is invested in Switch, a US data centre provider which has been running on 100% renewable energy since 2016. The company's efforts were recognised by Greenpeace in its latest Clicking Clean Report, where Switch received the highest rating for any class of company. In our portfolio we also have the world's largest data centre operator, US company Equinix. Since 2015, Equinix has increased its renewable energy coverage from 33.5% to 92% globally in 2019 even as the portfolio has doubled.
Recognising social responsibility
Increasingly we are seeing companies in the real estate space recognising their social responsibility, particularly in the residential sector. One of our investments, Deutsche Wohnen, a German residential landlord has written five promises to their tenants, one of which is to let one in four apartments to tenants entitled to social housing. During the Covid pandemic we have also seen several of our portfolio companies engaging with their tenants and providing them with rent deferrals to help them through the challenging period.
Within healthcare-related real estate we have also noted strong commitment to advance positive social impact. One example is Assura, our UK medical office provider, which launched a new "six by six" strategy, where their ambition is to have six million people benefit from improvements to and through their buildings within six years. They launched a community fund to support health improving projects in the communities around their buildings and issued their first social bond, raising £300m over 10 years with 1.5% interest. The bond will be used to further scale and deploy publicly accessible primary care and community healthcare centres. 2021 should certainly provide further impetus for innovation within the real estate sector and stimulate the engagement of potential tenants and investors alike.