The environmental footprint of real estate funds continues to shrink
Residential real estate is generally considered stable in value, even in times of inflation, and has long since proven that it is crisis resistant. In terms of sustainability, a large part of the industry is already on the right track. Whether developers or portfolio renovators – many are setting a course for ESG. Consequently, there are also more and more real estate funds with sustainability criteria that not only offer investors the opportunity to enjoy stable returns, but also present the chance to invest in environmentally and socially optimised properties. But how can you tell which funds tick all the right boxes?
The EU’s agreement on the European Green Deal was the logical consequence for many industries after Paris 2015. Since it was launched in December 2019, Europe has been working intensively towards the noble goal of net zero greenhouse gas emissions by 2050. To get there, the EU has set numerous interim targets, including for the real estate sector. For example, according to the latest proposals from the EU Buildings Efficiency Directive, the annual building renovation rate needs to double by 2030, the deadline for phasing out fossil fuels is 2040, there will be a new energy certificate from 2025, plus a mandatory renovation passport by 2025, all of which are designed to accelerate the carbon phase-out.
EU taxonomy provides investors with a road map
The transparency requirements and disclosure obligations for sustainable financial products are defined in the Sustainable Finance Disclosures Regulation (SFDR), which distinguishes between Article 6, Article 8 and Article 9 funds. According to the EU regulation, Article 6 funds are financial products that must disclose whether or not they take sustainability risks into account. Article 8 funds must transparently disclose sustainability features in their annual reports and are commonly referred to as “light green” funds. The designation “dark green” is given to Article 9 funds that aim for a positive sustainability impact or pursue an explicit sustainability goal as defined by the UN. Such investments, known as impact funds, must measure and demonstrate the degree of their impact.
New rules apply to all financial investment products as of 2 August 2022
From 2 August 2022, the new version of the Markets in Financial Instruments Directive (MiFID II) will come into force. From this date on, investors must be asked about their sustainability preferences whenever they are given financial advice. The question – after explaining the different levels of sustainability – will be something like: “Would you rather invest in a sustainable product or a less sustainable fund?”
Anyone who expresses a preference for sustainable products will then only be offered funds that also fulfil the specific criteria set out in the EU Taxonomy and meet the requirements of the MiFiD II Directive. Depending on the orientation of the fund, these requirements stipulate that a certain proportion of the fund portfolio must meet the same, particularly high requirements, as an “impact” product. Accordingly, the fund’s strategy will have to take into account the largest potential adverse sustainability impacts of its investment decisions. It won’t be enough to simply disclose information on specific environmental and social factors. Rather, tangible information will be required on specific environmental, social and labour concerns, including respect for human rights and the fight against corruption and bribery. Funds whose policies meet these requirements will be classed as Article 8 Plus Funds. In this way, the MiFiD Directive offers investors a sound basis for their decision-making and at the same time helps to prevent greenwashing.
The high bar for sustainability
No sooner had the SFDR been passed than the number of Article 8 funds skyrocketed. In order to ensure that these funds can actually be recommended to investors as sustainable investment products, Germany’s financial regulator, the BaFin, attempted to raise the bar significantly in its draft guidelines published in April 2021. The idea of Germany going it alone in this area has since been blocked and, at least for now, withdrawn. The discussion is ongoing and open-ended. For the time being, Article 8 Plus is defined via the MiFiD II Directive. Nevertheless, the issue of greenwashing cannot be dismissed out of hand. It is highly unlikely that the BaFin’s initiative will be the only one for Germany, especially since the regulation is by no means final. In the taxonomy for sustainable economic activities, the EU has prioritised climate protection. In the meantime, however, a final report on the social taxonomy has been published, placing the focus on corporate due diligence with regard to social and labour standards. This poses great challenges for asset managers of real estate funds in particular.
How can real estate meet ESG criteria?
Real estate fund asset managers can make a big difference with a consistent ESG strategy. They can, for example, invest in projects that use climate-friendly construction methods and low land consumption, or by regularly striving to optimise their portfolios. Positive environmental impacts can be achieved in new construction through densification of undeveloped areas or by adding extra storeys to buildings and converting attic spaces. Existing properties benefit from an increased use of renewable energies, the generation of solar power by photovoltaic systems, the use of rainwater, and a well-thought-out waste management strategy. Positive social impacts are achieved via the creation of affordable housing and sensible quarter and neighbourhood development with inclusionary and multigenerational housing as well as affordable housing units. Investors can find information on methodology, measurement, monitoring and evaluation in each fund’s sales literature and annual reports.
Article 8 Plus is a seal of approval for real estate funds
We believe that the real estate industry is going in the right direction. If investors prefer to invest in a real estate fund with sustainability features as of 2 August, they will be best served with an Article 8 Plus fund. This is because only funds that take account of investors’ sustainability preferences in accordance with the revised MiFiD II Directive may be marketed to this investor group from then on. In a way, 8 Plus proves that change is in full swing in the real estate industry – which is now offering products tailored specifically to these requirements.