Laure Ferrand, Associate Director - Head of Transaction Services and Thomas Gibbs, Senior Consultant, Longevity Partners

From Risk Management to Value Creation: Why Sustainable Due Diligence is critical

2022 was transformational for real estate investment activities. New frameworks such as the Sustainable Finance Disclosure Regulation (SFDR), SRI and the EU Taxonomy brought a new layer of complexity and furthered the need for a strong due diligence process. 

Due diligence is a key step for the effective management of funds classified as Article 8 or 9 under SFDR. It enables fund managers to keep track of their investments’ contribution to the characteristics or sustainable investment objective of their funds.    

SRI funds are required to take the results of ESG analysis into account when it comes to investment decisions, stock selection and management processes. They should do this through an ESG assessment method, with ESG analysis tools and frameworks, to guide the strategy for selecting real estate assets.  

Sustainable Due Diligence and ESG Risk 

From an investor’s perspective, a good understanding of the characteristics of an asset is vital. With the growing share of “stranded” or “obsolete” assets on the market, if screening is not conducted to ensure the fund’s ESG performance is preserved, then the risk is simply too high. Indeed, not completing an SDD leaves a portfolio open to numerous risks. Buying an asset without considering alignment to overall fund strategy creates the risk of regulatory consequences, as well as exposing the asset to future repricing at exit. However, if the full spectrum of material ESG risks and value creation opportunities are analysed prior to acquisition, a much clearer path for real estate assets can be made. 

Matt O’Shaughnessy, an Executive Director at J.P. Morgan Asset Management, notes that “ESG criteria have a considerable impact in the negotiation process. Our assessment of an asset’s relative and individual position on ESG performance criteria directly affects our investment thesis, including acquisition pricing and targeted capex improvements. ESG factors are recognised at investment committee level as key metrics that significantly impact returns, and ESG performance is now recognised as a key metric of defining quality for occupier and future investor targeting.” He adds that for those reasons, all J.P. Morgan’s European acquisitions undergo specific Technical, Environmental and Sustainability due diligence, with specialist consultants engaged to ensure opportunities for ESG improvements are delivered through the business plan and holding period. 

Michaela Dettki, an investment professional at DWS, informs that the firm conducts ESG screenings on all acquisitions: “We conduct an initial ESG acquisition risk screening and if a specific risk indicator scores high in the pre-screening process, we mandate Longevity to perform a detailed sustainability due diligence on the specific risk indicator”. In this process, Longevity Partners assists DWS. 

With a gap in the market for a provider of real estate acquisition advisory services, Longevity Partners launched its Sustainability Due Diligence (SDD) service line towards the start of 2020. Since then, it has become one of Longevity’s fastest growing offerings, with approximately 250 assets under acquisition assessed in 2022, and now with dedicated SDD experts in multiple geographies (UK, France, Netherlands, Italy, Spain, Germany, APAC and the USA).  

This has been driven by a number of factors, including the need for assets to comply with specific ESG performance requirements (e.g. EU Taxonomy, CRREM, BREEAM), increased materiality of ESG-related issues, including climate change, energy security and regulatory exposure (e.g. MEES, Décret Tertiaire), and ensuring capital expenditure is adequately accounted for in dealing with such issues. 

Sebastian Dooley, a Fund Manager at Principal Asset Management, notes that ‘we are seeing that the investment committee is scrutinising more whether we have taken an appropriate approach to the due diligence of ESG items than previously. For most, it’s ensuring that the fund / deal team are acquiring assets “eyes wide open” since sustainability issues will need to be worked through, whereas before that wasn’t always the case.’ DWS’ Michaela Dettki adds: “ESG criteria has got increased scrutiny and is discussed in every investment committee. Red Flags are being seriously considered and can influence a deal; notably when assets are immediately stranded, with no refurbishment plans at hand. Other red flags are, for example, assets with high exposure to natural & physical climate risk, where mitigation is not a technical or financially feasible option.” 

How can Longevity Partners help? 

Longevity Partners’ sustainability due diligence service seeks to address such issues faced by investors, allowing strong ESG performers to be highlighted, providing actionable insights to unlock sustainable value, and pinpointing where material ESG risks lie in assets under acquisition. 

The SDD framework encompasses approximately 60 material ESG items, with a bespoke scoring methodology developed for each, covering 13 ESG themes, including operational energy, water use, waste management, biodiversity and regulatory risk. Responses are provided for each ESG item, with detailed recommendations provided for those deemed to be underperforming. For each recommendation, an indicative capex estimation and guidance on when to implement is provided, allowing for priorities to be set for when assets are under ownership. 

Longevity’s team of experts are trained to recognise opportunities and leverage an asset’s key strengths, with Michaela noting that “with the support of Longevity, we were able to achieve strong ESG impact through selected refurbishment measures under a limited capex budget.” 

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