Sustainability and Impact – Implications for Real Estate Investing in Asia Pacific
The terms Sustainability & Impact (S&I) and ESG (“Environmental, Social and Governance”) are often used interchangeably and the considerations are similar. Sustainability criteria tend to be broader and more holistic, while ESG typically refers to the measurability, risk management and data aspects of a strategy. Consideration of ESG factors, in particular the environmental and governance aspects, as part of the investment process is now a well-established practice in best-in-class commercial real estate investment management. Impact investing goes beyond the integration of the ESG considerations in a strategy and imposes stricter objectives including the pursuit of measurable positive environmental and/or social outcomes alongside financial returns. We consider the application of S&I guidelines to APAC real estate investment, and the potential for real estate fund managers to follow Impact investing strategies in the region.
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I. Introduction
Many leading global institutional investors and fund managers have adopted broad sustainability and impact goals across asset classes. These are often related to global initiatives such as the Net Zero Asset Manager (NZAM) initiative and the Sustainable Development Goals (SDGs) adopted by the United Nations in 2015.
Figure 1: United Nations’ 17 Sustainable Development Goals
Real estate investors and fund managers have a particular responsibility to pay attention to environmental goals, because buildings are responsible for about 39% of global energy-related carbon emissions: 28% from operational emissions (i.e., from the energy needed to heat, cool and power them), and 11% from materials and construction.1 Relatively speaking, environmental criteria are also the easiest for real estate investors to report on within a standard ESG reporting framework (see example overleaf).
Real estate investors can also help achieve social goals, by influencing the well-being and working conditions of their tenants and by improving the living quality and prosperity of the communities which surround the assets that they own. It is harder for real estate investors to achieve governance objectives, which lie more within the purview of equity and bond investors. However, through promoting the use of green leases, which encourage environmentally sound practices by occupiers, real estate investors can exert some influence over governance criteria too.
Figure 2: Standard ESG reporting framework
II. Differences between APAC and other regions
Physical climate risk
All parts of the world must contend with climate change, but APAC is especially vulnerable for two key reasons. Firstly, most of the big cities of Asia are closer to the equator than the big cities of North America or Europe, and so they face temperatures that are rising from already high levels. Secondly, mountains and deserts make up vast areas of Asia, with populations concentrated in large cities in the areas of arable land. Many of those cities are near the coasts, and hence exposed to rising sea levels. As a result, Asian cities score poorly in comparative rankings of vulnerability to climate risk.
Figure 3: Vulnerability of cities to climate change by region
However, the leading cities of developed APAC, e.g., Tokyo, Seoul, Beijing, Shanghai and Singapore, are also wealthy, and so well-placed to invest to mitigate the effects of climate change, which has to be taken into account when assessing the ultimate investment risk. The leading cities of emerging Asia, e.g., Mumbai, Bengaluru, Bangkok, Jakarta and Manila, face many of the typical problems of emerging market growth and development in addition to climate change risks, e.g., overcrowding, unsustainable ground water depletion and poor infrastructure. However, these cities also encapsulate the attractions of APAC for many investors, notably high GDP growth and favourable demographic profiles, allowing investors also to invest to address these specific climate and infrastructure related-issues, reducing the ultimate risk.
Low standardisation of approaches to sustainability among markets
In APAC, regulations and standards vary greatly between markets, and there is no structure like the European Union (EU) to foster harmonisation. Approaches to sustainability in APAC thus also differ. In real estate, one result is that the key markets have their own preferred ESG certifications for buildings. These vary in focus: for example, BEAM in Hong Kong Special Administrative Region (SAR) concentrates on energy, while CASBEE in Japan takes earthquake resilience into account. A uniform approach is therefore hard to apply to APAC, and investors may require some flexibility in applying global guidelines.
Figure 4: Key APAC developed markets: net zero targets and preferred ESG certifications in real estate
Which markets are most advanced in sustainability?
Partly as a result of the low standardisation of approaches, it is hard to say which APAC countries and cities are most advanced in addressing sustainability issues in real estate and construction. It is generally agreed that APAC as a whole lags a few years behind Europe, and that developed APAC (including Mainland China) is well ahead of emerging APAC, but beyond those points consensus ends. It is worth noting that China, while the world’s largest emitter of greenhouse gases, has introduced progressive regulation – comparable to regulation in the EU – aimed at promoting a “circular economy” in the built environment, i.e., one which is restorative and regenerative by design.
One large real estate consultancy has attempted to rank APAC cities in terms of sustainability progress. Of greater interest than the rather complicated ranking itself are some of the key conclusions:
• Transition risk: Japan and South Korea are leading the transition to a low-carbon economy
• Water stress: most markets face to medium to high water stress, with Singapore under the most pressure
• Air pollution: only 10 out of 28 cities have air pollution levels below the acceptable threshold according to the WELL standard; these 10 include Singapore, Tokyo, Osaka, Melbourne and Sydney
• Green buildings: green building adoption in APAC stands at 43% overall, and 63% for new buildings; all new buildings in Australia and Singapore must be green-certified or comply with a relevant benchmarking system (2)
Impact investing: environmental and social
Consideration of ESG factors, in particular environmental aspects, as part of the investment process is now a well-established practice in best-in-class commercial real estate investment management. However, Impact investing as a concept goes beyond ESG integration. Schroders’ definition of Impact investing conforms to that of the International Finance Corp. (IFC) and Global Impact Investing Network (GIIN), i.e.:
“investing into companies and assets with the intent to contribute to measurable positive social or environmental impact alongside financial returns.”
As stated here, Impact investing can target environmental outcomes as well as social outcomes. In both cases, there is a requirement for “additionality”, referring to measurable benefits clearly defined upfront which exceed those that would have been delivered solely through pursuit of financial returns.
There is a misconception that Impact investing concentrates on social outcomes, and moreover that social impact investment in real estate principally targets affordable rented housing. Impact investing also covers creating positive environmental impact.
III. Strategies for achieving positive environmental outcomes in APAC
Real estate fund managers can employ various strategies in APAC to achieve both positive environmental outcomes and adequate financial returns. We focus below on two strategies with wide potential application.
Green leases
A green lease is one which includes sustainability linked targets and measurable performance indicators agreed between landlord and tenant. Some fund managers offer “green tenancy” recommendations that encourage tenants to adopt measures to improve energy, water and waste management. Such recommendations could be included in standard lease contracts, making them legally binding. Drafting leases in this way is probably most appropriate today for large corporate and retail occupiers, but residential tenants could be covered in time.
To the extent that green leases encourage environmentally sound practices by occupiers, they also achieve governance impact. That said, based on current market developments, simply having green leases in place would not be sufficient for an investment programme to be classified as an “Environmental Impact” (EI) strategy. It might be sufficient if combined with other methods of achieving environmental benefits.
Brown-to-green: sustainability-led building upgrades (especially of offices)
APAC countries have mostly not set deadlines for buildings to meet energy efficiency targets. That said, large corporate occupiers will increasingly demand sustainable buildings as they adopt ESG targets themselves. This is especially true in Australia (where occupiers have a long-standing preference for prime-grade offices), Singapore and South Korea. Older and lower-grade offices will therefore start to face obsolescence risk, notably outside the central business districts (CBDs) of major cities. This risk is probably highest in the office sector, but it also applies to older retail, industrial and residential buildings.
Figure 5: Office obsolescence set to become a risk in APAC too
In the face of rising obsolescence risk for older or lower-grade buildings, the question arises: why not simply demolish and rebuild? The problem is that redevelopment is very carbon-intensive. Huge amounts of energy are required – and high volumes of carbon dioxide are emitted – during the manufacture of components for modern buildings as well as during their construction. Such emissions create the so-called embodied carbon in the building. Saving an existing structure and retrofitting rather than rebuilding saves all this embodied carbon. Property developers in the UK and the EU are increasingly focusing on retrofitting buildings.
In certain cities, there may be no choice but to demolish and rebuild. Retrofitting (or full conversion to other uses, such as mixed-use or residential) is more difficult for the vertical office buildings found in the CBDs of most APAC cities than for the low-rise offices commonly found in suburbs or business parks. However, we expect that large APAC developers will steadily move away from a demolish-and-rebuild model as APAC governments start to impose more regulation to accelerate net-zero transition, and as the developers strive to boost their own sustainability credentials.
Sustainability-led office upgrades are viable in much of APAC. In Japan, 70% of people work for SMEs, which are less likely to have long-term ESG targets than big multinational companies. However, Japanese cities have high Grade B and Grade C office stock, as well as high average building age, so there is ample scope to source deals. In Singapore, the government’s CBD Incentive Scheme promotes revitalisation of the CBD by encouraging conversion of offices to mixed use; it permits an increase in GFA of 25%-35%. Value-Add fund managers can seek upgrade opportunities that capitalise on this scheme and promote sustainability in their plans. In contrast, Tier 1 Chinese cities have short land tenure and – at least in their CBDs – low average building age, so they offer less scope to upgrade older assets and sell on to income-focused investors.
The retrofitting required in office upgrades may be substantial. Depending on the building, refurbishments which minimise carbon emissions can cost 25-60% more than standard refurbishments.3 Whether the financial returns justify the additional investment will have to be determined on a case-by-case basis. Studies from various markets point to higher rents for green buildings, with rent premiums of 10%-20% often claimed. However, the evidence is inconclusive, partly because it is hard to separate the premium offered for sustainability from the premium offered for other features of prime assets, e.g., good location or quality fittings. The likelihood of higher occupancy in more sustainable buildings, and an increasing risk of obsolescence for non-sustainable buildings, seems a firmer argument why retrofitting should justify additional capital expenditure.
Another good argument is the lower operating costs of more sustainable buildings. As an example of the energy efficiency of a prime new office, Bloomberg’s European headquarters building in London, opened in 2017, has design features which cut water use by up to 73% and uses 35% less energy than a standard office block; hence its BREEAM rating of 99.1%.4 As an example of successful retrofitting of an existing office in APAC, Keppel Bay Tower in Singapore was the city’s first development to win Green Mark Platinum (Zero Energy) certification by the Building and Construction Authority. This followed the installation of energy-saving devices in late 2020 which were forecast to cut the building’s annual energy consumption by over 30%, to about one-half of the level of typical offices in the city.5
IV. Strategies for achieving positive social outcomes in APAC
The most ambitious long-term sustainability strategy for real estate in APAC is “Social Impact” (SI) investment in deprived area. As noted, there is a misconception that SI investment in real estate principally targets affordable rented housing, but it can take many forms.
SI investing aims to deliver clearly defined social benefits which go beyond those that would have been achieved solely through pursuit of financial profit. Social outcomes are usually harder to measure than environmental outcomes, and the financial returns on SI investing are likely to be lower than on more traditional investing styles.
Which markets could a social impact strategy target in APAC?
Most international real estate fund managers in APAC will not normally consider investment in rural areas or smaller cities given the smaller available opportunity set and lack of market liquidity. It is more likely that they will consider disadvantaged districts of major cities. Possible examples follow:
- The Hong Kong government publishes median monthly household income by district. The most recent figures are for 2022. They show that the poorest district is Kwun Tong, followed by Sham Shui Po and Kwai Tsing. Two of these districts are in Kowloon, while one is in the New Territories. Median monthly household income in Kwun Tong is HKD22,100, i.e., about one-half of the level of the top-ranked district, Central & Western, on HKD42,300.6
- In Shanghai, the wealthiest district is Huangpu, with GDP per capita of RMB499,000, but the population is also small at 580,000. In second place comes the much larger Pudong New District, with a population of 5.77 million and GDP per capita of RMB266,000. At the other end of the scale, four districts with a combined population of 6.04 million have GDP per capita of below RMB100,000: Chongming (the lowest), Baoshan, Songjiang and Putuo. With average income less than 40% of the level of Pudong, these areas may be considered deprived.
- In general, the northern and eastern sides of Tokyo along and to the east of the Sumida River are older and less prosperous than the southern and western sides. These are the areas traditionally referred to as Shitamachi or “Lower City”. The poorest district of Tokyo is often said to be San’ya, an area which straddles Taito and Arakawa Wards in Shitamachi and is traditionally frequented by day labourers. However, this district is not officially defined.
- A similar district in Osaka is Nishinari, which lies south of the Namba transport hub. Nishinari likewise has a high population of day labourers and homeless people, and was traditionally considered rough and dangerous, although recently it has started to attract tourists and new investment.
Which sectors could a social impact strategy target in APAC?
In APAC, we see SI investing as an umbrella strategy which could include any of several strategies for individual asset types. Two asset types which ought to offer both positive social outcomes and adequate financial returns are:
Shopping centres (especially neighbourhood retail)
The main attraction of neighbourhood retail malls is that they are important to local communities. Upgrading and repositioning neighbourhood malls and accommodating a wider tenant base that can support the local community (general medical practitioners, mental healthcare, education centres,…) can therefore be a useful step in improving the quality of life in deprived areas. In developed APAC, investing in neighbourhood retail is a viable strategy in its own right in Hong Kong and Singapore. In Australia, it also makes sense to consider regional and sub-regional shopping centres, which often become the focal points of leisure and entertainment in suburban areas as well as smaller towns.
From a financial perspective, neighbourhood retail malls in most APAC markets have high exposure to necessity retail categories, notably food, for which demand is stable and inelastic. For Value Add fund managers, neighbourhood malls offer high potential for tenant repositioning to boost rental income and less arduous asset management needs than prime malls. Retail yields have now reached the highest levels among major sectors in the APAC real estate sector.
Affordable rental housing
APAC markets are seeing continuing migration to large cities. In the developed markets, the combination of ongoing urbanisation, smaller household sizes and high home prices is driving demand for rented housing. This has been reflected in the emergence of an institutional multifamily apartment sector. This sector is most mature and developed in Japan, but is also expanding in Australia. However, Mainland China is widely considered to offer the greatest long-term growth potential, given the market’s sheer size and particularly stretched price/income ratios for homes in the Tier 1 cities.
Multifamily rented accommodation is typically targeted at higher-income or middle-income population segments, and in its standard form is not a target for SI investing. However, low-rent multifamily apartments in deprived areas of big cities could well meet the criteria. This would be especially true if they were built as part of a more general strategy of regenerating deprived urban areas. Such a strategy might cover housing assets, retail assets and upgraded local offices or mixed-use buildings to boost local employment opportunities.
Mainland China is a market where a model may be emerging for provision of rented housing for lower-income segments of the population. Led by Shanghai, city governments set aside land, designated as R4 land, for affordable rented housing. Buyers of R4 land may not alter the land use for the 70-year duration of the term; further, rents, rental growth rate and strata-title sales are capped. This does not have to come at the expense of financial returns. Developers are often offered the land at a discount, and enjoy a low tax rate on rental income and other tax benefits. The city government is thus supporting and in effect subsidising the rented housing in a public/private partnership to increase supply.
Figure 6: Rental housing in Mainland China: types of investment strategies
For fund managers, potentially the main disadvantage of the R4 scheme is required participation in a development project by state-owned enterprises (SOEs) that have veto rights, which reduce required control for the fund manager. There is an alternative strategy: to partner with developers or operators of low-cost rented housing platforms. Conversion of industrial buildings to corporate accommodation for their workers (especially in lower-income segments such as manufacturing or hospitality) is one example. Exit from such a project would be achieved through onward sale to C-REITs – now permitted for affordable housing – or to income-focused funds.
Other possible target sectors: retirement homes and medical real estate
Two other sectors in APAC that combine underserved market needs and high social value are senior living and medical real estate. An SI strategy focusing on deprived areas could probably encompass retirement homes for the elderly and medical facilities outside the prime districts of cities, to increase accessibility.
Retirement/nursing homes
Total transactions of retirement homes across APAC grew 43% in 2022, to USD2.6 billion. The current focus of attention is Japan, which has 36 million people aged over 65 (29% of the population). REITs active in the sector include Healthcare & Medical Investment Corp., which owns 47 nursing homes, and Singapore-listed Parkway Life, which owns 57 (mostly located in dense residential districts of major cities), but demand is still rising and an opportunity exists to convert or develop more accessible homes. The Hong Kong market is also largely undersupplied. There are only six publicly or privately owned high-end retirement homes in the city, with fewer than 2,000 places in total, and further developments or conversions are required.
Medical real estate
This category essentially includes medical offices and medical centres. Medical offices are a small asset type, with total APAC transactions in 2022 of only USD0.8 billion. They exist in various gateway cities, notably Hong Kong, Tokyo and Singapore. In Hong Kong, private medical groups tend to select office space in Central or other key commercial districts such as Tsim Sha Tsui. Coupled with the aging population, a greater focus on primary care and prevention in the wake of Covid-19 should drive further growth in local demand for private medical services, while visits by health tourists from Mainland China ought to resume now the border has reopened.
Bespoke medical office specifications differ somewhat from those for Grade A offices, and may include extra plumbing, separated ventilation systems, special waste disposal facilities, and lifts reserved for patients. Conversion of existing buildings to medical use is complicated, but feasible for experienced fund managers. Dedicated medical office buildings offer exclusive facilities to surgeries and clinics which do not need to be shared with standard offices in the same building, but building them entails development risk.
Social impact investing in APAC: other considerations
Various other considerations should be noted regarding the potential for SI investing in APAC:
• Fund life. The investment term might need to be eight to ten years or more, since improving the character of local communities is usually a long-term project. Some real estate impact funds in the UK market allow share trading or redemptions after an initial lock-in period, making them effectively openended.
• Expected returns. Real estate fund managers could consider a mix of Core Plus, Value-Add and even Opportunistic strategies within the same SI fund. However, the potential returns from new sectors like affordable rented housing are not easy to judge, and investment in Japan (where interest rates remain near zero) may yield more modest returns than elsewhere in APAC. Our best estimate is that that net IRRs from an SI strategy in APAC would be in the 10%-12% range.
• Local support. Successful SI investing is likely to require cooperation with local governments, charities, communities and investors. A uniform investment approach across APAC is unlikely to be effective; rather, approaches should be tailored to the conditions of specific markets. For example, China’s R4 model for affordable rented housing has been suggested as a model for the Hong Kong government to attract workers to the new towns envisaged in its “Northern Metropolis” development plan.7 Working out in detail how to encourage private-sector participation in low-cost rented housing in Hong Kong could attract high government attention and support.
• Additional risks. SI investing, particularly in affordable housing and similar areas, carries significant potential regulation and reputational risk, if not executed with care.
V. Sustainability and Impact – implications for APAC real estate: summary
In this report, we have mentioned various potential real estate strategies to achieve positive environmental or social outcomes in APAC. In pursuit of environmental benefits, fund managers may make greater use of green leases and focus on sustainability-led building upgrades (especially of offices) across the region.
Shopping centres and affordable rented housing are possible target asset types for a full social impact (SI) strategy. In various markets, affordable housing could take the form of lower-cost multifamily products in deprived areas, but for now Mainland China is the most promising market for very low-cost accommodation such as workers’ housing. Investments to enhance accessibility to senior living and medical health care can also create positive social impact. To achieve lasting improvement in deprived areas, it will be necessary to follow various asset strategies together with a broad goal of community enhancement or urban regeneration.
Positive social outcomes are a key element of the return on SI investment, alongside financial returns. SI investing is most likely to succeed where capital is raised and deployed very locally, and where investment approaches are tailored to the conditions of specific markets in cooperation with local governments and partners.
Figure 7: Achieving environmental and social benefits in APAC: asset types and markets with potential
[1] Source: World Green Building Council, Bringing embodied carbon upfront report (2019)
[2] CBRE, Asia Pacific Sustainable City Ranking (December 2022)
[3] Source: Schroders Capital Real Estate Investment Outlook (1H 2023)
[4] See https://www.bloomberg.com/company/offices/bloomberg-london/.
[5] See https://www.keppelreit.com/property-portfolio/singapore/keppel-bay-tower/ and Straits Times article of 10 December, 2020.
[6] See https://www.censtatd.gov.hk/en/web_table.html?id=130-06806. For clarification, monthly household income of HKD22,100 equates to annual income of c.USD34,000. This is not disadvantaged by the standards of APAC’s poorer countries, but it is in the context of Hong Kong.
[7] Source: Colliers blog, Getting the right accommodation mix will be crucial to the Northern Metropolis’ success (19 April 2023)
Important Information
The information in this market update is current as at July 2023 and does not necessarily reflect subsequent market events and conditions. This update is provided for information purposes only and does not provide individual financial, legal, tax or investment advice. Past performance is not indicative of future performance. Graphs and charts are used for illustrative purposes only and do not reflect future values or future performance. The statements and statistics contained herein are based on material believed to be reliable but are not guaranteed to be accurate or complete. Investments strategies should be evaluated relative to each individual’s objective in consultation with their legal, investment and/or tax advisor. Schroders Capital is not liable for any errors or omissions in the information or for any loss or damage suffered.
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