“It sounds very philosophical, but the pandemic has opened our eyes to how fragile the world is,” says José Pellicer from an apartment overlooking the Croisette in Cannes. It’s the final day of MIPIM, and M&G Real Estate’s head of investment strategy is taking stock of the changes he’s seen in the last few years.
Pellicer zeroes in on the one topic no one can avoid – sustainability. “I would have never thought of a law firm to negotiate in ESG terms three years ago. Now it’s happening. A law firm!” he says.
Negotiating with law firms is an everyday occurrence for the investment manager. With a portfolio of £34.5bn, M&G Real Estate primarily works with blue chip tenants in its commercial assets, and they are becoming more demanding – as are M&G’s investors themselves.
Over a small plate of M&G branded macarons, Pellicer reflects on growing pressures on landlords to deliver greener buildings and the limits of doing so around the world.
Low- and high-hanging fruit
“Just like most of our peers, we’ve committed to net zero by 2050,” Pellicer says. But like any broad net zero target, a lot of detail and caveats are hidden under the headline figure. In Europe, M&G has committed to operational net zero by 2030 and embodied net zero by 2050.
The potential for a building to be green, therefore, is central to M&G’s investment strategy. Pellicer says: “This is going to be the key performance indicator of the 2020s.” Before an acquisition, the investment manager weighs up the numbers: what are the costs of achieving an EPC rating of A or B, having a green building certification equivalent to BREEAM ‘Very Good’ or higher and ensuring 100% of the building’s energy can be generated through electricity?
“If the cost of that business plan is too high and it affects the returns too much, that [asset] shouldn’t be bought,” he says.
But the net zero targets are not totally straightforward. The 2030 operational target refers only to emissions M&G directly controls – not what its occupiers are putting in the air.
The next step is convincing commercial tenants to cut emissions. Fortunately, those tenants – the large blue chips with their own demanding shareholders to answer to – tend to have their own targets and they’re open to installing smart meters and sharing emissions data with M&G. “They help us; we help them,” Pellicer says.
From there, he expects to introduce more green leases “that basically force certain tenants to take certain utility providers, use renewables, etc.”
The downside is that all this falls under Pellicer’s “low hanging fruit” category. Things get significantly trickier in the residential sector – which makes up 20% of M&G’s European Property Fund.
Should families be punished for inefficient choices?
“The residential sector requires that you get into privacy issues,” Pellicer says. “Can you actually force a tenant to share their energy consumption data with you? Can you force a tenant to use a particular energy provider?
“In a way you’re curtailing the individual freedom of a person or household.”
In other words, hitting operational net zero in residential real estate – a fifth of M&G’s European portfolio – is beyond M&G’s control and outside of its 2030 target. What can it do about that?
In the UK, where M&G has a massive £1.2bn residential fund with approximately 4,000 tenants, the buildings tend to be newbuilds “so at the very least there is some energy efficiency embedded in it,” Pellicer says. There is also a falling reliance on natural gas.
Beyond that, he believes that progress will depend on regulation. He imagines this could allow landlords to, for example, offer a default (sustainable) utility provider, install energy saving tech and offer stricter green leases. Perhaps, Pellicer suggests, residents could opt out of these – but for a price.
“[Residential net zero] will require certain regulations for tenants – individual family tenants – to change their behaviour, or at least get financially punished in terms of higher rent, or higher charges, or something like that for opting to be inefficient,” he says, emphasising that this is his personal opinion.
“Privacy is an important principle, but the greening of buildings is another one. Governments need to decide what’s more important.”
US and Asia fall behind
Another hurdle is that some places are much more reliant on fossil fuels than others. About 24% of electricity produced in Europe in 2020 came from renewable sources, compared to 12% in North America and 10% in Asia Pacific, according to data from BP.
“In Asia, we have delayed our net zero targets relative to Europe – at least in terms of short-term milestones,” says Pellicer. Part of that is due to the grid limiting how sustainable building operations can be. While M&G aims to achieve BREEAM ‘Very Good’ or higher in 100% of its European portfolio by 2025, Pellicer doesn’t think it can achieve that in its $4.8bn Asian portfolio.
Renewable electricity generation by country
The problem isn’t just the grid; it’s also a lack of expertise in the region. Instead of sticking to one or two service providers, M&G works with a range of consultants to identify the best companies and tech operators to deliver specific ESG-related projects. While that market has grown rapidly in Europe since the Paris Agreement, Pellicer says “there is a far smaller degree of professionalisation in the consultant community” in Asia Pacific. “We don’t feel we can commit to 2030 operational [net zero] unless we have a list of consultants we can rely on.”
Meanwhile, in the US: “The problem is that there are fewer tenants that are taking their targets seriously. There are [some], but fewer – and the grid is very inefficient.” Despite there being plenty of consultants, he says, occupiers care less and the grid will likely remain a stumbling block for a long time (though this does vary from state to state).
Fragility gives rise to action
Pellicer’s hunch is that cultural and geographical differences go some way to explaining regional variation in ESG urgency. He returns to the idea of fragility: “In Europe, there is this general philosophy that the government has a strong role to play in people’s wellbeing and that the world is fragile, because we’ve been destroyed a few times as a continent.”
Countries at the forefront of decarbonisation believe strongly in the role of government, he says, singling out the Nordics and the Netherlands. The latter has a “very fragile geography” – small, few natural barriers and lying below sea level – that spurs on action against perceived existential threats.
“They’ve been pioneers about being worried about this,” he says, contrasting the Netherlands with US values around individual freedom and small government.
However, Pellicer senses that the pandemic has sparked a similar sense of fragility around the world, including in parts of the US.
He sees it in the law firms that are negotiating leases in M&G’s buildings. He also sees it among the company’s investors, especially in Europe: “They want a roadmap. They want ESG to be taken into account in all business plans.” Some, he says, even want investment committees to include an ESG expert with veto powers.
That rapid shift is clear to Pellicer at MIPIM. He suggests that the term ESG would not have featured nearly as much in 2019. But as our conversation reveals, talking about it is not even half the battle.
Outside the MIPIM bubble is a world of limitations. The reality for Pellicer is that, far from existing in a vacuum, real estate is entangled in a complex web of public and private sector pressures with varying interest in climate change. Until all those parts take decarbonisation seriously, net zero goals will only go so far.