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Under the EU’s Sustainable Finance Disclosure Regime, Article 9 – or “dark green” – funds are generally considered the most sustainable. The classification requires a fund to have “sustainable investment as its objective” and is often used an approximation of “impact” investment.

It has proved popular. The final quarter of 2022 saw €5.1 billion flow into Article 9 products across all strategies, according to data from Morningstar Direct. That still represents a smaller market share than Article 8 funds, which gathered €10.7 billion of new money, but nevertheless it is clear sign that dark green funds have gained a foothold.

This appetite for Article 9 is not reflected in real estate. The asset class makes up a small portion of funds generally, and even more so in the SFDR-regulated space. According to Morningstar, just 0.9 percent of the total AUM of Article 9 funds is held by property funds, compared with 3 percent of Article 8 products. Conversations with real estate investors back up the numbers.

Those looking to categorise under the Article must ensure all of their investments will be considered sustainable under the regulations. Thus far, the EU has provided guidance using the environmental taxonomy, which spells out exactly what types of investment qualify as being “sustainable” in the eyes of the regulator; all assets must be environmentally sustainable at the point of investment. The equivalent social taxonomy does not yet exist, meaning that socially-focused funds are flying blind when deciding whether their strategies are deemed sustainable or not.

The result is that many GPs find that their strategy falls outside the provision. Newcore Capital is an example; the UK-based manager launched a £300 million ($360.8 million; €339 million) social infrastructure fund in July last year, seeking to invest in assets that “deliver essential services to society, which require repositioning, modernising or refurbishment to bring them up to institutional and future-proof quality”. When it comes to returns, Newcore is aiming to deliver an annual 13-15 percent net internal rate.

Unusually, Newcore has elected to “shadow” Article 9, meaning that it is voluntarily providing investors with data points required by the legislation. COO Neil Sarkhel explains: “When we launched, the EU’s SFDR provided an opportunity to articulate our intentions for the fund through exploring Article 9. We were disappointed when the social taxonomy was deferred and the environmental taxonomy required assets to be operationally net zero from the start. As a result, because we didn’t market in the EU we elected to voluntarily shadow the Article 9 and wait to see the direction of the FCA.”

Newcore is far from the only manager to find its strategy sits outside Article 9. “Of the Article 9 funds we have worked on to date, none are in the real estate sector,” says Justin Cornelius, a partner in law firm Goodwin’s Real Estate group. He echoes the common sentiment that, due to the requirements of the article, “You end up in a situation where you’ve got funds that are generating a phenomenal level of environmental improvement, but nevertheless are not achieving that Article 9 classification.”

German manager KGAL is one of the few managers to establish an Article 9 fund in the asset class. The Core 5 LIFE fund reached a first close in January this year, having received commitments “in the hundreds of millions”. The fund provides an example of where Article 9 applies, as it seeks to provide affordable and energy efficient residential space across Europe by purchasing sustainable assets. Its first acquisition was a newly built BREEAM-certified property in Málaga with 142 residential units.

Fund portfolio manager Philipp Langbehn believes that Article 9 status makes the fund “quite unique”, and points to the fact that such funds have seen positive capital inflows in an uncertain market as a vindication of the strategy.

Committing to Article 9 status as a means of wooing investors may not always have the desired effect. “I am sceptical of any Article 9 funds in this area,” says one global real estate-focused director at a major pension fund. “Article 9 classification is often a marketing ploy.”

Derk Welling, senior responsible investment manager for real estate at APG, also has reservations: “Article 9 requires that you only buy sustainable assets, ie, the completed product. You can’t make it more sustainable because it’s already sustainable. So Article 9 is not better for me because I want to improve the assets in our portfolio.”

Newcore’s Sarkhel echoes the point, noting that “Some of the value-add funds in our space are Article 9 and have followed the environmental route. But in order to be Article 9 compliant, you have to adhere to criteria from day one – that means developing new buildings, using a huge amount of carbon in the process. That doesn’t suit our environmental strategy; our preference is to improve buildings that already exist.”

Overall, the lack of engagement with Article 9 should not be seen as a lack of commitment to sustainability. Says Welling: “We shouldn’t make the mistake of thinking that Article 9 is better or worse than Article 8. That misperception comes from managers also. The true impact investment, which is you buy an old asset, renovate it and make it fully sustainable, can never qualify as an Article 9.”