A decade ago, the global financial shock derailed, or at least delayed, efforts to improve the sustainability of logistics buildings. However, the coronavirus crisis appears only to have given further impetus to an ESG agenda that has broadened to encompass a range of social and wellbeing factors as well as environmental considerations. Market participants testify that the majority of investors, developers and users of logistics facilities, together with the sector’s workforce and the wider public, appear to be united in the drive for higher standards.
In a world where peril from an unexpected quarter has caused such havoc recently, the defensive quality of sustainable real estate comes to the fore, argues Emily Hamilton, head of ESG at Savills Investment Management. “Investors are prioritizing stable, resilient assets, and ESG assets tend to be ones that have assessed their risks thoroughly. That is why institutional investors in particular are favoring them.”
“You could argue that for large institutional investors with diversified global portfolios, logistics presents an advantage for LPs in terms of their corporate sustainability targets, because logistics buildings have a large footprint with a lower energy use per square foot. In addition, LPs recognize that an increasing number of corporate tenants are pushing the sustainability agenda for their logistics real estate,” says Stéphane Villemain, vice-president for corporate social responsibility at Canadian investor Ivanhoé Cambridge.
“LPs recognize that an increasing number of corporate tenants are pushing the sustainability agenda for their logistics real estate”
One of the perennial dilemmas of raising ESG standards has been how to prove that more sustainable buildings are better for investors’ bottom line. Hamilton accepts that is still problematic for logistics assets while valuation techniques catch up with other sectors like offices.
However, she says investors are already beginning to apply a “brown discount” on buildings that have lower energy efficiency and are subject to climate risk.
Greg Goodman, chief executive officer at Sydney-headquartered logistics platform Goodman, says the biggest financial impact for managers will be on their ability to attract capital, and the cost of capital in the long term: “From a return point of view, in the short-term, investing in ESG will be neutral at best. But it is the right thing to do, and if you do not invest now, buildings will become obsolete, or you will have to retrofit them, so you will be making that investment later on anyway.”
Obsolescence will be a growing concern. “The most modern buildings show very high environmental performance. But most active warehouses worldwide are much older,” adds Kristof Verstraeten, co-managing director at European platform Logistics Capital Partners.
“The wider portfolio of buildings will have to go through an upgrade and we will most likely see better yields and rent levels for new compared to old buildings. That will create the business case for renovation and upgrading.”
The boom in e-commerce, which has been further fueled by the pandemic, has boosted the value of older buildings in urban locations, and together with more advanced warehouse automation, that has made retrofitting more viable, suggests Mario Morroni, executive vice-president for industrial, North America at Ivanhoé Cambridge.
Morroni says: “Buildings that would have been considered obsolete five years ago now have a new lease on life because they are well-located, so there will be an e-commerce tenant that wants to occupy them. The dollars to be invested, and the willingness of the tenant to pay the rent required, are both there.”
The emergence of the GRESB sustainability benchmark has provided crucial impetus for the widespread implementation of ESG improvements, argues Philip Dunne, head of EMEA logistics at CBRE Global Investors. “Up until four or five years ago investors had corporate policies on investing in sustainable real estate. But the gap between that statement and its execution was to be able to track performance robustly, which is what GRESB has provided. It is becoming the industry standard around the world, enabling that move from policy to action because investors are increasingly able to differentiate between managers, funds and platforms.”
Now that performance can be measured, the advent of green lending is further bolstering the business case for ESG, says Villemain. “The commercial banks, especially in Europe, have developed products where the coupon of the debt is linked to ESG performance, so for example if Ivanhoé Cambridge reports a certain GRESB score which has been negotiated with the bank, then we will get a slightly lower coupon rate. That is one way to clearly align financial and ESG performance.”
Last summer LCP sold a 1.75 million square meter, LEED-platinum certified distribution center in Trecate, Italy, let to luxury brands retailer Kering, to Deutsche Bank’s asset management arm, DWS. “Sustainability is becoming a more tangibly-priced factor in logistics capital markets. That set a new benchmark pricing level in Italy, partly based on the fact that the buyer could represent it as the most environmentally advanced building in the country,” says LCP co-managing director James Markby.
However, he argues that while the “pull” of pricing is a factor in increased standards, it is the “push” from corporate occupiers that is the more important driver. “As a developer, working with businesses that have wellness and ESG at the top of their agenda means you are able to stretch the boundaries of what is deliverable. What can be incorporated into speculative buildings is very different. If the majority of your pipeline is pre-let there is more opportunity to work on those things together.”
Environmental and beyond
Environmental considerations have so far largely eclipsed social ones on the logistics ESG agenda, although platforms in some countries have historically been more highly motivated to improve worker wellbeing.
“Our ESG was born out of necessity,” says Stuart Gibson, chief executive at APAC-focused ESR, which provides free childcare and leisure facilities for workers in its larger buildings. “Japan is an economy with zero structural unemployment and an aging population. Customers were asking how they were going to attract labor.”
Distribution landlords in other regions are now beginning to provide more amenities for workers, says Dunne. “E-commerce has led some warehouses to become more sophisticated and increased the skills required to work in logistics. That means there is greater competition for labor, so creating a great place to work has become really important for our customers.”
“From a return point of view in the short-term investing in ESG will be neutral at best. But it is the right thing to do”
While green construction techniques are most advanced in Europe, and workplace amenity is the primary focus in Japan, increased efficiency through technology is the main driver for logistics ESG in China, argues Craig Duffy, managing director of fund management, for global logistics platform GLP. “We have been investing very heavily in logistics-related technology which impacts efficiencies and the sustainability of the supply chain,” he says.
“We have invested in G7 Networks, a telematics company that tracks trucks so that when they arrive at the warehouse they go straight to a smart gate, reducing congestion, waiting time and idling. We also recently formed a joint venture with a battery manufacturer focused on electric trucking because we believe a lot of the Tier 1 cities in China will soon restrict the movement of petrol and diesel vehicles.”
ESG progress is not uniform around the globe, notes Ivanhoé Cambridge’s Villemain. “The weight of regulation differs across regions and is a stronger driver in Europe than in North America, while the latest 2020 GRESB survey showed that 25 percent of logistics facilities in Asia are green building certified as compared to only 7 percent in the US.”
Investors and managers have a role to play in spreading best practice, suggests his colleague, Morroni. “When we work with investment partners from regions with high ESG expectations, their policies become our policies. Even in the US, where the regulation is pretty much state-driven, we are starting to see California develop its standards, and once we adopt something for California, we roll it out across our portfolio nationally.”
While much still remains to be done to improve the ESG performance of logistics real estate, the agenda has moved from a marginal consideration to a pivotal one in recent years. Covid-19 has concentrated minds further, and as climate change becomes an increasingly existential threat, there is no doubt it will continue to be front of mind for investors in the sector.
Logistics’ road to carbon-neutrality
Major platforms look to solar power and low-carbon construction to meet emissions goals.
Constructing and retrofitting buildings with more energy-efficient features is now commonplace within logistics real estate. But more far-reaching measures are needed to mitigate the sector’s contribution to climate change.
“The sleeper in all this that nobody is talking about in great depth yet is the embodied carbon in steel and concrete,” says Greg Goodman. “We have close to $5 billion of development underway around the world, so the really big challenge is to measure the impact of that, and to make sure we are doing something to offset it in a consistent and permanent way. Investing in renewables helps to offset that carbon. That is what we have to get right, together with making buildings super-efficient.”
As part of its initiative to become carbon neutral by 2025, Goodman has committed to increase rooftop solar energy capacity from 100 MW to 400 MW. Solar power generation is also a crucial component of other international platforms’ climate change mitigation efforts. Prologis has also set a target of 400 MW by 2025, GLP is aiming to generate 415 MW in China alone by the end of 2021, and ESR is aiming to generate 150 MW from the roofs of its Japanese warehouses by 2025.
The next logical step for many developers will be initiatives aimed at reducing embodied carbon in the construction process, which can account for up to 50 percent of a warehouse’s lifetime carbon impact. GLP claims to have completed the world’s first building verified net zero carbon for construction, its Magnitude 314 in Milton Keynes, UK, a benchmark achieved through measures including low-carbon concrete mixes, using recycled materials, and maximizing structural efficiency.