Authors: Meghavi Patel, Sustainability Manager, Epic Investment Services 

                 Emily Nield, Senior Sustainability Research Analyst, Epic Investment Services 

Department Lead:  Steven Pacifico, VP, Sustainability, Innovation, & National Services, Epic Investment Services 

    Responsible investing is widely understood as the integration of environmental, social and governance (ESG) factors into the investment and decision-making process. ESG covers a wide range of issues such as environmental mitigation measures, protection of health and well-being of occupants, and incorporation of policies to increase transparency behind investment decisions. It is now one of the largest economic opportunities for the commercial real estate sector.

    ESG is a relatively new concept, in fact the term ESG was first coined in 2005. Today, ESG investing now represents 61.8% of professionally managed assets in Canada [1]. The incorporation of ESG practises into investment decisions and portfolio management surged in 2020 when the pandemic emerged. Properties that had strict health and well-being practises were more resilient to the risks posed by the virus. Investors are now making ESG a priority when it comes to portfolio management to reduce their exposure to risk. However, the largest material risk that is currently facing the commercial real estate sector in Canada demands more attention. That risk is climate change.

    All properties across Canada are being impacted by climate change, however the value-at-risk will vary based on two factors: physical risk and transitional risks. Physical risk accounts for the impact of climatic events, such as extreme weather, on a property. In Canada, these extreme weather events, such as flooding and forest fires caused $2.4 billion in damage in 2020 [2].

    Transitional risks arise from efforts to address environmental changes including new government regulations such as the national carbon tax, shifts in consumer demand, such as tenants requesting Net-Zero buildings and new investor demand, such as the growing ESG interest of millennial investors. 77% of millennial investors, claimed that ESG issues are top priority when assessing investment opportunities, with nearly 90% setting it as a first investment criteria [3]. Millennials will play a key role in future investments as they are the largest population by generation, and they will inherit multi-trillion dollars from their baby boomer parents.

    These risks present a large opportunity for investors, as there are numerous ways to reduce the value-at-risk from properties. Here are three steps that one can take to minimize the impacts of climate change on their portfolio.

1. Property-level climate risk analysis. The first step to protect a portfolio is to understand the key physical climate risks that the property faces at the postal code level. These assessments should be factored in for property valuations, acquisitions, and dispositions.
2.  Implement measures to reduce the physical impact on your property. After key threats are determined, capital can be allocated to implement measures to reduce risk. For example, if the property is in a high-risk flood zone, then it would be advantageous to install elevator water sensors that prevent them from submerging into flood waters. According to an analysis from FM Global, for every $1 a company spends to protect structures from hurricane, wind, and flood damage, estimated loss exposures decrease by an average $105 due to reduction in risk of property loss and business disruption [4].
3. Governance and regulations investment planning. Stronger action is now being taken by governments to reduce GHG emissions that buildings are emitting. Portfolio managers need to understand current and future regulations and allocate capital to meet these new requirements. For example, Canada’s federal government has implemented the National Carbon Tax, in which the price of carbon is set to increase 8.5 times in the next decade [5]. Costs of natural gas are expected to increase by 450% by 2030 and electricity costs to increase by 135%. To mitigate these increased costs, properties will need to (1) reduce energy consumption; (2) decarbonize their portfolio by low-carbon fuel switching; and (3) consider onsite renewable energy. The first step to decarbonizing a portfolio is to identify key carbon emitting systems at properties and when they are due for renewal. Then, capital can be set aside to replace these systems with a low or no-carbon system. By embracing the opportunities outlined above, investors and portfolio mangers can protect their assets by preventing lower property valuations, higher insurance rates, higher utility costs, and potentially costly building repairs if an extreme weather event occurs. COVID-19 has highlighted the vulnerability of building portfolios that did not incorporate ESG principals. The virus gave us little time to prepare after this unprecedented event. Time has been given to prepare for climate change, however that time is quickly running out. The industry must take climate risks seriously as its impacts are already being felt throughout the world. Investors have the power to control how their capital is spent, so it is crucial they use their power to ensure vigorous ESG practices are in place to mitigate climate change. Only then, will investors be able to embrace the full economic opportunity presented by ESG.

[1] Financial Post. Nov. 26, 2020

[2] Financial Post. June 2021.

[3] CNBC. December 2019.

[4] FM Global, 2019.

[5] The Globe and Mail. March 2021.