Private Real Estate Managers are Skeptical of ESG

While many organizations are adopting environmental, social, and governance principles, private capital managers are asking whether it negatively affects fund performance.

Nearly a fifth of those surveyed by Preqin believe that ESG constraints will cost them yield and, ultimately, clients. Respondents also pointed to performance and performance track record as the key differentiating factors among managers in the industry.

Out of all of those surveyed, real estate managers were the most skeptical about how ESG affected performance. Thirty-percent of real estate respondents, by far the largest portion of any asset class, said ESG was a challenge to outperformance. While 12% of all respondents said that ESG narrowed the opportunity set, 18% of real estate GPs said ESG was an obstacle.

Sentiment is one thing. Performance is another.

While private real estate managers without an ESG policy have outperformed those committed to ESG over the past decade, returns from the most recent vintages have reversed the trend, according to Preqin.

After further analysis, Preqin found no statistical significance in average IRRs between ESG- and non-ESG-committed groups. On top of that, the ESG-committed group’s return variance was about half that of the non-committed group.

Preqin also took a look at private equity funds in its survey and found that only 19% said they were concerned about the effects of ESG on performance. Also, it noted that ESG-committed private equity funds were more competitive than those who hadn’t committed.

As of June 2020, the private equity asset class had a 66% share of total private capital assets. On the other hand, real estate had 13.4%. Out of 1,567 funds in total, 700 were managed by ESG-committed managers.

Preqin notes that real estate is smaller and has fewer investment options. It says that in some cases, a real estate manager may not be able to afford to forgo a property in lieu of leaving LP cash on the sidelines. However, stricter environmental regulations and tax incentives could alter how properties are managed. Additionally, consumer demand plays a large role. If homeowners and renters prefer energy-efficient homes, ESG’s will become more popular.

Adopting ESG can also set companies apart.

In a recent report, Bain & Company argues that ESG should be a core part of what differentiates companies as competitors. ESG principles should be baked into due diligence, value-creation plans and exit strategies.