Residential real estate: the right measure of impact

KGAL has developed an ESG scoring model to establish the sustainability of assets for its residential property fund. By Philipp Langbehn.

The convincing fundamentals for residential real estate in Europe prompted independent German investment and asset manager KGAL to launch the KGAL Core 5 LIFE residential fund, and it was quickly agreed that it should be an Article 9 product.

KGAL recognised that demand for impact funds among institutional investors is high, but supply is low.
The Core 5 LIFE therefore addresses key ESG objectives, such as combating climate change, alleviating the shortage of homes, and providing affordable housing in particular.

The SFDR (Sustainable Finance Disclosure Regulation) and EU Taxonomy require the sustainability of investment properties to be measured and proven. KGAL has developed its own in-house scoring model to capture the complex array of ESG parameters and weigh them according to their impact. It is important that the parameters represent real impact, that data accessibility and reliability are guaranteed and that the scoring is transparent and comprehensible for our investors.

More than 30 screening criteria

Our ESG scoring model comprises more than 30 assessment criteria, distributed across environmental, social and governance spheres in line with the United Nations Sustainable Development Goals (SDGs).

The scoring enables us to quickly assess potential acquisition targets, prior to the complex due diligence process, to determine whether a purchase is even worth considering. Once a property has cleared this first hurdle, it must then achieve a defined minimum score in each ESG category to be considered for the Core 5 LIFE fund. The closer to the maximum score of 100, the better.

In the environmental category, the model evaluates, among other things, energy efficiency and carbon footprint according to the relevant regulatory standards, as well as the use of renewable energy.

In the social category, affordable housing is a cornerstone of our model. We therefore look at the rents of a property in relation to the local average household income, as well as building quality and the provision of social infrastructure.

For governance, for example, we aim to implement green leases and embed sustainability goals within service contracts.

KGAL Core 5 LIFE’s first purchase, a BREEAM-certified new-build in Málaga, Spain, is proof that high ESG standards and decent returns are fully compatible. The property was acquired at an attractive purchase price and also achieved scores of up to 100 in ESG components.

Further potential with ‘Manage to Green’

ESG due diligence at the time of purchase is just the beginning. For older properties, KGAL pursues a ‘manage to green’ strategy, taking measures to continually improve the ESG score. Over the holding period, asset management ensures that impact requirements are monitored and continue to be met for the whole portfolio.

This brief overview shows the effort required for impact investing, but these resources are well spent. Investment products that fail the ESG principles also fail investors. This is already evident in the foreseeable loss of value of real estate with high CO2 intensity (so-called ‘stranded assets’).

KGAL is convinced that investments with ambitious ESG strategies will ultimately prevail in the market.

Philipp Langbehn is portfolio manager of KGAL