Podcast: A clear green premium

Andrew Teacher

Hello and welcome to today's podcast. I'm Andrew Teacher from Blackstock Consulting. Now, this is the first in our special series on ESG, where we'll be speaking to some of the biggest brains in the sector, about how they're going to be tackling the biggest issue of the day. And I want to bust some myths, cut through some of the jargon, and ask some tough questions and hopefully get some real answers as well. Now, Aviva Investors last month, published an ambitious net zero pathway for its real assets business. I'm joined today by Ed Dixon, who's the firm's head of ESG. And he's going to tell us all about it. Now, just so we're clear Aviva Investors is the global asset management business of Aviva PLC, an active manager with 355 billion pounds of assets under management. The firm has 47 billion pounds invested in real assets across a range of strategies. They invest in real estate debt and equity, infrastructure debt and equity, private corporate debt, and structured finance. So Ed, you guys have come up with five interim goals to achieve by 2025 and we'll come to those in a second. But first, can you just give us a very straightforward explanation of net zero? What does it mean for you? Because there are a raft of interpretations swimming around right now.

Ed Dixon

Well, thanks for inviting me to be here today, Andrew. I think this is the big question everybody's thinking about at the moment. What is net zero? And how do we actually get there? And how do we achieve it? If we think about the way that our world is operating at the moment, we're really operating way outside of our boundaries, we're producing too much stuff, we're using too much energy, and that's contributing to the climate crisis. So net zero is really something that was thought out at a government level to try to transition the economy that we are living in to such a state that by 2050, the emissions that we're producing have been reduced in the first place - so we're using less energy, we're producing less stuff - but also that those emissions are then balanced to zero by removing emissions from the atmosphere. So we accept that we're still going to need to fly, to drive, we're still going to need to produce buildings, we're still going to need to operate infrastructure. But we also accept that we're going to need to remove those emissions and balance ourselves to a point where at the end of each year, we're reaching a point of zero.

Andrew Teacher

Let's move into it then - what's your role as Aviva going to be in balancing the scales so to speak, because you've talked about the fact that we're obviously still going to need to create emissions, whether it's through aviation or data centres, which obviously throw out a fair amount of emissions. But clearly, there's quite a lot that can be done through investment in technology and renewables and a range of other things. So let's dive into what your role is going to be.

Ed Dixon

I think the first and most important thing to say is that, as an asset manager, we are looking after other people's money, we're looking after other people's assets. And it's in our interest and their interest to make sure that those assets are being managed in the right way to create and to protect value over the long term. And that's what all of this comes back to. These investment goals that we've put into our 2025 strategy are really around getting our teams to do what they do best: investing into the right things that are going to help to solve some of the issues that are preventing us from making progress against tackling the climate crisis. But also looking at the existing assets that we hold, and working out how we can transition those assets faster. And you're absolutely right, we've got to pull totally different levers, whether we're operating as a landlord in traditional real estate equity, or whether we're operating as a lender in real estate debt. And the rules are different. Again, when we think about infrastructure, and slightly more niche asset classes like structured finance, where it's highly bespoke, very specialist, we're dealing with large amounts of money - usually in emerging markets - we need to pull different levers across each of those different strategies to try to accelerate the transition, and drive things ultimately in the right direction.

Andrew Teacher

Let's start with one of the more tangible areas which is asset management. And if we think about the current state of different markets in the UK, High Street, we think about offices, there's a lot of properties, a lot of real estate, that's going to need to be repositioned, refurbished, and arguably, as an occupier if you want a green building,  one that doesn't have a huge negative impact on the environment, you're probably better off moving into an existing building aren't you? So what, from the Aviva perspective, will that look like? What will your asset managers now be doing to minimise impact and crucially how they're going to be measuring this?

Ed Dixon

Yeah, it's a really good question. So let's look at the really practical steps that our asset managers are going to be taking in real estate to address this. So the big target is 30% carbon intensity reduction and 10% energy intensity reduction by 2025. So we've got five years to pull that off. Now, for an asset manager working today on our portfolio, what that means is that they need to pull multiple levers across different levels of the property lifecycle. So first, fundamentally, are we buying into the right products in the first place? Are we bringing the right kit into the portfolio? Does it have the right specification to start with, or actually, is that a value opportunity where we're bringing it in, and we're hoping to refurbish, improve energy efficiency, and get it back on the market? We've got to understand that at the point where we're going out and originating those deals, looking for the right stock and bringing it into the portfolio. We then need to think about developments. And Aviva, we have a one and a half billion pound development pipeline, and that spans all sorts of different configurations. We're sometimes the direct Development Manager, we're sometimes employing development managers on our behalf, sometimes we're forward funding schemes, and we need to pull different levers to make sure that those assets are future proofed in the way that they're designed. But also that they're designed in a way that can be operated to decarbonize that asset over time. So we've got to think super long term. Perhaps getting back to the real nitty gritty of asset management, this is where the real grind is. If you're looking at a standing portfolio of assets at the moment, and you're thinking about how to transition them over time, again, you've got to pull lots of different levers. So take, for example, we have a smart buildings programme, where we work with our occupiers on really complex large buildings to improve their energy performance. So what we do is, we install equipment, we use specialist engineers, we understand how the building's performing, and then we put in lots of time to make sure that we can improve it, working with facilities management, the occupiers' facilities management on site. Now, that initiative, it's a small thing, but it saved 700k last year, purely just from switching things off, operating things in a more efficient way. So number one, you've got to really get into the basics of actually running the building in the right way.

Andrew Teacher

In terms of that long term view, I guess that makes sense for an investor such as yourselves, but for many people, many strategies that people will be looking at will be three or four year plays within closed ended funds - where people are looking to pick stuff up, put it back on the market. And some of those investors listening to this will say, Well, look, why do I have to bother about what's gonna happen in 2030/2050? When I'm buying up my regional offices and buying up some reasonable sheds? And provided that they're meeting current regulation, I'm good to go.

Ed Dixon

Yeah, I think that's a really fair challenge. I think what the real estate industry has suffered a lot from in the past is seeing this as a hurdle, seeing this as a burden. And actually, we need to switch mindsets and start to think about the opportunity. All around us, when you pick up the paper at the weekend, you see adverts on the side of buses, when you're served adverts through social media, green is becoming something that's attractive to people, it's something that's linked with...

Andrew Teacher

Well, it is but at what cost? Because this is always the point, isn't it? You can see this in most census data or public surveys where the public will say one thing, but clearly mean the other. They'll say on one hand, I'd like more local shops, but then they'll say I'm going to spend more money online. And I think it's a similar quandary here, isn't it? That lots of investors will come out with these big promises saying we're going to do this gonna do that. But actually, when it comes down to it, is someone going to pay, or someone's going to give up, say 150-200 bips of return, because they've got to do X, Y and Z?

Ed Dixon

I think the research says that they are, it is certainly going in that direction. There's a great piece of research from JLL. That proves the green premium for offices in central London. And of course, you'd expect it to start in a market like that. You're dealing with very high quality kit, really high quality assets, and the very best occupiers that are really keen on making sure that they're occupying the right space, but it will permeate to other parts of the market.

Andrew Teacher

And that's a good point because we're certainly seeing those sorts of pledges coming out from firms like Microsoft, who have not only pledged to be carbon zero, they pledged to be carbon negative, by 2030, eroding every emission from every box of Microsoft Office that you've bought in the days where software used to come in massive boxes in Dixon's. And that's a remarkable and hard to imagine sized pledge isn't it really? And that from a real estate perspective should have a knock on effect, shouldn't it? In terms of how we shape buildings and obviously Microsoft are one of Aviva's big occupies in Cambridge.

Ed Dixon

Absolutely. This is the way that I think it's going. I think, yes, admittedly, it's going to be led by a small group of very educated and very forward thinking occupiers. But we're starting to see that spreading into logistics, we're starting to see it spread into more regional markets in the UK. And I think we've just got to be ruthlessly focused on that value opportunity. It is there, the rents will come. And if we're not focused on capturing the opportunity, it's going to sail past.

Andrew Teacher

Over what time period? Because this is the question that people are going to want to figure out. If I'm investing, and I'm financing all of this stuff, at what point would rents come? Because at this moment in time, when you look at the office market, and you look at the retail property market, it's going to be pretty difficult to scrape rental growth in these sectors right now.

Ed Dixon 

I think that's an absolutely fair point. And obviously, the industry is in a very tricky place at the moment. But I think we need to think at least five years ahead, and we need to look at where the trends are going. There's huge, huge demand for green and sustainable products. And that's only going to grow. We see it permeating every aspect of our lives. I think, also, if we think about growing regulation in this space, it's only going to add fuel to the fire and continue to get more and more leading companies to be driving and asking for more from their landlords.

Andrew Teacher

Right. So it's very easy to say companies must do this, companies do that. And in fairness, whilst a massive industry titan like Microsoft can make a big bold claim, it's gonna be much tougher for smaller businesses, and many smaller occupiers to do a lot of this stuff. So I mean, what what role does the public sector have here? Should the public sector be an agent of change with some of these things? Because we've got huge programmes to build schools, hospitals, and then obviously, Aviva as a business is investing hugely in infrastructure, and many different programmes. Should some of these projects be anchoring this change? And could that then have a halo effect across the wider supply chain, across everything else around it?

Ed Dixon

Absolutely. I think that's a big, big part of the answer. If we just look at the 10 point plan for a Green Industrial Revolution, that was launched recently...

Andrew Teacher

So this is launched by the government?

Ed Dixon

Launched by the government. It's incredibly ambitious, and is going to lead to a huge amount of change in public sector projects. And I think what's really important about this is that it's very broad, and it touches in on multiple different levels at the industry, I think there's a huge, huge opportunity that's going to be created by this for government to signal to investors and to signal to the industry where they believe the dominant technologies will be, and to start to provide subsidies and ultimately give long term investors that comfort, and that faith in those technologies to go up alongside government and invest. And I think that's not just infrastructure related, it's going to spread into retrofitting our real estate portfolios, it's going to spread into those much smaller corners of the markets and start to really create benefits for smaller occupiers.

Andrew Teacher

And that's one of the four roles that Aviva has set out in it's pathway. You've talked about supporting investment into renewables and also emerging technology. And I was speaking to one of the world's biggest cement manufacturers, actually, last week - he'll be on a future episode of PropCast - and he was talking about carbon capture and a host of other, almost science fiction-like evolutions that are occurring in cement and concrete. And how some of these things could actually help reduce emissions if we can recycle buildings and recycle concrete more effectively. How will Aviva interact with such technology? And again, where does that then sit within your universe?

Ed Dixon

So what's really needed is clear subsidy signals from government that make emerging complex technologies - such as battery storage, which is absolutely critical to supporting the drive to renewables - underpinning those technologies with subsidies. We saw exactly the same thing happening with wind power, and with solar over 10 years ago. And that's had an enormous and transformative effect, attracting long term money, sticky money that wants to invest into those sectors and build them out, but is a little bit cautious because of the risk. Those subsidies can act as a conduit to increasing institutional money going into those sectors. So I think that's what's really needed and it's needed fast.

Andrew Teacher

And from a consumer perspective, we're obviously still seeing that with electric vehicles and the subsidy we're offering people through reduced car tax and some of the other emissions schemes that are coming forward penalising dirtier older vehicles. Is there a case for more top down regulation when it comes to emissions from buildings? Because we have a bunch of different ideas and frameworks being put forward by all the various professional bodies, but does there need to be something a bit more draconian, that that's driven from from a central government position?

Ed Dixon

Potentially. If we look at the success of the minimum energy efficiency standards initiative, which has really - despite its flaws, and there are some flaws in terms of accuracy, and some flaws in terms of whether it's being upheld correctly - actually, it's been enormously successful in driving a basic understanding throughout every single corner of the industry of basic energy efficiency principles.

Andrew Teacher

And that regime effectively meant that if your building wasn't up to scratch, you couldn't trade it, couldn't transact it, couldn't rent it out.

Ed Dixon

Precisely, you couldn't rent out your building unless you had a certificate. And actually, what the last few years have done of the industry adopting and moving forward to take on that standard, led by the regulation has actually provided a really good baseline position to then ratchet up the tension. So government currently consulting about increasing the minimum standard that's required by 2030, which will really drive a lot of investors to need to actively retrofit their property portfolios, and that's going to start to achieve the desired results that we really need. So it's legislation that's truly working.

Andrew Teacher

And when we're talking about measurement, target setting, certification, lots of buzzwords, what are some of the actual outputs here in terms of when we think about measurement, and benchmarking? How are you going to be setting targets within Aviva? And what are some of the things that other people in the marketplace could learn from what you're doing?

Ed Dixon

I think the important thing to say about target setting is: it's all about trust. Because you're working within the confines of a business, fundamentally, trying to get them to commit to the future. Put your neck on the line and say, we're going to do x by y date. And that's a big ask. So it's all about trust in working with the business and trying to set the targets that we've set. It's taken a lot of iterations, it's taken a lot of work. It's taken a lot of tough conversations. But ultimately, we've ended up in a place where people feel comfortable to commit to change their commits.

Andrew Teacher

What's the measurement though? Because I think cynics would say, commitments are fantastic, but show me the numbers.

Ed Dixon

Yeah, I think we've been super clear about our commitments in so much as that four out of the five are investment targets. And we're really mobilising our teams to do what they do best. Our teams are good at investing money. If we could encourage them through our target setting, through our net zero commitment, to commit to investing into the right sectors, we support them to do that, then it should be a clear run. But investment goals are fundamentally very easily measurable. The only other target in our set of five targets that we've set as part of our net zero pathway is the carbon and energy target. And measurement around that is very robust now. The systems and the processes that we use to measure carbon, measure energy intensity, they're proven and they've been around for a long time. And that means that ultimately, we can hold our teams, our suppliers, our partners, our occupiers, we can hold everyone to account.

Andrew Teacher

And for a business wanting to work with Aviva on some level, what are some of the things that they're now going to have to do that they didn't have to do a couple of years ago?

Ed Dixon

A really good example on this would be our sustainable lending strategy. And that's one of the goals that's part of our net zero pathway. So we've committed to providing a billion in sustainable transition loans by 2025. And really, this sort of creates an incentive. So as a real estate lender, we lend commercial mortgages to a variety of different organisations of different sizes throughout the real estate sector - it tends to be usually on the smaller end, because the larger listed companies are accessing listed debt and the smaller ones are perhaps accessing commercial mortgages - we can provide, backed by our clients and supported by them, incentives, small but meaningful incentives to real estate borrowers, to encourage them to speed up and get on with transition focused activities in their portfolios. So talking in really simple English, if you want to take out a commercial mortgage with Aviva investors, and you are ready to commit to putting more solar on top of your roof or you're ready to commit to achieving a green certification for your building or setting a more ambitious climate target and sticking to meeting it, then you can access cheaper debt. That's it in really, really simple terms.

Andrew Teacher

And who is it that essentially checks this? Because, if I've got a hotel on the Outer Hebrides, putting a load of photovoltaic panels on the roof isn't really gonna make huge difference is it? So who is it that you bring in to say, actually look, yeah, investing 50,000 pounds in this or 20,000 pounds is actually going to make a difference? How do you judge that?

Ed Dixon

So there are two elements to this. The first is that the framework which we put together, that sets out the process - in terms of what's important, what sort of KPIs we should be focusing on, what sorts of projects we might start to look at to reward - that framework is overseen by a third party and approved. Now, there are lots of companies out there in the sector that do this, that usually oversee green bonds over in listed markets.

Andrew Teacher

And that's Vigeo-Eiris?

Ed Dixon

Exactly, yeah. So they look over it. And they would assure that framework in the same way that they'd look over a green bond.

Andrew Teacher

They're an ESG rating and research agency?

Ed Dixon

Exactly. So they're pros, they're good at doing this, they understand it, and they give that external validity to our framework, which sets out the things that we'll focus on, the sorts of KPIs and targets that we believe in and know to be important. And then the other element of it is overseeing the actual transaction itself. So as the transaction is being negotiated between us as a lender, and then the real estate company, as a borrower, that company is also getting involved in overseeing the transaction to make sure that the KPIs that we've picked and that we've agreed that will be incentivized through the structure of the deal, are the right ones, that they're material, that they're contributing to some meaningful change. And that the evidence that will be provided is ultimately the right evidence.

Andrew Teacher

One thing I wanted to ask, moving on from just the bricks and mortar, given given a lot of real estate are high rise buildings, highly dense buildings that come with a lot of mechanical engineering, lots of lift systems, lots of complex electrical, and plant machinery inside them - do you think people are adequately estimating the impact of all of the M&E in buildings? Do you think we have a grip on that? Because again, when we're thinking more broadly around environmental impact, this consideration towards what we do at the end of a building's life isn't something that's really been explored hugely, is it?

Ed Dixon

I completely agree. And we need to do a lot more work in that space. I think what it really comes down to is two things. One is that our economy at the moment is completely linear. And real estate is a great example of that. You pay manufacturers, suppliers, contractors, to produce the building. The building stays largely in its steady state for a set number of years. And then ordinarily, it's demolished and goes back into the system. But we're not very efficient at taking out those elements, reusing them, recycling them in ways that aren't completely damaging to the planet. So we've got to do a lot more to make it more circular. Now, I think part of the solution to that problem is ultimately a much better and much closer level of supply chain integration. At the moment, what we tend to do is we work as developers, as investors, in quite an isolated way. And we need to get much closer to the actual manufacturing of those elements that contribute to creating our buildings, and create closer supply chain relationships so that those elements can be refurbished, replaced, over the building's lifetime in a far more sustainable way. I mean, just take lifts as a really simple example. Who do you want to deal with lifts over the lifetime of a building? Of course, you want the person that designed the list in the first place. And the person that designed the lift, they want to be the person that's operating it and dealing with across the lifespan. So we've got to be much better at procurement, setting up our supply chains in a way that can actually accommodate that thinking. So that everybody's involved in the whole lifespan of the building from creating it, and operating it to ultimately recycling or refurbishing it at the end of its life.

Andrew Teacher

It's not a world away from some of the discussions that have been had in the fashion industry over the last couple of years, as people are starting to work out that maybe buying a pair of eight pound jeans every three months isn't great for the environment. And a bit of a disconnect there between consumers, retailers and the manufacturers that are often overseas and in quite distant locations. What can Aviva do in this area? Obviously, you develop a fair amount of stuff, but you're not developing everything. And you're not going to be the people involved necessarily in prescribing what lift systems go into a building, but what pressure can the finance community bring on the supply chain and on some of these issues of procurement?

Ed Dixon

I think what's really important is setting out intentions. And a big, big part of the problem in terms of the materials that we use is that it all happens behind closed doors. It isn't regulated at the moment, it isn't necessarily legislated, the amount of carbon that you emit through your supply chain. And I really don't think that people understand it. And it's the same with the jeans problem, right? If you're going to buy an eight pound pair of Primark jeans, in all honesty, you're probably not aware of the impact that it has to actually create that pair of jeans in terms of the dyes, in terms of the amount of water that it uses to wash the denim. And it's the same with things like mechanical and electrical systems, with lifts. I don't think we really understand that actually producing all of those components to buildings, happens in really difficult and hard to manage sectors where the emissions are huge, massively contributing to the climate crisis. And are very, very difficult to change. Producing steel in a sustainable way is still not something that's necessarily proven. And it's going to take a lot more pressure from investors and pressures from finance, to incentivize and encourage developers and encourage contractors in the supply chain to understand better those emissions and those impacts to measure them and hold them accountable. And to push for the sort of change that we need.

Andrew Teacher

There are some big questions there. And hopefully, we'll be able to cover some of those off over the next couple of weeks. But before we go Ed, let's leave on a positive. What would you say is the single biggest and most positive thing you're seeing right now in this area? What's one of the things that people should be really enthusiastic about and should really get behind?

Ed Dixon

The big thing that I'm noticing is that sustainability, ESG, whatever we want to call it, is very, very rapidly becoming something that's commercial, and something that's a part of every conversation. Even two years ago, I can remember that it wasn't like that. It was still something that was on the sidelines, it was still something that was dealt with separately and dealt with in different meetings. Now what I'm hearing is every leader in every conversation, every borrower, every occupier, every team, constantly bringing it into the conversation and considering it in a way that is commercial. Understanding how it will affect the business, how it will impact risk, how it will actually lead to potentially better outcomes for stakeholders for clients. So it's becoming something that's really woven into the way that we do business every day. And that's a really, really good thing.

Andrew Teacher

A great place to leave it there. Thanks so much for joining us today Ed Dixon, head of ESG at Aviva Investors and anybody wanting to read through Aviva's proprietary sustainable transition framework can look at that online. It's all on their website. And we'll be sharing the link as well with the podcast but thanks a lot for joining us. Do subscribe to PropCast on Apple, Spotify and all other good podcast platforms. I've been Andrew Teacher at Blackstock. Thanks a lot for joining us and we'll hope to see you again soon.