May 7, 2019 / In-depth

‘Embarrassing’ tenants create ESG conundrum for property funds

By Jessica Tasman-Jones, Portfolio Adviser

Investors mixed on whether occupiers such as betting shops are a problem

‘Embarrassing’ tenants create ESG conundrum for property funds

Ethical investors are worried investing in broad direct property funds could expose them to tenants involved in activity that does not align with their values and are instead turning to more specialist vehicles, such as social housing, primarily via closed-ended funds.

A handful of funds have policies to only lease to tenants who do not engage in so-called unethical activities, such as animal testing, alcohol, tobacco, arms or the sex industry, but other fund managers argue environmental and social considerations should apply to the building only.

The £1.3bn Charities Property Fund “will not invest in properties whose tenants could potentially cause embarrassment to our unitholders”, while the £630m Mayfair Property Income Trust for Charities will not invest in property assets where an “unacceptable level” of revenues comes from activities that could bring the fund “into disrepute” with its investors.

Both invest across property sectors, including offices, retail and industrial.

Charity and closed-ended funds lead the way

Whitechurch Securities and EQ Investors are among wealth managers who say they would not invest their respective SRI or impact portfolios in funds where they were concerned about the underlying occupiers of commercial space.

Real estate exposure in Whitechurch Securities’ portfolios comes via Social Housing Reits such as Civitas and Triple Point, while at EQ it is via Sarasin Sustainable Equity Real Estate and Time Investments Social Long Income. “While the closed-ended universe offers a number of opportunities around care homes, social housing or shared ownership, the open-ended universe is more restricted,” says EQ head of impact investing Damien Lardoux.

Quilter Cheviot head of responsible investment Gemma Woodward says the charities sector has led the way in demanding asset managers invest responsibly. The bespoke investment manager holds both the Charities Property Fund and Mayfair Property Income Trust for Charities in its portfolios.

Is the property or the occupier the product?

But BMO Gam fund manager Guy Glover says the property itself rather than its tenants should be judged for their ethical credentials, although he will discuss the activities of end occupiers with investors.

“It’s a bit like when someone buys into Apple. There might be people who use their products who might not necessarily be the people you’d want. We invest in the building not the occupier,” Glover says.

The fund is not tagged as a responsible fund but several such investors hold the fund due to BMO Gam’s integrated ESG approach across its funds, according to Glover. “It’s important for all the funds to appeal to all investors not just one sub-sector.”

It uses 100% renewable energy across gas and electricity, using anaerobic gas generation for the former.

It is also living wage accredited paying cleaners and security guards above the minimum rate. “It costs a little bit more but we thought it was the right thing to do because it protects the most vulnerable people in society,” he says.

Difficulties of collective vehicles

UBS Asset Management does not exclude certain occupiers from the properties within its funds unless a segregated mandate requires them to do so, says real estate and private markets chief operating officer David Hirst. “It’s difficult because in our large UK fund we have over 500 tenants. To analyse each of their business activities and come to an informed decision about each is very difficult.”

However, exclusions are possible. As an example, a segregated mandate for Spain and Portugal warehouse assets needed to be sharia compliant and therefore could not lease to tenants involved in pork production, Hirst says.

UBS AM did not struggle to find occupiers for that particular mandate, but Hirst says exclusions have the potential to cause problems in areas where vacancy rates are high. “It depends on the asset, what sub-market it was in, how much vacancy there was and who the likely occupiers were. Those are the type of considerations you’ve got to think of,” he says.

The asset manager discloses all occupiers to existing and potential investors. “Tenants are key to the value of our assets,” he says.

Full tenant list disclosure

Not knowing who the tenants are is one reason EQ doesn’t invest in mainstream open-ended UK commercial property funds via its Positive Impact portfolios, says Lardoux. “Property fund managers usually look at the financial viability of a business but are less concerned about how ethical or harmful the business activities can be,” he says.

The Global Real Estate Sustainability Benchmarking initiative (GRESB) does not cover the issue of tenants, points out Whitechurch Securities head of SRI portfolios Amanda Tovey. GRESB is one of a handful of labels funds use to highlight their green credentials, alongside BREEAM (Building Research Establishment Environmental Assessment Method) and LEED (Leadership in Energy and Environmental Design).

Tovey says: “We feel our investors would not be happy invested in a property fund where the rental payments were coming from as an example, betting shops, so would not invest in a fund unless they were happy to disclose and discuss the full tenant list and we were happy it met our key criteria.”

The Charities Property Fund, run by Savills Investment Management, discloses all tenants in its annual and interim report and accounts and on the fund website. Its largest tenants include Macmillan Publishers and Sainsbury’s, according to its Q1 2019 factsheet.

An advisory committee with representatives from six charities that are investors review all proposals and tenants. “We take the ethical considerations very seriously and continue to monitor every tenant to ensure that the tenant is acceptable, however it would be easy to find a reason to not accept a multitude of tenants and so we look at the bigger picture,” a spokesperson said in an email.

This is not necessarily the case for some of the largest funds in the Investment Association UK Direct Property sector. The £752.35m Aviva UK Property fund only discloses its top-10 tenants in its quarterly update to investors, while Janus Henderson discloses its top-10 tenants based on income in its monthly factsheets for its £2.5bn UK Property Paif.

No response has yet been received from the £3.2bn M&G Property Portfolio and £3.3bn LGIM UK Property fund.