Morgan Stanley IM: Climate Change is Here – And So Is the Need to Embrace Sustainability in Real Estate

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“It is unequivocal that human influence has warmed the atmosphere, ocean and land.” So said the scientists on the United Nations (UN) International Panel on Climate Change (IPCC) in their sixth assessment report released in August 2021.¹ Using their strongest phrasing ever to stress that human actions are responsible, this report heightened the sense of urgency to act on climate change.

Not surprisingly, the real estate industry has been under pressure to focus attention on sustainability. After all, building operations and construction account for approximately 40% of global energy-related CO₂ emissions.²

Morgan Stanley Investment Management’s (MSIM)³ Global Listed Real Assets (GLRA) team⁴ believes environmental, social and governance (ESG) factors and a real estate company’s approach to sustainability will significantly influence its future risk and total return prospects. Given this view, we believe it is imperative to focus on analyzing sustainability factors and integrating these risks and opportunities into an assessment of value.

Why Investing Sustainably Matters in Real Estate

Climate change is an important factor to consider for the real estate sector.⁵ Existing buildings face chronic and acute physical risks, including intensifying hurricanes, floods and wildfires, as well as economic, social and regulatory changes necessary for decarbonization. To limit the global temperature increase to 1.5°C in this century as required by the Paris Agreement, it has been estimated that real estate’s direct carbon emissions will need to be cut in half by 2030, compared to 2020 levels, and reach net- zero by 2050.⁶

Publicly traded real estate companies hold a significant share of the building stock globally. As such, they are in a unique position to play an important role in achieving global sustainability targets. As public market investors, understanding how companies can influence and achieve net-zero targets is important, as is assessing the financial implications and, importantly, the capital expenditures required to reach such targets.

With 80% of the existing building stock expected to still be in place through 2050, retrofitting the current stock is critical to meeting global net‑ zero targets.⁷

DISPLAY 1:
What Is Sustainability?

DISPLAY 2:
Three-Pronged Focus on Sustainability

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RISK WARNING

There are special risk considerations associated with investing in the real estate industry securities such as Real Estate Investment Trusts (REITs) and the securities of companies principally engaged in the real estate industry. These risks include: the cyclical nature of real estate values, risks related to general and local economic conditions, overbuilding and increased competition, increases in property taxes and operating expenses, demographic trends and variations in rental income, changes in zoning laws, casualty or condemnation losses, environmental risks, regulatory limitations on rents, changes in neighborhood values, related party risks, changes in the appeal of properties to tenants, increases in interest rates and other real estate capital market influences. Generally, increases in interest rates will increase the costs of obtaining financing, which could directly and indirectly decrease the value of a strategy investing in the Real Estate Industry.

RISK CONSIDERATIONS

There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market values of securities owned by the portfolio will decline and that the value of portfolio shares may therefore be less than what you paid for them. Market values can change daily due to economic and other events (e.g. natural disasters, health crises, terrorism, conflicts and social unrest) that affect markets, countries, companies or governments. It is difficult to predict the timing, duration, and potential adverse effects (e.g. portfolio liquidity) of events. Accordingly, you can lose money investing in this portfolio. Please be aware that this portfolio may be subject to certain additional risks.

There is no guarantee that these objectives/results will be achieved. The views, opinions and forecasts expressed herein are those of the investment team, are not necessarily indicative of those of Morgan Stanley, are subject to change based on market, economic and other conditions, and may not necessarily come to pass. The information presented represents how the investment team generally applies their investment processes under normal market conditions.