We’ve seen a growing awareness of the importance of environmental, social, governance (ESG) within the CRE sector. Commercial real estate professionals are using the ESG framework to assess and inform how their portfolios manage risks and opportunities created by a shifting market and non-market conditions.
Currently, there’s no universal categorization of ESG issues. While business models, company characteristics, and industries have some differences, the core remains the same.
Environmental criteria refer to and address company/organizational environmental impact and stewardship.
Associated with climate change, the environmental aspect of ESG also measures carbon and greenhouse gases resulting from daily activity. Some estimates suggest buildings create 30% of global carbon emissions. ESG’s broader environmental criteria are designed to measure a building’s environmental impact—like water consumption and wastewater production/treatment, biodiversity, solid waste or trash, and greenhouse gas /carbon emissions. It examines the environment’s impact on buildings, too, such as the effects of natural events like earthquakes and floods, hurricanes and wildfires, and even windstorms.
Social criteria refer to the way in which companies/organizations manage stakeholder relationships and create value.
The social element of ESG is, according to the United Nations Principles for Responsible Investment, difficult to quantify. It says, “the social element of ESG issues can be the most difficult for investors to assess. Unlike environmental and governance issues, which are more easily defined, have an established track record of market data, and are often accompanied by robust regulation, social issues are less tangible, with less mature data to show how they can impact a company’s performance.”
Social elements look at issues surrounding the impact on communities and people. In CRE, those social evaluations can include diversity, equity, and inclusion (DE&I), health and safety, wages, and any other impact on a community within which economic activity is occurring. ESG’s social criteria—in connection with CRE—examines:
- Affordable and workforce housing for multifamily buildings
- Gentrification’s impact on communities
- Project located in opportunity zones
Governance criteria refer to company/organizational internal controls, management and leadership philosophies, policies, practices, and shareholder rights.
Focusing on an economic entity’s behavior and organization, governance examines a property owner or sponsor. CRE investors evaluate DE&I among executives and board members, the commitment to transparency, and corporate behavior. For example, how does a company behave ethically? Does its leadership plan for the long-term while meeting its customers’, employees’, and investors’ financial needs?
The drive to track and prioritize ESG factors in CRE has accelerated exponentially in the past few years and elevated ESG as a strategic, critical requirement for portfolios. Why? Because it’s seen as necessary for creating and sustaining long-term value in a swiftly evolving world.
We’ve seen a growing acceptance worldwide of climate change and its risks—and increased investment in clean energy infrastructure and green buildings. Regulators continue enacting stricter energy benchmarking standards and regulations to help address climate change.
ESG’s Impact on CRE
A recent trends report released by PwC US and the Urban Land Institute shows that ESG will play a greater role next year (and beyond) in CRE. Evolving trends shared by nearly 1,700 CRE experts include 82% considering ESG elements when making investment or operations decisions. There is significant agreement that the property sector is in a unique position to incorporate positive improvements designed to increase resilience to environmental risks.
The PwC-ULI report suggests that growing risks of climate-related property damage may encourage more investors to factor market-level climate risk into their decision-making.
One chief strategy officer said, “While the initial and primary focus of [one investment] group was concern for issues related to climate change, what was perhaps most innovative was the inclusion of a broader range of social and governance factors like infrastructure, education, and business climate. Today many more investors, especially those with global portfolios and longer-term investment horizons, are actively doing similar evaluations. Some sophisticated investors have creed internal resources to address this issue, and all are now aided by a number of governmental and privately-curated databases with both historical averages and predictive modeling.”
Why Investors Must Consider ESG
In 2021 especially, ESG surged to the forefront within the CRE and commercial mortgage-backed securities (CMBS) industries. Because ESG captures concerns about sustainability, green finance, and climate change, global investors have seen ESG’s value in asset allocation, investment processes, and manager selection.
Investors and asset managers can use ESG to measure and quantify green finance and sustainability while targeting investments designed to provide better outcomes on those ESG measures. The idea behind this approach stems from the governing principle of sustainability: an assurance that today’s profits won’t come at the expense of future generations. We’ve seen many recent global initiatives and standards including the International Capital Markets Association’s “Social and Green Bond Principles” and the 17 Sustainable Development Goals of the UN’s 2030 Agenda for Sustainable Development.
Freddie Mac and Fannie Mae have launched green bond programs designed to reduce multifamily housing’s impact through energy efficiency, infrastructure and property improvements, water conservation, and more. Banks, governments, international agencies, and real estate companies are using green bonds as well to reduce environmental impact via financing infrastructure projects and improvements.
Reasons to Champion and Implement ESG
Because it represents opportunities and risks impacting how CRE companies can create long-term value, investors are also factoring ESG into whether or not to invest in a particular CRE company. In CBRE’s 2021 Global Investor Intentions Survey, 60% of respondents indicated already factoring ESG criteria into their investment strategies.
It isn’t just investors and owners who have increased their awareness and recognized the value and importance of ESG. Tenants and customers have also begun discussing it. Why?
- It’s a way to help improve the climate for future generations and it encourages transparency about business practices. In short, it’s the right thing to do.
- Many experts believe CRE companies’ abilities to raise capital will rely increasingly on how effectively they focus on ESG issues associated with how their company is operated.
- Customers, clients, and tenants will expect building owners to be as committed to incorporating ESG principles to reduce carbon footprints within occupied spaces.
CRE companies opting to adopt and invest in ESG strategies see many benefits including increased asset value and lower operating costs—plus more chances to unlock sustainable financing opportunities. And with the reporting practices and data collection providing a foundation to ESG efforts, it becomes much easier to comply with local, regional, national, and sector-specific disclosure requirements.
Wherever you are on your investment journey, you should talk to the members of CREA United. Representing all disciplines within the CRE industry, these professionals use a natural, collaborative approach to business development. Collectively, the group has spent decades building knowledge about all aspects of CRE, following its evolution and trends, including those associated with the rise of ESG.