The Growing Role of ESG in Commercial Real Estate Investing: 4 Trends to Watch
Investors and consumers around the globe are pushing companies to adopt better environmental, social, and governance (ESG) practices. Our 2018 ESG Sentiment Survey of real estate professionals clearly showed that ESG practices and expectations are on the rise across the sector. Commercial buildings are on the front lines of this trend, as they form the backbone of many communities and represent a significant opportunity to cut utility costs, mitigate greenhouse gas emissions, improve sustainability, and create value through improved ESG performance.
In our work with clients, RE Tech Advisors sees 4 key ESG trends driving much of this market activity:
1. ESG improves financial performance
Recent research suggests that ESG can create short-term and long-term financial value for investors while mitigating risk. This is true at both the fund and asset level. Since 2007, socially responsible funds have achieved gross returns of 5.62%, compared to the 5.08% of non-socially responsible funds. Additionally, green-certified buildings generally have positive sale and rental premiums compared to non-green buildings, as well as 9–14% lower operating costs and 9% higher occupancy rates.
Capital markets are taking notice. About 75% of senior investment executives consider ESG performance a vital aspect of investment decisions, and 66% of investment firm board members would consider divesting from a corporation with poor ESG performance. Individual investors are also seeking out ESG. About 67% of millennials believe in expressing personal values through investments, and as wealth transfers to the millennial generation, $15 to $20 trillion could be allocated to ESG-oriented investments over the next 2–3 decades.
2. Investors are pushing for transparency
Global efforts to report on ESG performance to investors continue to grow. One way that investors assess performance is through GRESB, the global ESG benchmark for real estate assets. Participation in the GRESB assessment has increased continually since its inception in 2010, with 903 entities reporting on over 79,000 assets and $3.6 trillion in gross asset value in 2018. It is not uncommon for investors to require a GRESB assessment — or a commitment to do one in the future — as a condition for placing capital in a real estate fund.
Participation in GRESB Reporting
Other ESG reporting efforts are gaining extensive market traction as well. The Principles for Responsible Investment, a signatory program and annual survey that ranks companies based on their ESG performance, now has over 1,900 signatories with more than $81.7 trillion in assets under management. Also CDP, an annual survey that allows companies to report on greenhouse gas emissions and climate change mitigation strategies, has seen a 33% increase in participation since 2013. Companies reporting to CDP now represent 56% of global market capitalization.
Aside from voluntary reporting, a push for legally requiring ESG disclosures is also underway. The Sustainability Accounting Standards Board (SASB), in coordination with a group of investors with more than $5 trillion in assets, have been pushing the Securities and Exchange Commission (SEC) to develop mandatory disclosures for public companies covering ESG factors.
3. The market is scrambling to understand and address resilience
In recent years, the U.S. has experienced a historic number of disasters related to weather and climate. Damages from these events exceeded $300 billion in 2017 and $90 billion in 2018, and they are expected to total $3.9 trillion cumulatively by 2025. The risks associated with climate change go well beyond direct physical damage to properties (see figure below). Therefore, the degree to which investments preserve their value in the face of a changing climate and the implications to fiduciary duty surrounding resilience are a critical focal point for real estate leaders.
The Spectrum of Climate Risks to Real Estate
Climate resilience is attracting the attention of some big names. For example, the Task Force on Climate-Related Financial Disclosures (TCFD) — formed by the G20 Finance Ministers, Central Bank Governors, and the Financial Stability Board and led by Michael Bloomberg — has issued an influential set of recommendations on how financial institutions should analyze and report on material climate risks to investors.
At the same time, real estate investors are beginning to create resilience policies and pursue climate risk assessments to inform investment decisions. A recent report by climate risk assessment and real market intelligence experts GeoPhy and Four Twenty Seven found that about 35% of REIT properties are exposed to climate hazards. This may already be having an effect on the market: properties exposed to sea level rise in the U.S. are now selling at a 7% discount compared to those with less exposure.
4. Resident demand for amenities is driving multifamily sustainability
The multifamily industry is experiencing an era of “amenities wars” in which properties compete to attract tenants with bigger and better amenity packages. But amenities are also changing how real estate owners think about sustainability, and how they interact with residents and tenants.
On average, while residents want to avoid increased rent, they are willing to pay for select amenities that cater to health and fitness, foster a feeling of community, and save them money. In this case, resident and owner preferences are aligned around sustainability: owners want to increase ESG performance, and many of these measures produce amenities that tenants are willing to pay for. This makes assets with sustainability features more competitive in the market, as tenants increasingly link satisfaction to sustainably-certified buildings, leading to higher retention rates and decreased costs from vacancies. This is particularly true for the Class A/luxury multifamily market — in which about 80% of residents consider living in a sustainable or eco-friendly building to be important.
Though ESG practices continue to evolve, one thing is clear: driven by a mix of investor pressure, consumer demand, financial performance, and climate risk, ESG will continue to be a critical pillar of commercial real estate investing in 2019 and beyond.
Operating at the intersection of sustainability, technology, and buildings, RE Tech Advisors is committed to helping the greater real estate investment community navigate these trends. We design and implement award-winning ESG programs that fulfill our clients’ fiduciary and investment objectives. We develop and deploy strategies at multiple scales — from individual buildings to nationwide initiatives — while continually seeking client-specific solutions. Find out more at www.retechadvisors.com or contact us.