How Environmental, Social and Corporate Governance (ESG) Practices Are Impacting Real Estate Funds

Environmental, social and corporate governance (“ESG”) and Sustainability practices are becoming a vital investment criterion for real estate capital sources. According to the 2019 PERE ESG Investor Survey (PERE Survey), 70% of institutional real estate investors have explicit ESG policies in place, and nearly all respondents reported that ESG principles have a role in shaping their investment decisions.

What is ESG

Environmental

• Climate action
• Carbon footprint
• Energy usage
• Air quality
• Waste management
• Greenhouse gas emmissions
• Usage & contamination of water
• Impact onsurrounding ecosystem

Social

• Working conditions
• Human rights
• Health & safety
• Diversity & inclusion
• Employee relations
• Community betterment and engagement
• Stakeholder returns

Governance

• Ethical standards
• Quality of management
• Board structure and independence
• Financial strategy & risk management
• Cybersecurity & data protection
• Transparency & disclosures

Real estate funds and their management must develop a plan for prioritizing the implementation of ESG policies and initiatives because capital providers look for climate data and disclosures as well as resiliency, proactiveness and a property’s ability to attract tenants. There are also new governmental policies and net zero goals that are being implemented for both new construction and preexisting buildings which may impact real estate development and management. Because of this, capital providers need to be assured that real estate funds are forward looking and performing due diligence to identify ESG related risks and opportunities in order to meet both state regulations and internal ESG and Sustainability goals.

ESG is one of the fastest growing segments in asset management today, and investing in the best ESG mutual funds, index funds and exchange-traded funds (ETFs) can help generate returns while supporting responsible corporate behavior without sacrificing performance.

How to Factor ESG Into Real Estate Investments

ESG factors into real estate investment in many ways. When thinking of this class of assets, most think of the environmental aspect first. However, both the social and governance components of ESG also play important roles in real estate investment. Below are some of examples of how ESG can be applied in real estate investments:

Environmental

• Developing properties with the lowest emissions level possible and then offsetting the emissions created by finding ways to reduce and/or reuse waste and utilize renewable energy sources.
• Utilizing eco-friendly materials such as timber rather than steel and concrete.
• Incorporating technology (Proptech) into developments, such as smart heating or ventilation.

Social

• Affordable housing projects - In the last 30 years, household wealth has quadrupled; however, in the lower 50%, it has dropped significantly. The relationship of wealth change and home ownership change tracks almost one-for-one. There is a huge need across country for these types of developments.
• Workplace wellness features – This focus is not only on physical wellness but also on employees’ mental health and can include increased ventilation and air circulation, increasing natural light, offering employee’s healthy food options, or meditation and yoga classes.
• Diversity & Inclusion – This can be applied to both the real estate investment firm as well as the tenants in the investment properties.

Governance

• Corporate social responsibility - A form of self-regulation that reflects a business’s accountability and commitment to contributing to the well-being of communities and society through various environmental and social measures. This can include environmental efforts, philanthropy, ethical labor practices, and volunteering.
• Data protection – Personally identifiable Information in real estate is accumulated while managing tenants, handling property guests, and selling properties, as well as servicing investors, employees, and contingent labor, such as contractors and handypersons. Fund managers should make sure there are policies and procedures in place to remain good stewards of the personal information they accumulate and use.
• Transparency and disclosures – Clear description of which factors are significant or a main concentration, and disclose how the fund measures progress on its ESG and sustainability objectives.

How to Measure ESG in the Real Estate Industry

ESG is not just a box being checked as part of due diligence. Investors also want fund managers to be held accountable to their ESG plans. As such, real estate funds need a way to measure and report on its ESG strategy. There are three ways one can benchmark ESG and sustainability performance:

1. Perform it in-house
2. Hire an external consultant
3. Receive tailored information from an ESG ratings expert.

The methodology a manager uses may be driven by the size and complexity of the investment properties.

One of the most well-known ESG benchmark and frameworks for real estate is the Global Real Estate Sustainability Benchmark (“GRESB”) Real Estate Assessment. GRESB is the leading global ESG benchmark specifically designed for the real estate industry to help investors and managers understand and measure the performance of a company’s ESG initiatives within its portfolio. GRESB enables investors to assess ESG data and benchmarks for real estate funds, REITs, property companies, real estate developers, infrastructure fund managers and asset managers.

The GRESB real estate assessment includes a data validation process, a scoring model and peer comparison. The real estate assessment can generate one of two benchmarks: one for new construction or properties undergoing major renovations, and one for Standing Investments. Standing Investments are assessed at Management (30%) and Performance (70%), while new construction or major renovation of old properties is assessed at Management (30%) and Development (70%). Management measures an entity’s strategy, policies, and leadership while performance measures an entity’s asset portfolio performance and includes information on performance indicators including energy consumption, GHG emissions, water consumption and waste management and development measures an entity’s efforts to address ESG during a building’s design, construction, and/or renovation phases.

The GRESB real estate assessment includes a data validation process, a scoring model and peer comparisons. All participants receive an overall rating, and its scoring is then compared to all other participants. GRESB also provides a rating among peer groups based on structure (public or private), property type, geography, and ranks participants within their respective peer groups. All participants also receive a benchmark report and an online tool that provides an analysis of the company’s sustainability performance.

GRESB also offers an Infrastructure Assessment which, collects, analyzes, validates, and benchmarks ESG performance of infrastructure investments. There are two GRESB infrastructure assessments: one that scores and benchmarks participating funds against one another, and one that scores and benchmarks assets against one another. Both assessments address key components of sustainability, ESG performance and infrastructure sectors such as data infrastructure, energy and water usage/resources, and environmental services. Like the real estate assessment, the infrastructure assessment ranks management at the organization level and performance at the asset level. Participants then receive a GRESB Fund score, a GRESB Asset score, and an overall rating which is then compared to peers

Additionally, there are multiple organizations, including the Urban Land Institute (“ULI”) Greenprint Center for Building Performance, Sustainable Forestry initiative (“SFI”), Leading Harvest, Task Force on Climate-related Financial Disclosures (“TCFD”), Sustainability Accounting Standards Board (“SASB”), Principles for Responsible Investment (“PRI”), and Carbon Disclosure Project (“CDP”) that collect industry-specific data and publish their standards and recommendations that Fund Managers can use to compare to its own strategy sand performance.

Why it’s Important to Have an ESG Strategy in the Real Estate Industry

As ESG continues to be on the forefront for investors, fund managers should consider assessments conducted by these organizations as it will help them identify areas of risk, opportunities and impact, as well as aid to attract new investors that are looking for more comprehensive risk, opportunity and impact analysis. The assessments offered by organizations such as GRESB will help systematically improve investor engagement while helping benchmark performance against competitors and the industry. Developing a strategy and reporting around ESG and sustainability will be crucial for real estate funds to gain a competitive advantage, mitigate its risks and exposure, and improve the financial performance and investment attractiveness to investors.