For the past decade, investors have increased awareness about and interest in Environmental Social Governance (ESG) issues and their importance in investment decision-making. However, the tide has been turning into a more proactive approach to ESG investing, especially in commercial real estate (CRE).
According to the USGBC, commercial building owners and managers will invest an estimated $960 billion globally between now and 2023 on greening their existing built infrastructure. This stronger focus on ESG is also coming from significant institutional investors like BlackRock and Vanguard, who are taking a longer view of business performance.
ESG information serves as proxy for management quality and investors are motivated to use ESG data because it’s financially material to investment decisions. However, the biggest challenge lies in being able to use ESG data comparably, timely and reliably – leaving the marketplace with a lack of data.
Verdani recently took a deep dive into these topics during an annual IMN conference on real estate investment where we spoke on an ESG panel and NAREIT's 2018 ESG Forum that had an insightful investor panel. Here are some of the key takeaways:
The Drivers of Sustainability and ESG Trends in the US
Are commercial real estate firms jumping on the ESG bandwagon?
Anyone trying to raise capital in this competitive market has probably noticed a big uptake on ESG-related questions. That is because ESG information is material for investment decisions and primarily relevant for assessing a company’s, legal and regulatory risk. Investors are seeing the benefits of sustainable investments – so they are putting more pressure on managers investing on their behalf to focus on ESG issues, and we predict that this trend is going to continue increase upward.
Some of the key requirements of investors include having:
Staff dedicated to managing ESG programs
ESG policy in place
Investments in efficiency improvements for value creation
Transparent reporting to organizations like the Global Real Estate Sustainability Benchmark (GRESB), Sustainability Accounting Standards Board (SASB), and annual ESG Reports
Increasing the percentage of their portfolio that obtains 3rd party certifications such as LEED and ENERGY STAR.
Commercial Tenants Are Demanding Sustainable Buildings
Tenant demand has been among the strongest drivers for greener workplaces. More tenants are seeking out green office space, and many are willing to pay more to occupy it. With indoor air quality and access to natural light leading as the two most important green factors to tenants, an increasing number of real estate owners and managers are implementing these specific green features.
Engaging and educating tenants are important to build and implement a successful sustainability program. Whether tenants are demanding green occupancy based on improved productivity, lower utility costs, or even a greater concern for climate change, the result remains the same – higher rents and lower operating expenses resulting in an improved bottom line for building owners and managers.
The Competitive Edge of ESG-focused CRE
The competitive advantage of sustainable buildings has no doubt led to a rise of efficiency projects and upgrades across the sector. As part of the full service ESG programs that Verdani offers we also help our clients with a wide range of energy audits and engineering services to identify efficiency opportunities with costs and potential savings to help owners improve the efficiency of their buildings. By implementing some simple yet comprehensive projects, property owners can see immediate and significant return on investments.
REIT’s with above-average energy efficiency performance, taken as a group, outperformed below average companies on stock price by nearly 2000 basis points (20%).[2] Below are some key statistics and real cost savings associated with ESG-focused CRE.
ASSET VALUE
Savings through energy efficiency measures, result in increased NOI and increased asset value
For every $10,000 saved through energy efficiency, asset value increases by $153,846 (assuming a 6.5% cap rate)
Increased tenant retention, reduction in lost rents, lower vacancy at turnover
FINANCIAL PERFORMANCE
There is a significant link between portfolio sustainability indicators and REIT stock market performance
REITS with higher GRESB ratings deliver higher returns per unit risk.
REIT’s with higher GRESB ratings deliver higher returns per unit of risk. (Carbon War Room)
REDUCED OPERATING COSTS / NOI [5]
8.5% reduction in operating costs
6.8% increase in building values
9.2% increase in ROI
6.4% increased occupancy
6.2% increase in rent
What the US Can Learn from European and Australian Commercial Real Estate Markets
Europe and Australia are leading the market when it comes to ESG performance, with Australia ranking highest on overall GRESB performance, Europe second, and North America 3rd. When it comes to GRESB coverage for listed firms, 70% of European funds are reporting versus 54% of North America funds.[6]
The British Government is committed to using CSR as an integral part of all annual company accounts and, as of April 2013, has mandated quoted companies to report on their greenhouse gas emissions. The Carbon Reduction Commitment (CRC) Energy Efficiency Scheme is a mandatory carbon trading system designed as both a ‘carrot and stick’ to incentivize large public and 8 private sector organizations, which are responsible for around 10% of total UK greenhouse gas emissions, to reduce their environmental impact.[7] The scheme works in tandem with the existing European Union Emissions Trading Scheme (EU ETS) and climate change agreements. It applies to organizations with one or more half-hourly electrical meter readings over 6,000 MWh in 2008, which includes many large contractors.
At Nareit’s investor conference, the CEO of a new U.S. ESG fund (that had spent over 14 years in Europe) mentioned that regardless of investor priorities, all of them should care about risk management, from board diversity to climate and resilience risks. The panel highlighted that we are indeed at a "tipping point" for the role of ESG in evaluating portfolio performance. And real estate is effectively a gateway to sustainability, because the value of a higher-performing, resource-efficient building is easy to understand for the average owner and investor.
The Benefits of ESG for CRE Investments
Investors, lenders, building owners, asset managers, and tenants all benefit from ESG initiatives. While tenants benefit from lower operating costs, building owners/managers enjoy increased rent, building values, occupancy, and retention. Meanwhile, lenders lessen their risk with reduced default rates and investors improve their ROI.
Bloomberg’s Global ESG Outlook for 2018 indicates that companies focusing on ESG are outperforming the market, so the focus on ESG will continue to increase. We also expect to see more emphasis on renewable energy as countries work toward their Paris Agreement commitments. In addition, greater push for gender diversity will continue to increase backed by policies in many countries.
The market has seen a huge uptake in ESG questionnaires and due diligence from investors and we expect this trend to continue –companies that want to remain competitive should be focusing on things that matter to both building occupants and investors.
Policy and regulation will continue to drive the CRE market to address these issues and increase transparency in these topics. Successful leaders must stay in front of these trends and be proactive about what is important for building occupants. More efficient use of space, increased resilience, focus on diversity and greater health and productivity should matter to all who want to remain competitive and increase their bottom line.
Click on this link to download Verdani's latest ESG Business Case Presentation _____________________________________________________________________
[1] Pogue, David L., et al. “Do Green Buildings Make Dollars & Sense?” Buildingrating.org, Burnham-Moores, CBRE, McGraw Hill Construction. http://buildingrating.org/sites/default/files/DoGreenBuildingsMakeDollarsAndSense2010.pdf
[2] Sims, Taylor. “Creating Value through Sustainability: Take Action on ESG or Be Left Behind.”GRESB, 18 Oct. 2015, gresb.com/creating-value-through-sustainability-take-action-on-esg-or-be-left-behind/.
[3] Fuerst, Franz, The Financial Rewards of Sustainability: A Global Performance Study of Real Estate Investment Trusts (June 16, 2015). Available at SSRN: https://ssrn.com/abstract=2619434 or http://dx.doi.org/10.2139/ssrn.2619434
[4] Brounen, Dirk, and Maarten van der Spek. “Sustainable Insights in Private Equity Performance.” Tilburg University, 8 Nov. 2017, www.tias.edu/docs/default-source/Kennisartikelen/gresb-lessons_db07172017.pdf?Status=Temp&sfvrsn=2.
[5] “Green Trends 2011: Green Trends Driving Growth.” McGraw Hill Construction, 2011, aiacc.org/wp-content/uploads/2011/06/greenoutlook2011.pdf
[6] “2017 GRESB Real Estate Results.” GRESB, 2017, gresb.com/2017-real-estate-results/.
[7] “Carbon Reduction Commitment Energy Efficiency Scheme (CRC Scheme).” Department of Agriculture, Environment and Rural Affairs, 16 May 2017, www.daera-ni.gov.uk/articles/carbon-reduction-commitment-energy-efficiency-scheme-crc.