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Investors Eye ESG in Commercial Real Estate

Updated: Mar 21, 2022

When did businesses transition from ‘green’ or ‘sustainable’ to fully fledged Environmental, Social and Governance (ESG) policies? It was so inconspicuous it was hardly noticed after decades of talk about going green with what seemed like very little progress. It’s certainly very difficult to put a finger on a single trigger for the acceleration of ESG, but an increasing number of businesses, including those in the commercial real estate industry now seem to be actively pursuing and promoting a high ESG performance instead of cherry-picking the elements that impact them the most.

ESG in Commercial Real Estate

There are three main pillars of criteria that investors will unpick as part of the due diligence process and a high ESG score on all areas will attract the socially-conscious investor. The criteria covers how well the investment performs in relation to action on sustainability, how it manages relationships with employees, clients and customers and how the organization is governed with respect to risk management, legal compliance and cyber security.

Prior to COVID-19, sustainability was a growing factor in real estate investment decisions, however with much of the risk in real estate hinging on physical location, managing the geographical risks of a given site and reducing tangible energy consumption were often prioritized over ESG improvements in other areas.

As some asset classes took a downturn at the start of the pandemic, assets meeting ESG criteria outpaced the broader market according to a report from S&P Global earlier this year and this invoked a renewed interest from investors in examining the longer-term benefits of ESG investing as a way to future-proof portfolios. Additionally, COVID accentuated many aspects of ESG performance so that they were no longer trivial aspects of policy - equity and inclusion, health and safety of employees and cybersecurity quickly became top of agenda, demanding the undivided attention of building owners and operators.

What’s Driving Increased ESG Real Estate Investment?

  • Economic Uncertainty and Risk

One of the primary reasons for investors to prioritize sustainability is to mitigate risk in their portfolio. Having access to data that allows investors to successfully identify and manage risk is vital to making informed decisions, particularly as climate change events worsen and more and more assets are exposed to climate liabilities. As of 2018, it was estimated that 35% of REIT’S properties are exposed to climate change; If it’s not a catastrophic climate event or another round of a pandemic, it will be another unprecedented crisis and acknowledging this uncertainty is the first step to acknowledging the need for an ESG focus to every investment.

  • Increased Governance & Legal Compliance

Governments around the world are constantly adding to regulatory policy and reporting on ESG performance is going to become mandatory sooner rather than later. For those already ahead of the curve and incorporating ESG into their investment strategy, this won’t come as a surprise. The move away from fossil fuels to renewable energy sources is here to stay and building a strategy around this while embracing technology trends offers double the return as investors ride the wave of industry automation and benefit from a more resilient long-term portfolio. As regulatory fines and penalties are likely to increase for non-compliance, a proactive approach is required by property owners who want to avoid unnecessary costs and future price rises resulting from a poor location choice or a substandard building.

  • Younger Generations Influencing Family

Younger generations of a family feel the threat of climate change more than others and are influencing the non-financial goals of high-net worth parents or family office managers. Millennials are leading the charge in socially responsible investing (SRI) with 31% saying they usually or always consider ESG factors in their investments which is more than double that of the baby boomers. For these investors how they get to profit is more important than the profit itself and as their influence increases and they take over family offices, ESG will define investment.

What are the Benefits to ESG investing?

Historically, there’s been a view that investing in high ESG assets would be at the detriment of profits but that argument no longer holds true. Companies that integrate ESG issues into everyday operations or implement policies from the outset on a new-build can enhance profits through short-term reductions in costs and sustained long-term growth through the mitigation of risk and increased opportunities for revenue generation compared to others. Tenants are becoming more and more sophisticated, seeking energy-efficient, green certified buildings and investors able to attract this type of occupier will ultimately benefit from higher property values, less turnover and better returns.

For those businesses that take the time to identify and rectify ESG challenges, gaining energy-efficient certifications along the way, property valuations will undoubtedly be higher as buyers are less likely to negotiate on the basis of inadequate energy performance or doubts around future income performance.

Where to Start Making ESG improvements

Not all pillars of environmental, social and governance policy will apply to all assets in a portfolio, however an investor-driven global benchmark system such as GRESB provides a good starting point for real estate investors keen to identify areas of improvement and put a plan in place to address them. The program uses a common set of methodology across regions and property types to assess assets based upon their management, performance and development. Going through this process provides a clear view of ESG performance against competitors and generates a list of areas with scope for additional impact, opportunity and risk mitigation.

Armed with a coherent understanding of position in the market and dependent on business goals and needs, efforts can then be focused on attaining more specific certifications around energy and water usage, health and wellness, design and community impact. Although it’s impossible to list all of the international and national certifications now available, some of the more common designations aspired to are;

  • LEED - ‘Leadership in Energy and Environmental Design’ is a globally recognized green building certification involving five different rating systems;

  • Energy Star - demonstrates commitment to achieving reductions in energy usage and greenhouse gas emissions;

  • Fitwel - concerned with the design and operation of new and existing buildings with regards to how they improve health and wellness for occupiers.

Making a Positive Impact

It’s true that no business can be built on a dead planet and perhaps the most rewarding thing for an investor will be contributing to change on the real issues affecting the world we live in; there can’t be many things more gratifying than addressing homelessness and providing affordable senior living facilities while at the same time reducing our impact on the environment.

If you need assistance aligning your next investment in the GTA or Waterloo region with your environmental, social and governance goals, reach out to our experienced team.

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