What is your environmental, social, and governance (ESG) strategy?
Leaders of real estate investment firms should not be surprised to hear this question from investors. ESG strategy is a hot topic right now for a good reason. Direct carbon emissions from buildings represents roughly nine percent of overall greenhouse gas emissions in the United States, the fourth highest category after power generation, transportation, and industry. These emissions generally come from space heating and cooling, water heating, cooking, appliances, electronics, and lighting. The high emissions profile of real estate assets, paired with an increase in portfolio management focused on emissions and other ESG factors, drive more real estate investment trust (REIT) managers to control the narrative.
Globally, investments in sustainable assets grew 55 percent from $22.8T in 2016 to $35.3T in 2020.  With so much capital pouring into investment products with a sustainability bent, it is important for managers across the commercial real estate asset class to articulate their ESG strategy so they can access this growing source of capital. ESG was once just a footnote in private placement memorandums and 10Ks, but now has become a central tenet of investor reporting and capital raising. In 2021, a well-defined ESG strategy has gone from table stakes in investor conversations to a differentiator when large advisors are comparing investment strategies with similar risk-adjusted returns.
There are numerous frameworks or platforms that a firm can leverage to improve the overall ESG profile of its building stock. Below are some of the best resources to use when beginning on the journey of ESG strategy formation and disclosure.
There are two factors to consider in the environmental topic area. The first is management of consumption. If you are just getting started with environmental measurement, tackling the areas of energy, water, and waste will have the most impact. In the United States, ENERGY STAR offers resources for builders and owners of both residential and commercial properties. REIT managers can take advantage of a network of ENERGY STAR certified providers who can complete building assessments, provide benchmark data, and recommend projects to reduce the overall consumption of energy.  While some improvements, such as HVAC replacement, may require significant capital expenditures upfront, others can be planned and phased in over the course of the asset hold period. Earning ENERGY STAR certification goes a long way toward communicating to investors your commitment to reducing a building portfolio’s environmental impact. Additionally, operating expense reductions will flow directly from energy savings projects. Without the well-planned processes, procedures, and controls necessary to capture consumption metrics, and the supporting IT solutions required to capture them, firms will struggle to realize and mitigate their own foot print.
The second consideration is climate risk. Depending on the geographic location of buildings in the portfolio, long-term shifts in weather patterns caused by a changing climate may result in material financial risk. REITs that are operating assets in coastal and flood-prone regions will likely experience an increase in damages and insurance claims due to more powerful storms over the ensuing decades as the planet continues to warm. Similarly, years-long droughts in the southwestern United States are increasing the probability of damage due to wildfires, as well as driving concerns around water availability. For example, Arizona is about to implement Tier 1 cuts affecting eight percent of its overall water supply, after prolonged drought conditions reduced reservoir levels at Lake Mead below a critical threshold in June 2021.  To understand the best way to articulate climate risks to investors, refer to guidance from the Task Force on Climate-Related Financial Disclosures (TCFD).  The risks associated with acute and chronic shifts in climate patterns, as well as opportunities associated with new technology, a changing policy landscape, shifts in market demands for services, and perceptions of an organization based on contribution or detraction from the transition to a lower-carbon economy, should be laid out so investors can understand how they are being considered in a company’s strategy. Drafting statements to articulate climate risk and opportunities related to a firm’s operations must be a primary step in creating an ESG strategy and growth plans.
All organizations should have a strategy for managing and disclosing basic information about their workers and communities they affect. Typical human resources items, such as full-time and part-time employee mix, retirement plan availability, healthcare, benefits availability, and workforce diversity, should be benchmarked against peers and articulated in annual disclosures.
Firms operating in the real estate sector must go a step further, because the product that is being sold or managed—physical space—has been shown to have an impact on both physical and mental health. To learn more about these effects, consider leveraging guidance from the International WELL Building Institute (IWBI). It has created guidance and a standard roadmap for creating and certifying spaces that advance human health and well-being. The WELL building standard covers 10 core concept areas, including air, light, movement, thermal comfort, sound, mind, community, materials, nourishment, and water.
Another standard with more brand recognition is the U.S. Green Building Council LEED standard. Companies operating LEED-certified buildings have demonstrated increased recruitment and retention rates, increased employee productivity, healthier spaces with cleaner air that’s free from harmful chemicals, and reduced pollution from smog that is normally produced by less-efficient buildings. As the market leader in green building rating systems, LEED provides standards for the entire range of real estate projects, ranging from new construction to retrofits, residential to commercial. MorganFranklin recommends leaders assess the full spectrum of frameworks, consider the position of their firm in the market, and pursue a certification that aligns with the expectations of their customers, investors, and employees.
Providing adequate governance disclosure to investors has become a table stakes requirement for major U.S. hedge and pension funds. A REIT should disclose basic information, including corporate oversight procedures, company code of ethics, anti-corruption policy, financial controls, and annual independent audit process. Additional governance items recommended by TCFD include both a description of the board’s oversight of climate-related risks and opportunities and a description of management’s role in assessing and managing climate-related risks and opportunities.
Firms that under-invest in adequate staffing and governance structures will put themselves in an uncompetitive position relative to their peers. MorganFranklin recommends having specially trained leaders within the organization to support stakeholder engagement, employee surveys, and focus sessions that will help align and inform an organization’s ESG guiding principles and strategy. As a leading practice, the same ESG group and leaders in a well-governed program will help stakeholders create and automate processes for the collection and analysis of this data for subsequent internal and external reports.
For more robust and industry-specific recommendations, review the 2021 Real Estate Assessment from GRESB. Based in the Netherlands, GRESB delivers global ESG benchmarks to financial markets for the real estate industry. GRESB data is leveraged by firms, such as Sustainalytics and MSCI to determine ESG ratings, so completing a GRESB assessment is a great way to affect ratings from these organizations.
For those looking to use sustainability as a competitive advantage, leveraging the standards listed above can help to deliver operating cost reduction while improving the marketability of physical assets. But not everyone has the resources to pour into certifications.
If the goal is to simply track and report on the information most important to investors, consider starting with guidance from The Value Reporting Foundation, which has defined seventy-seven different industry-specific standards for ESG metrics material to enterprise value creation. The standards address sustainability-related risks and opportunities that are likely to affect an organization’s financial condition (i.e., its balance sheet), operating performance (i.e., its income statement), or risk profile (i.e., its market valuation and cost of capital). For real estate firms, SASB specifies 14 accounting metrics across energy management, water management, tenant sustainability impacts, and climate change adaptation topic areas. The metrics are easily digestible for firms looking to understand what they absolutely must track for investors. It is a great jumping off point to get the ball rolling before doing the more detailed work of determining how to integrate this thinking into a firm’s strategic plan.
MorganFranklin helps clients deliver value to their ESG programs by doing the following:
- Drafting statements to facilitate buy-in toward long-range goals (e.g., carbon neutrality) and managing projects to deliver on those goals.
- Supporting stakeholder engagement, employee survey, and focus sessions to align and inform an organization’s ESG guiding principle and strategy.
- Defining the processes, procedures, and controls necessary to capture ESG data and implementing IT solutions to automate these processes.
- Partnering with stakeholders to create and automate processes for the collection and analysis of this data for subsequent internal and external reports.
- Shaping external messaging by walking the stakeholders through the data collection and analysis necessary for publishing an annual sustainability report.
Reach out today and let’s get a conversation started.
- Decarbonizing U.S. Buildings. Center For Climate and Energy Solutions. July 2018. https://www.c2es.org/document/decarbonizing-u-s-buildings/
- Global Sustainable Investment Review 2020. Global Sustainable Investment Alliance. http://www.gsi-alliance.org/wp-content/uploads/2021/08/GSIR-20201.pdf
- ENERGY STAR. https://www.energystar.gov/buildings/save_energy_commercial_buildings/ways_save/water_waste_and_renewable_energy
- Arizona says it’s prepared to lose a fifth of its Colorado River water share. KTLA. https://ktla.com/news/nationworld/arizona-says-its-prepared-to-lose-a-fifth-of-its-colorado-river-water-share/
- Recommendations of the Task Force on Climate-related Financial Disclosures. https://assets.bbhub.io/company/sites/60/2020/10/FINAL-2017-TCFD-Report-11052018.pdf