By Michael G. McGuinness
What is ESG — or environmental, social and governance? It is basically a framework to assess how a commercial real estate portfolio manages risks and opportunities resulting from shifting conditions, market and otherwise, to environmental, social and economic systems. Environmental criteria address a company’s impact on and stewardship of the environment. Social criteria refer to how a company manages relationships with and creates value for stakeholders, such as customers, employees, suppliers, communities and shareholders. Governance criteria refer to a company’s leadership and management philosophy, practices, policies, internal controls and shareholder rights, including diversity, equity and inclusion and transparency of procedures and decision-making.
Although this concept has been around for a number of years, the appetite for tracking and prioritizing ESG factors has recently exploded, due to the convergence of worldwide events. Topping the list was the global COVID-19 pandemic, which revealed poor resiliency in our health and social systems and highlighted growing socioeconomic inequality and longstanding social justice issues. 2020 and 2021 were record-breaking years for climate-related floods, storms, heat waves and wildfires. With climate change impacts only expected to worsen, there is stiff pressure for world leaders to move to a carbon-free future. Most investors and many companies are now taking a very long-term look into the next couple of decades to reinvent their business paradigms to account for these changes. ESG has become a strategic imperative for CRE portfolios to create and sustain long-term value.
All organizations need to embrace ESG now for a host of reasons, and because it is the right thing to do. Companies that adopt and invest in ESG strategies benefit from improved corporate reputation and culture, enhanced risk reduction and opportunity management and increased intrinsic value. Commercial real estate firms with sophisticated ESG strategies can increase asset value, lower operating costs and unlock sustainable financing opportunities. The data collection and reporting practices foundational to any ESG effort make it easier to comply with local, regional, national and sector-specific disclosure requirements.
Investors are embedding ESG considerations into every stage of the property lifecycle, from due diligence to acquisitions, and from leasing to asset management. Compliance with ESG goals and strategies is becoming increasingly necessary in order to protect and even enhance ROI, because of demand from prospective buyers and tenants. For example, U.S. office rents for LEED-certified office buildings are 5.6 percent higher than those without such certification. According to CBRE Chief Responsibility Officer Tim Dismond, “ESG considerations are increasingly influencing how and where capital is being placed and how businesses are being operated.”
With a better understanding of the definition, origin and importance of ESG, property owners should develop an ESG strategy that is right for their portfolio. There is no uniform approach to determining which ESG issues are most important to the long-term success of your assets and most important to stakeholders. To get a better handle on your top priorities, you should first conduct a materiality assessment to identify which issue — environmental, social or governance — is of top importance to both your stakeholders and the success of your business. Once you establish your top priorities, you should then perform a risk assessment of the physical, social and transition risks to your portfolio, including existing assets, new acquisitions and loan originations. Included here would be: how to reduce disruption to building operations in the case of extreme weather events or long-term shifts in climate patterns; how to reduce exposure to risks associated with changing consumer preferences, technologies, energy sources and costs and enhanced energy and emissions reduction and reporting laws; and habitability and livability of properties resulting from poor air quality, natural resource scarcity, contamination potential, health codes, emergency response plans and occupant and community needs.
Granted, this all sounds overwhelming, but it’s best to get ahead of the ESG wave by pricing out the cost of compliance with ESG standards and adopting those that make the strongest ROI case to attract tenants and potential buyers. A good place to start is benchmarking energy and water usage, recycling and waste management. Invesco’s Scott Dennis explains, “Investors are more interested in ongoing measurement of the asset’s environmental impact, not a point-in-time certification award in the form of a plaque.” Many institutional investors are aiming for their assets to achieve zero-carbon by 2035. In fact, the New Jersey Board of Public Utilities (BPU) is rolling out a program in spring 2023 that will require certain buildings to start benchmarking their energy and water usage by submitting data for the prior year (2022). Objective data is the key to changing the institutional investor mindset of where and what to buy, and will be required for a paradigm shift in ESG compliance in commercial real estate.
ESG is quickly shaping commercial real estate strategies for the foreseeable future. As the focus on ESG strengthens, technology will play a key role in creating significant and long-lasting change within investors’ practices and portfolios by enhancing the collection and reporting of ESG data. These technologies include data management platforms to store and process ESG data, monitoring platforms to streamline ESG review and delivery processes, and PropTech-based platforms to enhance the tenant experience.
There is much more to ESG than is covered in this article. I encourage you to learn more by attending NAIOP New Jersey’s Annual Meeting & CRE Outlook Zoom webinar at 4 p.m. on Jan. 26. NAIOP Chairman Jeff Milanaik, of Bridge Industrial, will lead a stimulating conversation about ESG with experts from the consultant and investment sectors.
(Note: Much of the information in this article is attributable to: A Guide to ESG for Commercial Real Estate | Aquicore; The Case for ESG Adoption|CBRE and ESG and Real Estate: The Top 10 Things Investors Need to Know | CBRE.)
Michael McGuinness is CEO of NAIOP New Jersey and has led the commercial real estate development association since 1997. NAIOP represents developers, owners, asset managers and investors of commercial, industrial and mixed-use properties, with 830 members in New Jersey and over 19,000 members throughout North America.