From a small northwestern observatory…

ESG is an acronym for “Environment, Social, and Governance.” It is the current buzz-word in the industry for what was formerly called “green building”, although as you can tell from the title, it is so much more than that.

The US Green Building Council was formed in 1993 to “promote sustainability in the building and construction industry”. While it is active in many areas of real estate, it is perhaps best known for the LEED building certification. For quite a few years, the National Association of Real Estate Investment Trusts (NAREIT) awarded the “Leader in the Light Awards” to honor REITs that “demonstrated superior and sustained energy practices.” Back in 2015, I conducted a study about these awards and presented a paper at the annual meetings of the American Real Estate Society investigating whether or not there was any stock price bump (or other meaningful market reaction) associated with such an award. While I couldn’t find any statistically significant market reaction to the award itself, there was anecdotal evidence to suggest that such “green” behaviors were already capitalized in the stock price and the return generating process.

In recent years, the focus has shifted away from just “green” issues toward broader themes, including all of the ESG topics. Both large and small consulting firms (including Greenfield) are engaged in some or all of the ESG issues, including such key elements as dealing with catastrophic events, setting corporate goals for community development, and establishing adequate data protection.

Real estate firms of all stripes are increasingly considering ESG in their business models. There are enormous direct benefits up and down the real estate ladder. Local governments are now looking policies, commitments, and goals in some or all ESG areas as a precursor for permitting. ESG is a significant marketing tool, and customers are reacting positively to the ESG message. For example, Blackrock’s CEO, Larry Fink, announced at last year’s Morningstar Investment Conference that they planned to integrate ESG metrics into all of their portfolio by the end of 2020. This year, NAREIT reported that 98 of the top 100 REITs reported publicly on their ESG efforts.

By some reports, climate change has been a primary driver of ESG attention. Energy usage at the property level can be immediately reported and analyzed for potential cost savings. Noting that the incidence of climate events causing $1 Billion or more in property damage have quadrupled in recent years, it comes as no surprise that this has nearly everyone’s attention. Recent back-to-back environmental disasters in Texas have been cited as particularly concerning to investors.

S&G — social and governance — have worked their way into investment underwriting, and despite a surplus of liquidity in the market, investors want to know that S&G issues are being meaningfully addressed. This is particularly acute with public funds and public securities holdings. The Pension Real Estate Association (PREA) has instituted annual ESG Awards “[T]o recognize excellence in ESG programs within institutional investors in real estate.”

Many say that the pandemic has catalyzed ESG policy adoption, although the trend was clearly strong before the COVID outbreak. Nonetheless, it is now almost universally recognized that the ESG momentum will continue to grow. This doesn’t mean that universal adoption is imminent. Some firms still stand on the sidelines waiting for the metrics to come in — capital flows and returns being key touchstones. Transparency and benchmarking will be key elements to further adoption down the road.

As usual, if we can answer any questions on this topic, please do not hesitate to reach out.

John A. Kilpatrick, Ph.D., MAI — john@greenfieldadvisors.com