Historically, commercial real estate assets have been primarily evaluated based on the financial return. Although the return on investment (ROI) remains the most important tool for evaluating a physical asset, the concept of ESG has been pushing its way into the asset evaluation process since the mid-1900s but growing in importance in the last few years.
What is ESG?
ESG stands for:
- Social; and, corporate
Socially-conscious investors use ESG as a framework to screen potential investments. The concept of ESG has begun to transform the evaluation process of assets. It is increasingly more common for organizations to be evaluated by additional parameters such as social and environmental performance. Today both purchasers and lenders are using ESG criteria to screen potential investments, including the underwriting of loans and equity stakes. According to a 2020 survey published by Fitch Ratings, 67 percent of banks are screening their loan portfolios for ESG risks. Companies found with lower ESG standards may be seen as a greater financial risk. The same goes for buildings with low ESG standards. As ESG grows more relevant in the global economy, it is important to evaluate its inclusion in the real estate industry. Below we look at the three factors of ESG in relation to commercial buildings.
In real estate, this is generally seen as the largest of the three ESG pillars. Establishing a portfolio (including existing assets and potential future assets) with environmentally conscious buildings is critical in achieving high ESG performance. Why? According to the U.S. Energy Information Administration, in 2018, buildings accounted for about 40% of the total U.S. energy consumption. Important environmental contributors for buildings include such criteria as;
- Energy and water use;
- Waste generation;
- Indoor air quality (IAQ);
- Renewable energy;
- Resource conservation;
- Greenhouse gas emissions (including carbon footprint)
- Outdoor environmental quality or effects on the local ecosystem, and many more criteria.
“Green” buildings carrying recognized certifications focus on reducing environmental impacts. Several certification programs help to evaluate and guide building owners and developers on their journey to becoming more environmentally conscious. In the U.S., programs that help evaluate a commercial building’s environmental impact include, among others, the EPA’s ENERGY STAR Portfolio Manager, Leadership in Energy and Environmental Design (LEED®), and Green Globes. It is well known that energy “certified” buildings generally have lower operating costs, and perhaps lesser known that those same buildings often boast higher occupancy rates, higher rents, and higher value retention, resulting in higher sales prices.
Buildings can also demonstrate, and in some cases boost environmental /energy performance, by abiding by local energy disclosure & reporting laws, undergoing energy audits & retro-commissioning activities, and following new environmental policies such as those required in New York City’s “Green New Deal”.
Other “E” factors include how a building is positioned to deal with external influences such as climate change and natural disasters. Recent ESG awareness has made real estate investment companies and lenders increasingly more interested in the risks associated with buildings in relation to their susceptibility to flood risks, rising sea levels, coastal flooding, hurricanes, typhoons, tornadoes, earthquakes, etc. Investigating these conditions during the due diligence process helps buyers and lenders evaluate risk and helps owners more effectively manage their assets.
Although not inherently building focused, the social component of ESG is still important to consider within your company, management and building tenants. The “S” component generally focuses on your organization’s culture and issues that directly impact employees, customers, and consumers. Examples of socially responsible issues for which building owners can strategize include:
- Health & safety of building occupants;
- Wellness (such as fitness centers);
- Organization of community events;
- Location and ease of transportation; and,
- Accessibility for handicapped persons.
Organizations and owners can also approach other socially responsible issues such as human working conditions and diversity. Some examples of programs that highlight social importance include;
- Commuter benefits to encourage public transportation or carpooling;
- Financial planning assistance;
- Tuition assistance;
- Health benefit packages;
- Fitness benefits/exercise incentives;
- Retirement planning;
- Pre-employment and annual physical exams;
- Diversity and equal opportunity programs; and,
- Disaster training.
Similarly to the social aspect of ESG, governance is not directly related to real estate; however, it may be equally important. The “G” component generally focuses on the management or ownership organization’s processes, policies, procedures, and influence associated with the organizational environment of the company. Some examples of programs that highlight “G”-factors of ESG include policies on environmental operations or compliance, ethics, corruption, accountability, and transparency.
Other operational practices include training and access to the Foreign Corrupt Practices Act (FCPA), Anti-Corruption Compliance Policies and Codes of Business Conduct and Ethics. Highlighting and improving your company’s governance policies, while also understanding the governance policies of your investments, vendors, and associates, can help to enhance your company’s ESG performance.
How Can VERTEX Help with Your ESG?
As timelines during due diligence are typically short, screening for a building’s environmental impact can be challenging. VERTEX is equipped to produce ESG assessments during this or after this process to help clients screen existing ESG risks and look for positive opportunities to implement improvements. Our services include:
- Building ESG evaluation checklists and reporting
- EPA’s Portfolio Manager input and development of ENERGY STAR® Scores
- Energy Audits/Savings Investigations
- Energy disclosure filing in relation to local laws
- Climate Vulnerability Assessments
- Green Multi-family Assessments – Freddie Mac/Fannie Mae
VERTEX performs these services for a variety of clients in varying stages of real estate ownership and management. As a result, we are adept at tailoring one or many of these services into a dedicated client program to meet specific needs.