The following post is part one of a two-part blog series.
The last two decades have taught us that when it comes to buildings, green is a color, not a performance measurement. While the historical green movement was laudable for its ambition and catalyzing new ways of thinking, particularly in real estate, it lacked the capacity to generate objective, transactable comparisons of sustainability performance between one building and another, let alone whole portfolios of real estate.
Is a LEED “Platinum” building the same as a BREEAM “Outstanding” designation, and do either of them tell us the financial implications of that asset’s exposure to physical climate hazards? What does a GRESB 5 Star rating tell us about a given real estate portfolio’s compliance (or lack thereof) with local and national regulation? The real-world gap between green designations or certifications and the financial realities of real estate investment and operations demonstrates the market acknowledgement: there is no such thing as a “green” or “not green” building.
Instead, every building simply exists on a spectrum from less to more sustainable, and there are no certifications required to exist on that spectrum. It needs observable and comparable KPIs and metrics. It’s the same reason we look at lease rates or tenant improvement “TI” allowances to determine the overall cost structure of a lease as opposed to looking for these metrics to be rolled into some sort of overall “leasing” score.
ESG (environmental, social, governance), is a radical departure from green. ESG takes a precise, discrete and measurable approach to sustainability. In doing so, it liberates buildings and real estate transactions from subjective definitions of “green,” placing them instead on an observable spectrum as dictated by their inherent and objective measured performance. This transition from green to ESG has profound implications for the real estate industry.
In today’s post, we examine two of the five reasons this new approach will succeed:
The Efficient Markets Hypothesis states that asset values reflect all available information. The real estate industry has always lacked good information. In fact, it was the siloing of information that created the need for real estate service providers to help navigate opaque markets. The same is true for sustainability in real estate. Green was an opaque measure of sustainability. Its subjective nature gave rise to whole cottage industries of advisors and certifiers who could help us navigate the mysteries of what it meant to be green, and could deliver scores and certificates that were as much about our ability to navigate the “test” as the intrinsic sustainability performance of the underlying asset. ESG today is an altogether different proposition. New technologies make it possible to acquire, interpret and apply ESG data. Propelled by sophisticated investors who demand insight into the genuine risks and rewards of real estate investing, ESG represents an evolution in the business’s ability to capture and apply new information. The result is more efficient markets that take into account newly captured data: ESG metrics.
ESG indicators are just as important as financial data and provide investors with an edge over the competition. When combined with financials, ESG information paints the complete picture of an investment’s performance and potential. According to research by the Harvard Business Review, the majority of ESG funds outperform the wider market over a 10-year period. As a result, institutional investors place a premium on securities and funds that can prove their ESG credentials.
Previously, with opaque and unreliable data, no tools existed to compare buildings to each other on any green scale. Now, standardized ESG data can be compared from building to building (or investment to investment) so that owners know where they stand and investors can make informed decisions. While there is no singular standard to benchmark ESG performance (at least, not yet), there are established frameworks that can help. Two common disclosure frameworks in real estate are GRESB and CDP.
Accurate, timely and accessible ESG metrics can pinpoint specific information about a building and guide tactical and strategic decisions to reduce operating expenses and increase profitability. For example, ESG data may be utilized by onsite teams to lower utility costs and improve indoor air quality. Granular data can also provide clear guidance to allocate capital expenditures for retrofits, optimize onsite distributed energy resources (DERs), inform low-carbon energy procurement opportunities and more.
It’s no surprise that research from McKinsey found that ESG can substantially increase real estate value by facilitating top line growth, reducing costs, minimizing legal and regulatory interventions, improving employee productivity and optimizing investment in capital expenditures.
2. The Market Demands ESG Disclosure
ESG pressures are widespread, with a reported 85% of investors considering ESG factors in investments, according to Gartner research. Investors are placing importance on ESG now more than ever when making decisions. Consequently, investments with more favorable ESG performance are considered safer and less risky.
Access to capital is paramount, and investors are using ESG data to guide decisions. Investment in ESG funds is trending across the globe. Sustainable finance, which includes green bonds and sustainability-linked bonds and loans, is becoming a dominant force. According to figures from the Environmental Finance Bond Database, total green, social, sustainability and sustainability-linked (GSSS) bond issuance crossed $600 billion in 2020 – nearly double the previous year.
Please check back next week to read part two of our series, The Top 5 Reasons ESG will Succeed Where the Green Movement Fell Short. We’ll examine the role of regulation, societal influence and technology in the evolution of ESG. In the meantime, you can learn more in my new book, From Green to ESG: How Data-Driven Transparency Changed Real Estate for Good.