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For Commercial Real Estate Owners, Reliable ESG Data is Critical to Long-Term Success

Mill Creek Residential Trust had a challenge on its hands. With hurricanes and tropical storms on the rise, insurance companies were signaling that premiums and deductibles were going up on water damage claims. The Florida-based apartment-rental firm has 20,000 multifamily units operating or in construction across the United States, and another 13,000 in the pipeline, so the decision by the insurance companies was likely to be a substantial and costly increase in risk for Mill Creek and many other property managers operating in parts of the country susceptible to extreme weather.

Not only was Mill Creek facing higher premiums and higher risk of deductibles, it was also concerned with the cost of fixing any damage caused by a leak. The potential cash outlay in a water damage situation had suddenly become much higher than it used to be.

“Insurers were threatening twofold increases in deductibles,” says Jeff Kok, who had recently been asked to lead the company’s sustainability efforts, in addition to his role as Chief Information Officer. “And some were saying they wouldn’t insure you if you didn’t have a leak detection system.”

Kok’s new role meant coming up with sustainability strategies across a range of business functions, including energy management, smart home solutions, water monitoring, air filtering systems, carbon emissions, irrigation, and water damage insurance.

“For water damage, we already had a claim status system across our properties that could generate a report in Excel,” says Kok. “But the information we got out of that system wasn’t enough to help us understand our risk exposure.” So he decided to start looking at leak detection systems.

Kok quickly realized that to manage Mill Creek’s water damage risk in a holistic manner across thousands of properties would be almost impossible without digital, networked leak-detection systems.

“It was really important to get accurate, real-time data so that we could make sense of how everything correlated,” says Kok.

The solution was to put leak detectors on key pieces of infrastructure—irrigation systems, residential plumbing, sprinkler systems—that could turn off the water and stop a leak before it did too much damage.

“If a sensor catches a leak within the first five minutes, it can potentially turn $100,000 of damage into, for instance, $200,” says Kok. “You greatly reduce your risk factor.”

The data retrieved from the system could also be used for other business functions like helping to manage water usage and plan maintenance and repair schedules. And the same concept—using smart-technology sensors to collect data—could also be used to feed energy usage data from air conditioners and other large household appliances, providing more insight into the company’s energy usage.

Kok, who has now been managing Mill Creek’s sustainability program for two years, believes that technology provides real estate companies with new opportunities to move their businesses forward in a way they were never able to in the past.

“Before, you would have to spend a lot of money on a building management system to really drive sustainability. But now, you don’t have to make a big, bulky upfront purchase to have a sustainable asset,” Kok says. “The evolution of smart home technologies like leak detectors is lowering the barrier to entry.”

For Kok and many other real estate professionals who have suddenly had to become experts in sustainability, digital data has become their most valuable tool for not only understanding their new duties, but also fulfilling their responsibilities with stakeholders. Even in a world concerned with economic downturn after COVID-19, experts suggest that attention could shift quickly to the problems created by issues such as climate change, with sustainability factors taking precedence over pure profit. 

Investors need data on demand

ESG (Environmental, Social, Governance) has seen a wave of growth, and companies’ performance in these areas are becoming a predominant factor in determining where investors decide to place capital. The 2020 Insurance Report from Goldman Sachs Asset Management found 70% of insurers used ESG as an investment selection consideration—up from 28% in 2017. Those who said ESG was not a consideration fell from 68% in 2017 to 21% in 2020.

The report also found that investors largely use ESG to mitigate risk in their portfolios. In the June edition of the fund manager’s Fidelity Pulse Survey, 85% of analysts said their companies were willing to sacrifice profits to pursue a more sustainable agenda. Fiona O’Neill, director of global research at Fidelity International, says this has remained true even throughout the COVID-19 pandemic.

“This trend will last longer than the COVID-19 outbreak in some areas,” she says. “A good example of the social consequences of COVID-19 on business is a change in the role of banks, with lenders playing a useful role in distributing government stimulus packages and helping borrowers in times of financial distress.”

On the other hand, real estate companies that can’t produce data on their sustainability progress may find it difficult to attract investors.

Fund managers increasingly prefer hard data for their due diligence. The rationale for these institutional investors, fund manager EQ Investors tells Portfolio Adviser, is that requesting quantifiable data on an organization’s ESG stance provides a more accurate view of the company’s performance.

ESG investment surveys have become commonplace in a world where investors want to understand a real estate company’s sustainability plans before they invest. And if these surveys aren’t answered quickly and accurately, investors are unlikely to invest. 

Nick Wood, a fund expert at Quilter, a UK wealth manager with over £100 billion ($126 billion), says sometimes the survey responses from companies he wants to invest in can be concerning.

“Some are thorough and answer our questions effectively; however, some consistently send incorrect data or seem to answer a different question,” Wood recently told Portfolio Advisor.

Subsequently, many prospective investors are frustrated, believing that real estate companies appear unwilling to share important data points. What puts companies ahead of the curve—and therefore more likely to be attractive to investors—is their use and understanding of ESG data.

Technology is a key differentiator 

Alliant Capital, like many property companies, faces a number of challenges in operating a real estate business. From fundraising to building management, finding tenants and filing regulatory reports, the firm has had a secret weapon since its founding in the late 1990s: A proprietary database which tracks almost everything you can imagine a real estate company would need. Over time, new data tools have emerged for companies that do not own proprietary software to track asset performance. 

“The database was primarily developed to help us track deals,” says Nancy Que, head of operations at the California-based company that specializes in affordable housing. “But as the company grew from a two-man band into the $8 billion dollar company it is today, we learned along that way that the database could also help us track investor data, asset valuations, occupancy rates, outflows, income versus rent, solar and energy tax credits, and anything and everything you can imagine—it’s all now digitized.”

Over time, new data tools have emerged for companies that do not own proprietary software to track asset performance. 

Tracking operating data is critical to running the business sustainably, says Que. “If you’re a real estate company that’s not using technology at this point, you would be lost,” she adds.

Those businesses that are successful at data analytics are not only the savviest operators because they can use their data to inform business decisions, but they also have in their data a key differentiator with investors when it comes time for fundraising, Que observes.

“Some investors might believe the myth that ESG is more expensive, but data helps disprove those arguments and shows investors that businesses can be sustainable and profitable,” she says. “For other investors—like the younger generations—data is critical to their decision-making process. Many millennials simply won’t invest if you can’t show them your sustainability numbers.”

Eddie Lorin, one of Alliant’s founders, says good data is most important for ensuring that the company operates in line with its original mandate—providing affordable housing in a tax-compliant and profitable way.

“We started out as a firm created to utilize the low-income housing tax credits which were first offered in the 1980s,” says Lorin. “The goal was to not just create a lot of units, but to gather enough data to be able to prove that the program worked.”

Real estate companies are natural sustainability data users

While Alliant was an early adopter when it came to digital transformation of their sustainability data, Que says any firm should be thinking about digitizing. Kok agrees. He knows of many examples of people who have tried the old approach to collecting data—outsourcing or using spreadsheets—and have found themselves still recovering from that mistake.

Yet Que says real estate professionals are naturally inclined towards using data—even if they don’t realize it.

Property owners and developers might—in the eyes of some less enlightened observers—seem old school and anachronistic in their approach to business. But the history of the sector in aggregate tells a rather different story. The good business tenets of responsible cost management, preservation of assets over long periods of time, and fostering stable relationships with customers, have always been the hallmarks of good property management. No property manager wants to see excessively rising energy costs due to energy inefficiencies, nor will they use subpar construction materials that will wear out or unnecessarily increase maintenance expenditure in the long term. Building managers want to ensure they keep their tenants happy and satisfied so that they can renew leases and keep occupation rates at a maximum.

To fill all these business needs, real estate managers use business data wisely. They employ accurate financial recordkeeping to monitor profit and loss. They manage their supply chains and building maintenance to create efficiencies. When an ESG approach is seen as another tool to help property managers meet these fundamental business needs, Que says it becomes clear that accurate data which provides actionable information is no less important than traditional financial and accounting data.

Lorin says ESG data helps Alliant track costs and provide an affordable environment where residents want to live—which has translated into turnover rates as low as 20% for some of Alliant’s properties.

Implementing a sustainability policy leads to driving better, more sustainable outcomes for a property business, but it’s not an easy fix. For those serious about following their sustainability mandate—and even for those who have had the ESG mandate thrust upon them—checking a box or collating information the old-fashioned way just doesn’t cut it anymore.

“There’s push and pull,” says Lorin. “There’s a cost to keeping your ESG data accurate, so you need to make sure you use it effectively for the business. Part of the goal is to be able to show that we can deliver our returns. But at the same time, we can use the data to keep costs in line so that we can create a great environment for tenants.”

For data to be useful for decision-making, it needs to be accurate and up to date, says Que. Collating information from, for instance, paper copies of energy bills and sticking them into a spreadsheet, will satisfy neither your own decision-making needs, nor those of your stakeholders, she says.

Property firms face operational risks that data can help mitigate

The real estate sector faces a range of risks which require a data-driven approach to mitigation and management. Private real estate is particularly vulnerable to climate-related events, warns Jay McNamara, head of real estate at MSCI, adding that his company’s research has shown that the potential impact for real estate investors from climate events is far reaching and spans assets and geographies.

“Investors could face increased operational costs including property repairs, higher insurance costs, property devaluation and even the complete loss of property,” says McNamara. “As more global investors are increasing allocations to real estate and other private assets, there is a growing need to identify and understand financial risks from climate change and take necessary action for risk management, portfolio performance optimization and regulatory reporting purposes.”

But for ESG to be used as a way to mitigate risk, accurate data is needed to allow real estate companies to make informed decisions.

In an investment climate where stakeholders are demanding ESG data, collecting sustainability information ad hoc becomes risky. Those who adopt technology to digitize their data will be the best positioned to win, while those who do not will find it increasingly difficult to manage their properties, secure capital, and mitigate risk.

Regulators and investors don’t accept inaccurate financial reporting and it is increasingly becoming the case that stakeholders—regulators, investors, and clients alike—will not settle for inaccurate non-financial reporting. Accurate data means digital data, and without it, real estate companies will find themselves lacking capital and clients, says Mill Creek’s Kok.

“We’re almost at the point where investors will consider ESG data on par with financial data,” he says.

The lesson, he says, is that sustainability issues can no longer be ignored in the real estate sector. And those who have a handle on their digital data are best positioned to succeed in the long term.