Real estate websites have been abuzz about ESG. The abbreviation means “Environmental,” “Social,” and “Governance.” Though you can find the principles of ESG in virtually any asset class, it is playing an increasingly prominent role in the real estate market. ESG affect real estate in numerous ways and presents several opportunities for businesses looking for an edge over their competitors.
People’s awareness of the effects of climate change, corporate responsibility, and the need for good governance has increased significantly. Therefore, many investors realize how ESG affects real estate.
How Does ESG Affect Real Estate?
The principles of ESG affect real estate in several ways. By implementing these factors, operating costs are reduced, companies are able to grow faster, legal interventions are reduced, productivity is improved, and asset values are optimized.
Origin of the ESG Agenda
The concept of ESG has existed since the 1960s. It attained formal recognition when CEOs entered the UN Global Compact in 2000. The 2000 Global Compact was initially known as Socially Responsible Investing.
The ESG agenda gained global impetus during the Great Recession in 2007-08 as companies realized the importance of responsible investment and sustainable development.
ESG reporting is increasing, driven by government regulations and the expectation for environmentally conscious companies to prove their efforts towards a greener future. Real estate companies are also motivated by the expectation of increased returns.
Elements of ESG in the Real Estate Context
The following is a breakdown of every element of ESG in real estate.
The environmental component of ESG relates to matters like climate change, pollution, waste, recycling, and the use of natural resources. Traditionally, companies’ involvement in environmental protection revolved around the construction of environmentally friendly buildings. However, it is evolving to include the following.
- Reporting about the actual energy consumption of buildings and how efficiently they use energy.
- Accurate measurement of the total carbon emitted when constructing new commercial buildings.
- An evaluation of the climate resilience of buildings and property portfolios of real estate developers.
The social limb deals with human resources and social opportunities. It focuses on a building’s effect on society, for instance, the health of employees, tenants, and the local community. The social limb of ESG originates from previous Corporate Social Responsibility (CSR) efforts.
Corporate social responsibility efforts started in the 1960s. They were loosely defined and were often misused to improve companies’ reputations without passing tangible benefits to the local communities.
Today, however, there is more synergy between modern real estate companies and the social value initiative that has been gaining traction.
It relates to the leadership structure of a company, compliance with laws, diversity of staff and employee retention, corporate culture, and reputation. The governance limb of ESG affects real estate developers, tenants, and management companies.
The social and political upheavals caused by the Covid-19 pandemic have also aggravated concerns about diversity in the real estate industry.
Implications of ESG in the Real Estate Industry
ESG affects the real estate sector in several ways, as explained below…
1 | Attracting Investment
ESG is becoming an increasingly prominent topic for companies and a primary criterion for new investments. The increase in the number and severity of weather events is driving companies to assess the vulnerability of their properties and proactively manage their risk profiles.
ESG affects real estate valuation and is gaining prominence among providers of capital. A business’ ESG policy can also improve its attractiveness to potential investors because they seek forward-looking companies with sustainable business practices.
2 | Energy Saving/ Net-Zero Emissions
Real estate companies are increasingly focusing on sustainable building practices, the use of renewable energy, and developing net-zero emission initiatives. The endeavor for real estate developers involves finding the ideal locations for building commercial buildings. They also use weather and climate prediction trends and building properties with the lowest emissions. They are offsetting emissions by reducing waste and using renewable energy alternatives. Although the initial building cost is higher than traditional methods, owners recover it after tenants move into the property. The lower operating costs of greener buildings also help recoup the initial investment.
There is an increasing trend for landlords to enter ‘Green Leases’ with their tenants to meet environmental objectives. These green leases are ideal tools for investors to monitor how their real estate assets are doing. The metrics used to monitor green leases include electricity use per occupant/employee, water consumption in the building, and waste going into landfills compared to total waste produced.
Although it is not challenging to move towards zero emissions in office and commercial properties, retail tenants cannot readily reduce their power consumption. Retail tenants use intensive lighting for their product displays and have few viable alternatives.
3 | The Green Rental Premium is Increasing Compared to the Brown Rental Discount
One of the prominent ways ESG affect real estate is by increasing the income from environmentally performing buildings. In the U.S., LEED-certified office buildings command rental revenues 5.6% higher than non-certified buildings. The green premium is higher for LEED platinum-certified commercial buildings.
The implications of green buildings are clear for developers–people pay higher rent for them while the monthly operational expenses are lower than traditional buildings. In the U.S., for example, buildings with Energy Star certification use less than 35% of the energy used by uncertified ones.
In the United Kingdom, the building with the highest Building Research Establishment (BRE) Environmental Assessment Method (BREEAM) certification is the Bloomberg London Building. It consumes up to 73% less water and has 35% lower energy consumption than similar buildings that are not certified.
ESG affect real estate development even for buildings that don’t have sustainable designs. Traditional buildings can be modified to become greener. Designers of the Keppel Bay Tower in Singapore used conventional building techniques to create an ordinary and inefficient skyscraper. However, after a 2020 modification to improve its energy consumption, its energy bill reduced to half of what a similar tower would consume.
4 | The Availability and Viability of Green Building Materials is Increasing
The manufacture of concrete and steel accounts for almost ten percent of the construction industry’s carbon emissions. ESG affect real estate by encouraging investors to find alternative materials friendlier to the environment. Real estate developers often look for alternative materials that lower the carbon footprint of constructing industrial buildings.
One of the materials used to replace concrete and steel in construction is timber. Chemically treated wood is sufficiently fire-resistant and is also earthquake-resistant. Building with wood can be cheaper than using conventional materials. It can also reduce construction time because wood structures are ideal for pre-fabrication.
The only limitation for building with timber is the international building code requirement that prevents people from constructing buildings taller than 85 feet. The negative ways ESG affect real estate development using wood will gradually reduce as building technologies mature.
Advantages of ESG
Companies can reap substantial benefits from implementing tight ESG policies. These advantages include:
- Top-line Growth: Companies with strong ESG policies have an easier time tapping into new markets and expanding into existing ones. The growth comes from people’s trust in companies motivated by sustainability.
- Cost reductions: As mentioned earlier, environmentally-friendly design and construction can substantially lower the operational cost of industrial buildings.
- Reduced Legal and Regulatory Interventions: ESG affect real estate developers by easing regulatory pressures. Companies with robust ESG policies are at lower risk of adverse governmental interventions.
- Enhanced Employee Productivity: Companies with strong ESG propositions can attract and retain higher quality employees. These companies instill a sense of purpose in their employees and motivate them, leading to higher productivity. The high motivation of employees translates to higher returns for investors.
- Investment and Asset Optimization: Robust ESG policies can improve a company’s returns by directing money to promising opportunities such as sustainable buildings.
Drawbacks of ESG
The following are seven ways ESG affect real estate negatively.
- It is not easy to quantify all factors of ESG. Additionally, the immeasurable factors may not translate directly into earnings for a company.
- The current ESG disclosures are heavily skewed towards procedures and processes rather than performance. Most ESG considerations determine if a company has a relevant policy in place. It doesn’t measure the commitment toward the policy or its level of success.
- It is challenging to apply the same factors to different industries and geographical locations and get consistent results.
- Different regions have challenges that affect the quality of data you can collect.
- Information about a company’s ESG policy is disclosure-based and not easy to verify. Current ESG data is an accounting extension, and companies can misreport it.
- Companies use different methodologies to calculate their ESG performance. There is little agreement across industries on how to measure ESG.
- ESG analysis is mostly backward-looking and might be unable to capture anticipated change.
What Opportunities Does ESG Offer Investors?
One of the prominent opportunities of ESG for investors is enhancing efficiency and cost savings. ESG promotes higher efficiency that reduces a company’s costs. ESG reporting platforms also help companies identify wasteful areas and address inefficiencies.
ESG helps companies to manage risk because it is based on proactiveness. Businesses that leverage ESG policies during tough times like the Covid-19 pandemic now have robust structures to mitigate future risk.
Thanks to enhanced awareness about climate change, companies in the real estate industry realize the importance of implementing ESG policies. They have discovered how ESG affect real estate earnings by reducing the operational costs of commercial buildings. Consequently, real estate companies are joining the green revolution and implementing ESG policies because of their long-term benefits to their businesses.
If you want to learn more about sustainability, PropTech, smart buildings, and smart cities, feel free to take a look at our other articles.