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What ESG Means for Real Estate Investors

Real estate investors face dual imperatives: to produce returns and to advance the low-carbon transition.

ESG factors have become increasingly important in the real estate industry, affecting every stage in a property’s lifecycle from financing to permitting, construction to leasing, and sale to demolition. Every stakeholder including investors, governments, tenants, and service providers now weigh ESG in their decision-making process. Over the last few years, this has spurred significant investment into data collection, aggregation and reporting systems, with a goal of being able to catalog and report on a variety of metrics at the tenant, building, and portfolio levels including emissions, energy use, building conditioning, and community engagement. Businesses across the board have become adept at reporting, with compliance teams well versed in the various requirements of the alphabet soup of voluntary and mandatory reporting standards.

ESG is about action, transformation, and capital investment

However, there’s been a significant shift in how ESG is perceived broadly. A mix of disappointment in unfulfilled pledges and unmaterialized returns has prompted a deeper look at what it actually means to be ESG compliant and if it’s even worth striving for. This initial confusion which allowed everyone to define ESG for themselves is very quickly being replaced by a consensus understanding that materiality is key. ESG is not merely about checking some box and filing a dozen variations of the same report. Compliance regimes are becoming stronger by the day, but these are a means of verification, not the end-goal. Instead, ESG is rapidly becoming the measure by which stakeholders will rate, prioritize, and direct capital into comprehensive real-world transformation to unlock superior ROI throughout their entire value chain.

A few key trends have driven this shift:

  1. A growing body of corporate net-zero pledges. Today, over 91% of global GDP is covered by a new zero pledge or mandate. These mandates flow through supply chains and involve every facet of a company’s operation. Real estate construction and operations are together responsible for about one third of all greenhouse gas emissions and 40% of global energy use. Addressing these emissions is a core part of every company’s net zero trajectory.
  2. A renewed focus on ROI. We’ve exited the zero-interest rate period as quickly as we entered it. We’re now in the period of economic uncertainty that sparked concerns about the long-term viability of ESG. The financial underperformance of many businesses threatens their ability to meet their 2023 ESG goals as a renewed sense of investment discipline places unvalidated targets on the back burner. Investments that reduce costs while bringing assets closer to ESG goals which drive revenue and cost of capital are key to addressing business needs with a long-term lens. 
  3. A changing regulatory and incentive environment. As companies make ESG pledges, regulators feel increasingly comfortable passing corresponding ESG mandates. Hand in hand with this are incentive packages - the Inflation Reduction Act in the US, and the proposed Green Deal Plan in the EU - which back mandates with money to take action.

Real estate investors face dual imperatives: to produce returns and to advance the low-carbon transition. As a result, leads must effectively manage climate risks and aggressively capitalize on climate opportunities. This means drawing a distinction between the old world of data collection and compliance, and the necessary action of real-world capital investment and transformation.

ESG action unlocks incentives

Unlike the past, action is required to unlock incentives. For example, the Inflation Reduction Act is complex but contains tax credits that can be leveraged by stakeholders across the real estate value chain. These credits can be unlocked to enhance the ROI of technologies including building conditioning, power storage and generation, EV chargers, and the use of clean building materials. There are a variety of tax credits available: for example, Section 50131 provides incentives for adopting the latest energy codes, while Section 30002 provides loans for improving energy and water efficiency, indoor air quality, electrification, and resilience of certain housing units. The underlying theme here is that new regulations are focused on rewarding businesses that can move past analysis paralysis and take meaningful action through investment.

Transformation drives value creation

The G in ESG is really about comprehensive stakeholder engagement. Buildings last a long time and carry the values and desires of today’s market for decades into the future. Achieving superior ROI for the lifetime of the building means creating something that’s designed for the needs of future generations, not the whims of the past. Doing so requires bringing every stakeholder together - investors, regulators, members of the community, potential tenants, and many others—to understand, engage with and test your capital plan. 

Haphazard investment that drives arbitrary ESG metrics will no longer be justifiable. Instead, selecting metrics with materiality—for the asset, tenants, the surrounding community, and the planet as a whole—will be critical. ROI will drive decision making and will continue to be positively reinforced by incentives. Investment into the specific aspects that stakeholders view as material will be critical to drive investment and long-term success.

Karthik Balakrishnan is the President and Co-founder of Actual, an ESG Sustainability Platform that helps companies plan for climate goals while maximizing ROI. With a decade of experience and multiple degrees, including a PhD in Aeronautics and Astronautics from Stanford, Karthik is an established leader, having spoken at events on sustainable development and government policy. Karthik also co-founded Airbus UTM and Coin and founded Actual after gaining insight into the challenges of change in industries like climate. Fashioned after the model-based SimCity, Actual provides a real-world view to users for easier ESG transitions and planning.

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