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The Role of ESG Indicators in CRE Investment Decisions Is Only Expected to Grow Further

Industry sources say ESG indicators will soon become as important as financial indicators for CRE investors and developers.

Expect environmental, social and governance (ESG) metrics to be more influential in real estate investment decisions in the U.S., say industry sources.

“If you’re talking to a European investor, they don’t really differentiate between ESG and financial indicators. If you’re talking to an audience that’s mainly from the U.S. or Asia, the financial indicators are a little more influential in the way those conversations are actually happening. I absolutely think that’s changing,” says Uma Pattarkine, investment strategy analyst for CenterSquare Investment Management, a global investment manager. “One of the first things that we’ll see be impacted is the company’s cost of capital. You’re already seeing rating agencies taking into account ESG risks as they’re assigning ratings, which will absolutely directly impact the company’s ability to [obtain] debt.”

Real estate companies can achieve their ESG targets through more sustainable development and operational practices, according to Pattarkine. On the development side, these include:

Some U.S. companies are “leveraging LEED, ENERGY STAR and BREEAM to help drive their construction strategy, while others are starting to explore advanced building design strategies like Passive House and the Living Building Challenge program,” says Billy Grayson, executive director of the center for sustainability and economic performance at the Urban Land Institute (ULI).

Several real estate companies are also raising capital for sustainability efforts, including issuing green bonds, something Freddie Mac is pursuing; identifying new financing strategies, like green mortgages; and building new real estate funds around sustainability-certified buildings, Grayson notes.

On the operational side, Pattarkine says companies are using renewable sources of energy, signing green leases, redirecting waste through composting and recycling programs, reducing water usage, ensuring water quality protection, and monitoring greenhouse gas emissions regularly to identify risks and opportunities.

“To get to net zero [carbon], real estate companies will need to invest in renewable energy, including on-site renewables, off-site renewables green power through the grid, and possibly even carbon offsets,” says Grayson. “Many of the biggest real estate companies are pursuing an ‘all of the above’ strategy and looking for the most cost-effective ways to invest in renewable energy to offset any on-site energy use they are not able to eliminate through their efficiency programs.”

These changes are partially driven by the changing priorities of today’s fund investors.

Fifty-five percent of millennials factor ESG policies and performance into their investment decisions, compared to 25 percent of Gen Xers and 11 percent of baby boomers, according to the ULI's 2020 Emerging Trends Report. This generational skew suggests the potential of ESG to influence capital deployment decisions will be rising over time. The Global Commission on the Economy and Climate estimates a doubling of investments in renewable energy over the coming decade, according to MSCI 2020 report.

“Part of the theory behind the use of ESG indicators is that by paying attention to social and environmental concerns, companies actually stand to benefit directly by reducing expenses,” says Nate Loewentheil, senior associate at Camber Creek, a venture capital firm focused on real estate tech.

However, “there’s no question that for the vast majority of real estate developers, financial metrics are still the most important indicators.”

Commercial real estate owners track energy, water, waste and carbon emissions to reduce their environmental impact, but also because improving these metrics can help reduce operating expenses, leading to NOI growth, notes Grayson For this reason, real estate investment decisions, such as which markets or which building types to put money in, are beginning to be widely influenced by ESG indicators.

“ESG concerns are increasingly central to real estate developers, especially in urban markets where developers are dealing with regulatory and political pressures around issues like climate emissions and affordability,” says Loewentheil. “In that sense, the line between ESG indicators and financial indicators is starting to blur. To do business successfully in many cities, developers have to take into account social and environmental impacts.”

Nineteen cities globally have committed to achieving net-zero carbon emissions in new buildings by 2030, and for all existing buildings by 2050. Of these 19 cities, four are located in the United States.

“Some real estate companies are also getting more engaged in public policy, either on their own or through trade organizations like ULI,” says Grayson. “For city and national sustainability goals and programs to be successful, it will be important for public sector leaders to engage with the private sector, to identify the most cost-effective path to achieve these new sustainable goals.”

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