For what seems like an eternity, “location, location, location” has been a mantra for REIT executives and other commercial real estate professionals. Now, three more words are entering their lexicon with greater frequency—environmental, social and governance.
Due to a combination of drivers, environmental, social and governance (ESG) concerns are gaining prominence among REITs and their investors. The new Emerging Trends in Real Estate report from the Urban Land Institute and professional services firm PwC declares that a “sophisticated approach to ESG practices can be critical … in the world of public REITs.”
It’s critical from the standpoint that success or failure could ride, in part, on whether a REIT embraces ESG principles or gives them short shrift.
“The U.S. is rapidly catching up with the Europeans on the ESG front,” says Sam Adams, co-founder and CEO of San Francisco-based based Vert Asset Management.
In 2017, Vert Asset Management launched the Vert Global Sustainable Real Estate Fund, a mutual fund investing in publicly-traded REITs that rely on ESG metrics.
“Seven of the 10 largest pension funds in the world now invest on an ESG basis. It’s becoming a must-have,” Adams says. “If you don’t have an ESG program, you might lose some investors.”
The Emerging Trends in Real Estate report says sensitivity to ESG issues has heightened in the American real estate market since the Trump administration decided in 2017 to pull the U.S. out of the Paris climate accord.
The report adds to a growing body of opinion and evidence showing that it’s imperative for REITs to commit to ESG. And pressure is mounting for them to do so.
For example, US SIF: The Forum for Sustainable and Responsible Investment in early October joined legal experts, state treasurers, public pension funds, unions and foundations in filing a petition with the U.S. Securities and Exchange Commission seeking a rule that would mandate more robust corporate disclosure of ESG information. According to Nareit, 70 percent of REITs publicly do report their sustainability efforts in some form.
In a 2016 survey, US SIF found that investors that consider ESG criteria in asset management accounted for one-fifth of funds under professional management in the U.S., or $8.72 trillion — up 33 percent from 2014.
Meanwhile, a 2018 survey by San Francisco-based investment consulting firm Callan found that 43 percent of U.S. institutional investors had incorporated ESG factors into their investment decisions, compared with 22 percent in 2013. Another 2018 survey, this one by the Morgan Stanley Institute for Sustainable Investing and Morgan Stanley Investment Management, showed that 84 percent of owners of institutional assets are either pursuing or are “actively considering” integration of ESG factors into their investment processes.
The Emerging Trends in Real Estate report points out that investment managers are increasingly evaluating REITs on ESG measurements such as energy efficiency, carbon footprint reduction, conservation policies, employee engagement, community involvement, corporate ethics and board independence.
One global REIT asset manager disqualifies companies whose scores aren’t high enough on the Global Real Estate Sustainability Benchmark report card, according to the report, while a major international investor has developed an “environmental dashboard” for 950 of its properties so it can become an energy-efficient “landlord of choice.”
Despite those developments, there’s somewhat of a sense of the status quo among REIT fund managers as a whole regarding ESG, according to one ESG specialist.
“All in all, ESG is a factor that is considered by many REIT fund managers, but rarely is it the main consideration,” says Kevin Nagy, assistant vice president of Callan’s real assets consulting group and a member of Callan’s ESG committee “Valuation and cash flow metrics are still the primary considerations in the stock selection process for the majority of managers."
For his part, Adams, the Vert Asset Management CEO, says ESG funds like his are encouraging REITs to take a “triple bottom line” stance that encompasses “people, planet and profit.”
“The new frontier in ESG is health and wellbeing,” Adams says. “Firms are realizing that greener buildings have happier, more productive tenants because of the better lighting, temperature control and air quality. This translates to less absenteeism and better employee retention.”
In striving to achieve the “triple bottom line,” REITs, institutional investors and others are turning to big data.
Market intelligence provider Four Twenty Seven and real estate tech company GeoPhy recently rolled out a data product that offers projections on how climate change might affect REITs. The companies reported in a new white paper that, for instance, the three REITs operating in the U.S. that are most exposed to the risk of rising sea levels are New York City-based office and retail REIT Vornado Realty Trust and Chicago-based multifamily REIT Equity Residential.
As more emphasis is placed on ESG, Mario López-Alcalá, vice president of research at New York City-based MSCI, a provider of investment indexes and portfolio analysis tools, says U.S. REITs are now studying the business case, rather than just the values-driven angle, of ESG initiatives. And that dollars-and-cents view makes sense.
Case in point: Hannon Armstrong, an Annapolis, Md.-based “green” REIT. Since going public in 2013, the REIT has executed about $5 billion in transactions for financing sustainability infrastructure projects, such as wind and solar installations. Through the end of 2017, Hannon Armstrong’s total shareholder return sat at 175 percent.
“We see climate change as one of the defining issues of our generation, and we see finance as the key enabler to the rapid adoption of clean energy technologies,” says Amanda Cimaglia, director of investor relations at Hannon Armstrong.
Cimaglia says close to one-fourth of the REIT’s institutional investors employ some sort of ESG screening methods when picking investments. Hannon Armstrong’s board of directors now oversees the REIT’s ESG strategies, which Cimaglia says are in the midst of being beefed up.
Toledo, Ohio-based health care REIT Welltower Inc. and Los Angeles-based office REIT Kilroy Realty Corp. are among other REITs that have stepped up their commitment to ESG. Nareit formed the Real Estate Sustainability Council in 2016 to help guide ESG efforts at REITs.
In the long run, MSCI’s López-Alcalá says, paying attention to ESG promotes resiliency for REITs and other property owners, such as being able to withstand flooding and other weather events triggered by climate change and being better equipped to address shifting tenant demands for things like “green” mixed-use space.
“Given that buildings are long-lived assets, ESG factors contribute to future-proofing investments in real assets,” López-Alcalá says.