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ESG goes mainstream for real estate

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building outside view Real estate investors are no longer solely focused on price – they now consider supply chain transparency, green tech availability and values-based property development practices as part of their decision-making process. In the September 2021 Grant Thornton webcast, Unpacking Environmental, Social, and Governance (ESG) Practices for Real Estate, leaders from GRESB, Federal Realty Investment Trust (FRIT), and Nuveen Real Estate discussed the presence of ESG in the real estate industry today and how real estate companies can use it to better position their portfolios.  What follows are highlights from the webcast.
 

Defining ESG today in North America and its impact on real estate organizations

As the real estate industry acknowledges the ESG imperative and adopts differing approaches to resiliency planning, energy management and tenant engagement, an important early step for real estate is often conducting a benchmarking analysis. To facilitate the benchmarking process, many have turned to GRESB, which provides structured, non-financial data questionnaires around which to frame reporting. As organizations receive their benchmarking results and gain a clearer understanding of how they fair compared to peers, it becomes clear that some players are making strides by adopting smart meter programs, Energy Star certifications and other best practices. Real estate organizations are realizing leading organizations can be sources of information and guidance. For the past decade, the proliferation of reporting frameworks and standards, including GRESB, has catalyzed this environment, creating a competitive race to the top within the industry.


KPIs, benchmarking and starting the journey

Establishing a clear direction and set of ESG priorities is critical at the outset of a company’s ESG journey. While many organizations – both in and outside real estate – begin ESG engagement with relatively impromptu “random acts of sustainability,” those initiatives often fail to coalesce around a firm, company-wide vision. In turn, committing to a standardized disclosure framework can help real estate organizations formalize ESG as they become increasingly thoughtful, benchmark against peers, identify gaps and KPIs, and answer the ‘why’ questions that drive their sustainability strategies. For real estate organizations, using a framework to respond to ESG pressures provides two key benefits: facilitating sought-after, benchmarking-style insights and serving as a starting point for reporting that can later be extrapolated to other frameworks, like the Sustainable Accounting Standards Board (SASB), Task Force on Climate-Related Financial Disclosures (TCFD), or Global Reporting Initiative (GRI).


Investor insight

Investors are caught within America’s push-pull regulatory environment, which makes it increasingly compelling to market themselves as ESG-focused. That said, these claims must be supported with data. Firms must ask themselves:

  • What ESG issues are material to our business?
  • What are we doing to manage these issues?
  • How are we using ESG to differentiate ourselves from our competitors?

Through this reflective process, they uncover opportunities to create additional value.

While ESG can afford an opportunity for growth and competitive advantage, there is also a fundamental element of risk management. Even funds that don’t have ESG as a specific objective still have an obligation to manage risks associated with ESG topics. For instance, climate change-strengthened disasters and extreme weather events pose significant physical risks to assets. Furthermore, jurisdictions like New York and Washington, D.C. are passing laws and regulating energy use and carbon emissions from buildings. To ignore either of these realities would be to neglect a fiduciary duty to investors. When starting a basic risk management strategy, organizations must consider the risks that could affect their bottom line and recognize that they have an obligation to manage them.

Designing and maturing ESG

The real estate industry has historically taken a reactive approach to reporting; however, recent behavior suggests firms would rather be proactive. Industry players are anticipating investors’ demands and regulatory pressure by understanding material ESG issues, developing programs, and driving business value. Because of the wash-rinse-repeat behaviors that reporting frameworks encourage, they have been a useful conduit for this shift in disposition. Firms rarely drop out after committing to a framework and are increasingly put in an advantageous position to answer to other, complementary frameworks and standards.

In terms of data quality, firms also find that reporting incentivizes them to get their data in order. While going through the process can be tedious, the effort of providing a high level of detail pays dividends over time and creates the potential to have this information independently verified, if necessary. The time horizon for quality ESG data collection can span multiple years and reporting cycles. Firms can expect up to a three-year data collection cycle – one year to plan, one year to implement, and another year to collect the data and analyze the results from an initiative.

Another key to a strong ESG strategy is integration. Often, the first two years of designing an ESG program, collecting data and reporting is a silo-busting exercise. Demands for ESG data are suffused throughout the organization, and collection often entails a cross-functional effort that one individual cannot carry out alone. Encouraging stakeholders and employees throughout the organization to feel like they own sustainability can yield tremendous benefits. From property manager to engineer, from accountant to asset manager, everyone has a role to play in embedding ESG into organizational strategy.

Future trends in real estate

Looking forward, real estate companies should anticipate an increased focus on both greenhouse gas (GHG) emissions and climate-related resilience planning. The Task Force on Climate-Related Financial Disclosure (TCFD), which outlines best practice and guidance for developing climate scenario analysis and resiliency planning, is receiving increased attention from both investors and the federal government. In addition, the 2021 United Nations Climate Change Conference (COP26) approaches, increasing pressure to meet the Paris Accord commitments. Organizations need to understand how portfolio-level carbon emissions compare to Paris-aligned carbon budgets. Real estate organizations are likely to be judged on these issues.

Managing both physical and transition risks related to climate change are key risk management issues. In practice, firms must ensure that assets can physically withstand natural disasters and that they can comply with emerging regulatory demands and customer preferences. The importance of this forward-looking approach to risk management is becoming clear as institutional investors more frequently conduct their own assessments. Rather than waiting for real estate firms to share where risks lie within their portfolios, investors expect to understand how risk mitigation is being integrated into business planning and investment strategy.

From a disclosure standpoint, firms should expect a large increase in the focus and stringency around ESG reporting. Global standards continue to converge, and the SEC appears increasingly likely to formalize climate-related reporting requirements. Over time, we are likely to see that as the data improves, decision-making will become more robust, and assets and investments with ESG challenges are going to see a pricing adjustment. Getting ahead of these issues is now extremely important in order to manage financial risk and to create opportunities for future growth.

For more information, please download our report: ESG is a business imperative in real estate

Contact:

Angela Jhanji Angela Jhanji
ESG Strategy Director
Grant Thornton LLP
T +1 212 542 9947