Global ESG benchmark GRESB identifies three key performance indicators that have gained the most attention across real estate in recent years: greenhouse gas emissions, energy consumption and water use. Other environmental factors that the ESG benchmark highlights include waste generation and green building certification.

“I completely agree that environmental KPIs, such as energy, water and waste – which then allow you to track greenhouse gas emissions – are absolutely critical,” says Meredith Balenske, senior vice-president, global head of sustainability and ESG at industrial specialist GLP.

Regardless of industry, the Paris Agreement and global net-zero goals have brought climate risk and environmental impact front and center of investors’ minds. In 2021, an EY survey found that almost 80 percent of investors planned over the next two years to spend considerable time and attention evaluating physical climate risk implications for asset allocations and other decision making.

“The built environment is a major source of greenhouse gases, so our sustainability and operational carbon reduction plans are of critical importance,” says Peter Holden, managing director, co-head of private real estate asset management at Partners Group. The International Energy Agency estimates that the real estate and construction sector accounts for roughly 39 percent of energy and process-related carbon dioxide emissions, 11 percent of which result from building materials like steel, cement and glass.

Dutch asset management firm Robeco says to achieve net-zero goals the real estate industry would need to cut emissions at a decarbonization rate of 6 percent annually, costing more than $20 trillion. Based on current progress, the manager expects the sector to slash its carbon emissions intensity by 43 percent by 2030.

“At the asset level, the environmental aspects of ESG are probably the most important,” says Cope Willis, managing director of sustainability at Greystar Real Estate Partners. “We are already starting to see financial penalties for property owners that are not being more proactive about trying to improve their environmental performance and reduce the carbon footprint of their assets.”

Olivier Terrenoire, global head of asset, property management and sustainability investing at Generali Real Estate, adds that “institutional investors expect commitment, strategy and visibility on those sustainability KPIs – it is no longer a nice to have but a must have.”

Beyond just a social good, decarbonization also has an economic component. Most asset-level revenue and cost streams are relatively fixed in real estate. Utility consumption, particularly electricity and fuel, is often the largest variable cost that property owners can directly affect.

“Tracking utility consumption to identify target areas for improvement can uncover ways to directly increase an asset’s net operating income,” says Anuj Mittal, head of Europe real estate at Angelo Gordon. “GRESB is right to focus on energy and water consumption KPIs for asset managers due to this direct path to increased operational profitability.”

Making a difference

Tracking and disclosing environmental KPIs might seem the obvious starting point for real estate managers looking to advance their ESG credentials, but social factors should not be ignored either. “Historically, there has been a much larger focus on the environmental angle in real estate, partly because there has been such a need to address energy efficiency and therefore the carbon footprint,” explains Charlotte Jacques, head of real estate sustainability and impact investment at Schroders Capital.

“Institutional investors expect commitment, strategy and visibility on those sustainability KPIs”

Olivier Terrenoire
Generali Real Estate

A spokesperson from real estate investor Shorenstein notes that energy, water, greenhouse gas emissions and waste may be the industry standard KPIs for commercial real estate, but it is also “increasingly important to develop KPIs around health and wellbeing as well as quantitative metrics around DE&I.”

For construction projects, KPIs for health and safety clearly make sense, and labor regulations typically mandate responsibly sourced building materials and supply chains. “On the social side, there are very good systems in place to measure workforce and other human capital metrics like diversity, but the quality and completeness of environmental data has been a challenge for some time,” says Willis.

Tenant and community engagement are other important social KPIs that GRESB identifies. Customer satisfaction increases the likelihood that tenants will remain living in buildings. An effective engagement program creates a dialog between landlord and tenant, providing a platform to communicate needs, concerns and suggestions.

On the community side, Partners Group looks toward generating local employment for construction projects. “It is about recognizing our role as an influential member of the local communities where we invest,” adds Holden. Dutch real estate manager Bouwinvest also uses newsletters, community apps and narrowcasting to step up its communication efforts.

Laying down the groundwork

How can managers be kept answerable to those KPIs? Lauren Hochfelder,
co-chief executive officer of Morgan Stanley Real Estate Investing and head of Americas, says “setting targets, defining KPIs, benchmarking” and reporting help keep firms accountable.

Another tactic that is emerging is linking executive compensation to KPIs. In 2021, trade association NAREIT found 51 percent of its corporate members linked executive compensation packages to ESG performance, up from 34 percent the previous year.

The UN-supported Principles for Responsible Investment says that if structured appropriately and implemented effectively, ESG-linked pay could increase firm value, rebalance performance targets in favor of long-term strategy and create better accountability for sustainability-based results across management.

But linking compensation to ESG goals should not be thought as a panacea that will solve all sustainability issues. Businesses lagging behind their KPIs may avoid disclosing accurate information for fear of losing bonuses. Research from UK bank NatWest found that out of 916 companies surveyed with ESG-linked executive pay globally, the companies with the highest absolute emissions still paid CEOs more than those with lower emissions.

There could be many mitigating factors, but a lack of accountability and data transparency certainly undermines the process and adds financial risk. Managers may need to explain to investors why they missed goals and whether KPI metrics could be improved.

Boards also need to think about which KPIs are best suited and link these to a long-term sustainability strategy rather than mere short-term tokenistic action. Equally, focusing on executive level ESG financial incentives might not be enough to ensure that sustainability filters down.

“I think everyone is moving in the direction of ESG linked to compensation,” stresses Balenske. “But what we have to focus on is full integration and linking to GRESB is a good example because it covers such a broad range of ESG issues.”