Anyone who thought the economic squeeze and threat of prolonged recession would curb real estate enthusiasm for more ambitious ESG disclosures was very much mistaken. If anything, the volatile backdrop has shone a spotlight on the importance of sustainability and the dangers of ignoring long-term risks and opportunities.

“Over the last 18 months, how we look at the role of sustainability and net-zero carbon, in particular in relation to value, has transformed quite significantly,” says Abigail Dean, head of strategic insights at Nuveen Real Estate. “The reason for that is that for the first time we have had access to some tools that we can do some proper analysis with.”

Managers need to move quickly to keep up with emerging regulations and innovative technologies. Gone are the days when the sustainability agenda could be considered a luxury or indulgence.

The Paris Agreement and other net-zero pledges have made global decarbonization an inevitability that can no longer be ignored by real estate managers. Here are five key themes to keep an eye on in the rapidly emerging ESG space.

1Benchmarking success

The real estate sector requires a seismic shift to dramatically decarbonize and improve other ESG metrics. Making such significant progress depends on greater standardization and industry collaboration. Without agreement on the most important KPIs to track, it will be impossible for investors to compare sustainability credentials across different buildings and wider portfolios.

Against this reality, managers are turning to trusted benchmarks such as GRESB and Fitwel to demonstrate and track their commitment to sustainability. Over the past year, the total asset value in the GRESB real estate benchmark grew by over a fifth, taking total participating entities to just shy of 2,000. Since the pandemic, the number of firms opting into the benchmark has surged by 48 percent.

Europe leads the shift by sheer number of firms, despite the Americas accounting for 43 percent of total gross asset value. Over the past year, the continent added another 123 entities, just ahead of the Americas at 111, and accounts for roughly half of the entire GRESB real estate benchmark.

Asia is the second-largest market by gross asset value and participation grew by another 21 percent over the past year. The region comprises roughly 16 percent of total entities, but sustainability is becoming a greater priority in key markets like Japan, Singapore and Hong Kong. JLL’s Global Real Estate Transparency Index ranked the countries 12th, 14th and 16th, respectively, this year, and new regulations are forcing developers to weigh climate and other environmental risks ever more seriously.

2Ten key ingredients

The ESG agenda has become mainstream across the real estate asset class in recent years. Investors are calling for greater transparency and expect to see accurate data that reflects this industry shift. But the journey to fully integrate sustainability – and, crucially, decarbonization – into company strategy will take time and requires careful planning.

ESG also means different things to different people. The lack of standardization further complicates things. How should managers go about approaching the topic and what are the best practices that firms use to showcase their commitment to long-term sustainability?

PERE’s ESG report has taken a deep dive into 10 critical ingredients that managers should consider when constructing an ESG strategy: leadership, talent, portfolio construction, key performance indicators, governance, the social pillar, reporting transparency, regulation, technology and value creation.

“At the asset level, the environmental aspects of ESG are probably the most important”

Cope Willis
Greystar Real Estate Partners

How leadership is structured and how committed that leadership is to sustainability are paramount factors in fully embedding ESG into business practices. “I have seen different versions of who is responsible for ESG, but ultimately there needs to be a top-down approach where your board and management has ultimate oversight,” says Meredith Balenske, senior vice-president, global head of sustainability and ESG at GLP.

Governance also naturally feeds into decision-making at the C-suite level and has taken on greater importance since the 2008 financial crisis. Evaluating climate risk and designing appropriate KPIs to track and benchmark progress may be delegated but strong governance is about setting these objectives in motion and vigilant oversight.

Environmental targets are again the most obvious place for managers to start, especially considering the scale of the decarbonization challenge. “At the asset level, the environmental aspects of ESG are probably the most important,” says Cope Willis, managing director of sustainability at developer and manager 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.”

Mandatory regulations and disclosures are also only going to increase this attention on environmental impact. “The SFDR, EU Taxonomy and other regulations are all becoming increasingly important for our sector,” says Cristina Garcia-Peri, managing partner and head of corporate development and strategy at Madrid-based Azora Group. “However, equally – if not more – important than complying with national regulation is the need to meet ESG demands imposed on us by investors, to keep our products attractive and competitive.”

3Focusing on people

Developers and managers are also starting to look beyond the environmental component of ESG to consider how urban planning and building design can directly impact local communities.

Chronic health issues like social isolation, obesity and lack of physical activity are a serious threat to the wellbeing of modern societies, and the built environment can play a key role in addressing these problems.

Health can also be key to value creation and risk mitigation for managers. Healthy buildings enhance occupant satisfaction, lift rental rates and lower operating expenses, all factors that directly add value to portfolios.

Post-pandemic, monitoring air quality has become a basic requirement from employees
and more natural light is directly tied to less absenteeism, less turnover and higher work productivity.

In a 2022 study conducted by Canadian investor QuadReal Property Group, healthy food access strategies were also associated with higher median property recommendations.
A 2021 study by New York-based manager BentallGreenOak found that 87 percent of respondents experienced increased demand for healthy buildings over the previous 12 to 24 months, and 92 percent expected demand to grow over the next three years, while 89.5 percent of respondents also planned to enhance their company’s health and wellness strategy over the coming year.

Fostering greater diversity across the asset class and supporting local employment are other social factors that are gaining attention. “[If] we come at decisions from different perspectives… we are responsible for creating new spaces and those new places will have a wide variety of people,” says Olaide Oboh, director at developer Socius.

4Running out of time

Decarbonization and weighing climate risk are both important elements of ESG and vital for avoiding stranded assets. “ESG obsolescence risk applies to everyone, to every market,” says Joseph Consolo, director at Yardi Energy. “This could impact large institutional investors, a single property owner and everyone in between, in every market.”

“Valuations aren’t factoring in the upcoming policy and related transition risks”

David DeVos
LaSalle Investment Management

Regulations are also having a profound influence. In the UK, landlords are not allowed to let buildings that fail to meet minimum energy efficiency standards. Focusing on the carbon footprint, the government plans to lift this ‘E’ rating for all non-domestic buildings to a minimum ‘B’ standard by 2030. Authorities estimate this should cover 85 percent of the country’s non-domestic rented stock, up from the current 10 percent, and helping slash a substantial share of real estate emissions.

The UK is also not alone in this. Policy makers internationally, and particularly in Europe, are aware they need to make regulations more stringent if they are to meet their climate goals. Tougher rules will no doubt directly hit asset valuations – especially older assets that are harder to retrofit or decarbonize.

“Today in many markets, valuations aren’t factoring in the upcoming policy and related transition risks,” says David DeVos, global head of ESG at LaSalle Investment Management. “We are seeing awareness of this in Europe and in pockets of the Americas and Asia. However, quantifying the impact on value is very difficult as it varies by property type and region.”

If the world fails to contain climbing global temperatures, climate risk could also leave more assets stranded. Coastal and floodplain cities could soon be under threat from rising sea levels. Floods are already becoming more common in certain regions, while many buildings are not designed or suitable to cope with dangerously high temperatures.

Typically, managers conduct annual portfolio reviews to assess how future proof their assets will be in the near and long-term. As the world experiences the effects of climate change, real estate firms will need to anticipate how this will affect valuations. Too late, and obsolete assets will flood the market, with the immediate impact being further downward pressure on prices and valuations.

5Coping with the backlash

Despite all this, not everyone is convinced about the benefits of ESG. In the US, Republican leaders have frequently railed against the ESG movement and questioned the economic rationale of sustainability disclosures. In November, multiple Republican senators signed a letter sent to 51 law firms stating that “the ESG movement attempts to weaponize corporations to reshape society in ways that Americans would never endorse at the ballot box.”

US politicians have particularly raised concerns about efforts to phase out coal, oil and gas, arguing that it is driving up energy prices and “empowering America’s adversaries abroad.” In October, Louisiana Treasurer John Schroder said the state pension fund would divest from BlackRock for its “blatantly anti-fossil fuel policies.”

“Sound ESG practices… are essential to creating long-term value”

Lisa Brylowski
Brookfield Asset Management

This followed a letter penned by 19 Republicans in August that criticized the asset manager’s commitment to ESG and energy investments, stating that “BlackRock appears to use the hard-earned money of our states’ citizens to circumvent the best possible return on investment, as well as their vote.”

But even against these political misgivings, the market appears to be siding with those that have faith ESG can add tangible value. “We have not seen US LPs backtrack from their sustainability commitments,” says Priya Prasad Bowe, managing director and head of ESG at Oaktree Capital Management. “Meanwhile, LPs outside of the US continue to advance their sustainability objectives, seemingly agnostic to the American political and regulatory environment.”

Importantly, pension funds in the US are aligning themselves to the ESG agenda, not because of tightening legislation but because they believe in the long-term value generation potential. “Sound environmental, social and governance practices integrated throughout our organization are essential to building resilient assets and businesses and creating long-term value for our investors and communities,” stresses Lisa Brylowski, vice-president at Brookfield Asset Management.