With institutional investors increasingly focused on reducing carbon emissions, managers who want to pass the ESG sniff test should focus on showing investors data-backed proof.

by Raphael Rosen,Carbon Lighthouse CEOFirst published in NAREIM Dialogues Spring 2021

The Covid-19 pandemic has had a dramatic impact on the real estate world, forcing businesses to be accountable in entirely new ways. While one might assume that the resulting economic downturn would have negative consequences on sustainable investing, this couldn’t be further from the truth.

Responsible investing and the search for long-term value don’t disappear in a crisis. If anything, ESG investments have steadily increased since the start of the pandemic. By the end of 2020, the total assets in sustainable funds hit a record of $1.7 trillion, up 50% over the year. From January through November 2020, investors in mutual funds and ETFs invested $288 billion globally in sustainable assets, a 96% increase over the whole of 2019. The markets are responding and, in fact, are being increasingly proactive in their ESG strategies.

Maximizing a building’s energy usage through ESG measures has a direct impact on overall net operating income (NOI) and subsequently drives substantial increases in asset value upon disposition.

So what does this mean for commercial real estate? The industry is on the precipice of a digital transformation as the convergence of ESG, a new administration, occupant needs and market demands presents an ideal opportunity for CRE to prioritize the “E” in ESG as an integral driver of economic recovery and long-term portfolio value.

Increasing awareness and action

2019 and early 2020 saw a resurgence of climate change awareness, inspiring many to take action and capital markets to react like never before. Industry leaders such as BlackRock, Goldman Sachs and Blackstone, among others, have announced that ESG will be a key factor in investment assessments moving forward. One of the world’s largest investors, the New York State Pension Fund, announced this past December that the fund will divest from many fossil fuels in the next five years and sell its shares in other companies that contribute to global warming by 2040.

Data reveals that companies with strong ESG principles outperformed their conventional counterparts in terms of stock performance in the first quarter of 2020. And investors have taken notice.

Now, with a new Biden administration and a new climate plan that specifically calls for a reduction in building carbon emissions, ESG is only gaining momentum. The impact is felt even at the state and local levels as many hone in on their own climate plans. For example, Local Law 97 in New York City will require that buildings 25,000 square feet or larger reduce their carbon emissions by 40% by 2030 and 80% by 2050. These macrotrends have created a promising path for ESG and economic recovery in 2021, and CRE now has the cost-effective technology solutions — advanced AI, deep data analytics, sensors, modeling capabilities — to unlock the value that ESG has to offer.

Data-backed ESG for a competitive advantage

Critical to ESG is proof. Until now, the industry has dealt with greenwashing without real impact. Yet, with the market demands for demonstrable carbon reduction impact, many owners are struggling to find a path forward amidst the complicated economic impacts of the pandemic.

Quick Wins CRE Managers Can Adopt to Reduce Carbon Emissions:

1. Focus on the asset’s biggest energy users and carbon emission contributors: the heating, ventilation and air conditioning system. There are solutions that don’t require capex heavy fixes. For example, building management systems (BMS), advanced sensors, AI-driven software solutions and data analytics will help better manage the overall HVAC systems to ensure each individual piece of equipment is working efficiently and effectively as part of the overall system.
2. Start with low-hanging fruit with cost-effective updates in the lighting system. Make sure you’re using LED lights throughout the building, as well as sensors and automated scheduling to align use of lighting to when spaces actually need lighting (vs. after hours or when a conference room is not being used).
4. Find energy-saving solutions that also account for the 50% of energy used by tenants in triple-net lease structures.
6. Data-back carbon reductions to easily market proof back to investors, tenants, staff and all stakeholders alike.

With every expense — both existing and new — under increased scrutiny, only data-backed investments (ESG or otherwise) that show real financial and climate impact will pass investors’ sniff test. The good news is that technology is redefining measurement and reporting for key sustainability initiatives. With AI and machine learning technology, CRE owners now have the advanced technologies, sensors, software and analytics tools that are cost-effective solutions in demonstrating proof of their carbon emissions reduction.

As CRE looks toward recovery, it will be critical to also demonstrate ESG impact to tenants as well. Employers are seeking sustainable workspaces in response to the demands of their employees. They understand the benefits of ESG for their employees and their business and will require climate-friendly workspaces as a result. Being able to clearly demonstrate the true ESG impact of a building will provide an unparalleled competitive advantage as CRE begins to reopen this year.

The long-term value of ESG

Maximizing a building’s energy usage through ESG measures has a direct impact on overall net operating income (NOI) and subsequently drives substantial increases in asset value upon disposition. In the case that an owner ultimately wants to sell a property, they’ll be more likely to attract investors.

For those buying, ESG will be a key qualifier for which properties to invest in. So much of the built environment can be optimized for enhanced societal and environmental benefits. Now it’s up to forward-thinking CRE leaders to take the necessary actions to prove out the holistic ESG approach.