Environmental, Social and Corporate Governance Practices Gain Ground in CRE

Environmental, social and corporate governance (ESG) policies have moved in and out of the national and global headlines for decades. But these issues — especially those focusing on environmental sustainability — have remained front and center for many commercial real estate owners and operators due to the physical nature of constructing, operating and maintaining buildings.

After nearly 15 years of working to integrate ESG policies into their day-to-day operations, many real estate companies have gained ground, though most concede there is still work to be done.

Many have addressed environmental concerns and decreased operating expenses by upgrading building systems to conserve water and energy. Others have focused on social equity issues by intentionally hiring individuals of various races and genders and strengthening ties to their local communities. Additionally, some companies have modified corporate governance by appointing individuals with diverse experiences and ideas to corporate boards and challenging them to focus on long-term planning and investing.

Speaking at an Urban Land Institute conference in October 2021 at a session titled “ESG: The Strategic Perspective,” three CRE leaders shared their observations about the state of ESG at their companies and across the industry. They noted that:

• Working with partners outside of the real estate industry presents meaningful opportunities to reduce carbon output along the supply chain;

• Helping create a post-carbon world could be “the business opportunity of a lifetime;”

• Awareness about ESG issues among tenants, investors, employees and stockholders has and will continue to increase; and

• Growing demand for “green” investments is leading to a lower cost of capital.

Below are some of the key comments made by three commercial real estate leaders at the ULI Fall Meeting in Chicago.

Panelists noted that today their companies are immersed in areas of the construction supply chain they never imagined they would focus on.

Anne Kavanagh, chief investment officer of Germany-based real estate investment manager Patrizia, said that innovation relating to environmental sustainability is a criterion giving some developers a leg up in Europe when it comes to securing hard-to-come-by sites for development.

“We've been working with one of the German cities who makes it part of their job to encourage innovation and to award sites to creative developers, creative thinkers and people that are pushing the envelope,” Kavanaugh said.

Another effort has involved “working with universities to look at different solutions for producing concrete,” Kavanagh noted. “One of the challenges, though, is finding a sustainable production source to produce any new methods you use,” that is reliable, credible and able to scale up.

The challenges of finding suppliers that fit that bill were underscored by David Steinbach, chief investment officer at Hines. Right now, he said, there are specialists outside of the real estate industry “who fully believe that this is a massive wave of [opportunity] that they will take advantage of.” Working with partners outside of the real estate industry presents meaningful opportunity for each real estate company to be a “disruptive force of change,” he added.

Owen Thomas, CEO of Boston Properties, noted that to get to net zero, it’s critically important for the real estate industry to focus on supply chain details because the industry can’t get there by working alone.

“We at Boston Properties have reduced the carbon emissions in our portfolio (off a 2008 base year) by 86%. And we did about half of that through efficiency [of systems and operations] and the other half of that came through procuring green power,” Thomas added.

He clarified that these measurements were based on “scope 1 and scope 2 emissions, not scope 3, which is embedded carbon,” a level that is necessary to measure, and eventually to decrease, to get to net zero. “We need green power and … construction solutions, particularly [for] concrete and steel. The real estate industry alone can't do that.”

Thomas added, “it's important for all of us as an industry — as customers of power companies and concrete and steel providers — to say, ‘this is important to us; you need to come up with solutions.’”

Steinbach noted that what's changed in his mind around the conversation of ESG is that there has been a real convergence of stakeholders around the topic. “So it's now the cities, the investors, as well as the tenants and even our own employees,” raising the bar about what this means to them. The reality of living in a post-carbon world is starting to set in, he added.

“It's now becoming a chorus,” he said. “And frankly, even to simply do business in some cities, particularly when you zoom out through a global lens, this topic weighs heavy on city planners,” and professionals that are trying to solve serious and complex problems within the urban context.

Inside his organization, “this conversation in many ways [has] become much easier, at least with our board,” Steinbach said. He noted that internally they have “flipped the narrative” a bit. With sustainability, their conversations used to be about Energy Star and LEED, which began to feel rote.

Now, instead of checking boxes and adding up scores, the conversation has become, “let's make a business out of this and really lean into it,” he said. “And our collective view is that what's happening right now is [that] this idea of living in a post-carbon world is probably the single biggest business opportunity that we will see in our lifetime[s].”

“This is now the business reality,” Steinbach said, adding that what used to be questions are now imperatives that companies like his need to carry out.

Thomas concurred, conveying that six or seven years ago when his company began to look at these concepts, they paid sharp attention to how much it would cost to implement these changes. But after examining the business case, the firm’s chairman said that doing this well was not just the right thing, but the smart thing. “I think that's really been our north star,” Thomas said.

“Everybody we care about cares about ESG,” Thomas said, adding that ESG efforts are not a fad that will last for the next couple of years and then fade away. “Let's start with our customers. I would say five or six years ago, our tech customers were quite focused on this,” but other sectors did not prioritize these issues to the same degree.

Thomas noted that Boston Properties is currently working on an office space requirement for an asset management company. Their focus, apart from location and pricing that always factor into a tenant’s decision, is on trying to find a net zero arrangement. “That's new, I have not seen that. I've seen interest in the topic, but I've never seen that level of intensity,” Thomas said.

The percentage of Boston Properties’ shareholders who have expressed interest in ESG is also growing. “It's definitely bigger than it was a year ago and two years ago,” Thomas said. He indicated that he and his colleagues are now attending conferences set up by groups like Morgan Stanley, and other sell-side firms that set up conferences with ESG investors. “We attend them because we feel that's a great source of capital for our company.”

Reflecting on employees, Thomas noted, “we are a more purposeful company because of focusing on ESG. And I think we're a more sought-after employer.”

Increasing regulation at the municipal level was another factor Thomas mentioned. With coastal cities experiencing more flooding from storms or even just high tides, many are hyper-focused on building codes that will mitigate the effects of flooding.

He added that many have set net zero goals by 2050 and adopted regulations and levied fines based on levels of carbon emissions. New York, Boston and Washington, D.C., were cities he cited as having a variety of regulations. He said that municipalities that have not yet introduced new environmental regulations are thinking about it, adding “I think everybody's going to do it.”

"Green" investing can yield a lower cost of capital for a company, Thomas added, relating the following anecdote.

When Boston Properties carried out its first green bond issue years ago, there were no green investors. However, on a recent green issuance they did a few months ago, more than 60% of the investors were green bond investors. “And usually when you price a bond deal, you price it five to 10 basis points wide of where your current bonds trade. And this deal came in several basis points below, where the existing bonds were trading, which were not green,” he added.

The result of this green bond issue was a lower cost of capital for the company. “Talk about payback, several basis points on $850 million every year, for example; that's a lot of money.”

Since its inception, ESG has gained ground among real estate companies for a variety of reasons. Generally, conserving water and power, using renewable energy and carrying out meaningful recycling practices can reduce operating costs, generate tax credits and put less pressure on the earth’s systems and resources.

Additionally, creating a diverse workforce where employees are valued and treated fairly can help attract top talent, improve morale and reduce turnover. Also, many members of the millennial and Generation Z demographic groups value ESG principles and try to vet potential purchases and business relationships based on the ESG strategy and track record of a company.

Social and environmental concerns of the past differ from today’s concerns, and tomorrow’s matters will be different yet. CRE companies that make the necessary investments stand a better chance of not being left behind as ESG concerns become reality.

As Steinbach noted, “if we want to be relevant in 20 years, this is the way forward.”