How Does ESG Impact 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 profound environmental impact of constructing, operating and maintaining commercial properties.

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

Numerous companies have addressed environmental concerns and decreased their operating expenses by upgrading building systems to conserve water and energy. Other organizations have focused on social equity issues by hiring diverse individuals and strengthening ties to their local communities. Additionally, some have modified corporate governance by appointing individuals with unique (at least to CRE) experiences and innovative ideas to corporate boards, challenging them to focus on long-term planning and investing, as opposed to short-term profits.

The notion of tracking ESG among corporations originated in 2004 when Kofi Annan, then Secretary General of the United Nations, invited more than 50 CEOs from major financial institutions to create and integrate ESG policies and disclosures into corporations. The idea was that by incorporating these factors into the day-to-day operations of major global companies, these measures would help strengthen the capital markets, especially in small or underdeveloped countries where transparency was sorely lacking. Additionally, focusing on these three areas would help mitigate or eliminate behaviors that resulted in environmental degradation, exploitation of employees and stale corporate boards dominated by a select few individuals.

By requiring public disclosures that were verified by third party entities, a company’s compliance — or lack thereof — with ESG practices became part of the public record, making it clear for stakeholders —such as municipalities, investors, lenders, clients and current and future employees — which companies are good stewards of these practices.

Environment. Generally, environmental policies focus on reducing or eliminating negative environmental and/or climate impacts. They center around priorities such as reducing the use of natural resources, reusing and recycling materials and generating energy from renewable sources.

Social. Social issues require evaluation of a company’s diversity and inclusion efforts from the boardroom to entry-level employees and across the supply chain. Work environment policies and programs must ensure that employees are treated fairly and work in safe and harassment-free environments. Companies should also seek to engage with their local communities and aspire to have a positive effect upon them.

Corporate Governance. Governance focuses on a company’s leadership and how it upholds legal and ethical obligations and navigates critical risks over time. This includes ensuring that the board, company executives and managers represent diverse points of view and that can be communicated without reprisal, especially as it relates to emerging issues with long-term impacts.

Chris Pyke, senior vice president for product at the U.S. Green Building Council focusing on building performance software, noted that over the past five years, ESG areas that in the past were largely carried out by distinct business lines inside companies have become more integrated.

“They're not just the role of that person in the cube down the way who was the sustainability person. Now, you're having a dialogue between your CFO, the person who engages your capital providers, your chief operating officer, the person who's doing capital planning,” among others.

“You're finding that now these things are all tied together in a way that five years ago was not the case.”

This fusion is by design, as one of the foundational purposes of ESG was to marry corporate decision-making to social and environmental justice, so company leaders and financial resources would be directly linked to the desired outcomes of treating people fairly and conserving natural resources.

The degree to which companies implement programs or initiatives around ESG efforts varies by industry. For example, a chemical manufacturer will likely focus more time and resources on being a good steward of the natural environment as they mine and process materials. A labor-intensive hotel company, on the other hand, may need to concentrate on social policies by developing practices that ensure safe working conditions for employees that carry out physically demanding work like making beds and cleaning rooms.

Two aspects of the CRE industry that affect the natural environment significantly are the construction and operation of buildings. The construction phase requires intensive use of natural resources that are mined or harvested, processed and then transported to construction sites. Once a building is complete, its day-to-day operation consumes a tremendous amount of energy in order to power HVAC and electrical systems, which results in significant volumes of carbon being emitted into the atmosphere.

The current paradigm exerts pressure on CRE owners, operators and developers to incur the time and financial costs required to minimize the environmental impact of the development and operation of their properties.

But Pyke does not believe the environmental burden should fall solely on building owners and operators and emphasizes that it must be shared. “In some ways we are like the automobile industry,” and we are trying to get to where that industry is today, Pyke noted. “By electrifying, … they are trying to create, within their span of control, a vehicle that at the point of use has minimal operating pollution.” And, to accomplish that, “they shift that burden to the power plant, where it can get cleaned up.”

But shifting a burden from one industry to another does not eliminate a problem. Pyke said that relative to the built environment, there’s a lack of clarity about who is responsible for what. He concedes that “buildings have a phenomenal environmental footprint,” noting that “at a minimum, they are responsible for 30% to 40% of global greenhouse gas emissions.” But unfortunately, these metrics lead many professionals to pile a great deal of the environmental load onto buildings, Pyke said.

He noted that the energy that emerges from a building comes from a complex set of sources such as “the tenant, the owner, the city, the utility, and a bunch of other stakeholders. And so, the burden, yes, it may be very big, but it's also very shared.”