By Paul Cheng
Although the Environmental, Social and Governance (ESG) movement has garnered support from policymakers, regulators, and investors globally, there has been a recent emerging voice arguing that the ESG pendulum has swung too far in one direction. Over the past year, several lawmakers, as well as investment executives, have pushed back against ESG, attempting to reverse course, and in some cases, even ban the use of any ESG methodology in investment decisions. Certainly, ESG, or in fact, any investment framework, should focus on the merits of an investment in terms of its ability to earn sustainable returns. In this article, I would like to advocate that real estate investment professionals put aside any political leanings and approach ESG from both an “offense” and “defense” lens. That is, ESG does not have to be a nebulous, “touchy-feely” fad that caters solely to a “green” coalition. Instead, applying an ESG framework to investment decisions can help investors boost their bottom line while mitigating risks along the ESG spectrum.
In my own journey as a U.S. public pension plan investment professional over the past decade, I have witnessed the evolution of ESG in terms of awareness, acceptance, sophistication, evangelism, and now re-assessment. This sort of reflection and reevaluation does not have to be viewed as a repudiation of ESG; instead, investment professionals can embrace this as a feedback loop to refine and improve the underpinnings and processes. In the early 2010s, only a handful of investment managers had an ESG focus, with European investors and Endowment and Foundations at the forefront. If a manager was a UN-PRI signatory, that was often sufficient proof of their ESG credentials. They had checked the ESG box and both sides moved on. It seemed that sometime in the mid-2010s, the ESG movement gained steam and there was wider acceptance and urgency, both of which can be attributed to the Paris Agreement of 2015, where nearly 200 nations agreed to limit global warming by mid-century. That was a watershed event as investment managers increasingly – and more visibly – applied ESG rigor in their diligence and asset management. This was evident in more detailed assessment of climate related risks and mitigation and an emphasis on lowering emissions and energy consumption, as well as using sustainable building materials when possible. Managers and investors increasingly monitored third-party ratings like LEED certifications, as well as GRESB scores. Certainly, the “E” in ESG was a focal point given that it was accessible and more easily measured. Over the past several years, the “S” and “G” in ESG have moved to the forefront, as a reaction to growing awareness of ongoing racial injustice, gender inequity, and growing income and wealth disparity, that have led to social unrest across the world, leading many institutions to focus more attention and resources on human capital and social impact.
While the investment community may be swayed by changing political and ideological sentiments, I would encourage the adoption of both a defensive and offensive lens in applying their ESG frameworks in their investment analysis, due diligence, and asset management processes. By defensive, I am referring to the practice of being proactive in identifying and mitigating factors that may present potential risks that could impair the value of an asset. By offensive, I am pointing to actions that better position an asset for future use as it relates to ESG considerations. As you see, sometimes, actions can be both defensive and offensive.
In addition to advocating for both a defensive and offensive approach, I will reference ESG best practices and tools the NCREIF PREA Reporting Standards Council has created to help the investment community achieve better outcomes.
Environment
A case in point of playing defensive as it relates to “Environmental” is the impact on seawater levels and water availability due to climate change. Beyond one-off anecdotes, many investors in Florida have increasingly factored in rising seawater in their development and acquisition activities, leading them to evaluate location and elevation, flood insurance, and technology that can mitigate flood risks. A similar situation is occurring in the American Southwest where a decade long drought has impacted some communities’ access to water. Some residential developments have found themselves with dramatically reduced access to water – a situation that some developers and investors did not factor in during their development and purchase. In both situations, a failure to consider the impact of climate change can have a dramatic impact on asset usage and values.
An example of playing offense when it comes to “Environment” is CBRE Investment Management’s approach to Logistics assets, specifically future proofing logistics stock. Adopting a forward-looking stance, the firm is emphasizing assets that have power availability, vehicle charging efficiency, and modernity. Regarding power availability, investors cannot assume that local utilities can provide thousands of additional amps. Instead, they need to construct warehouses that can wear the weight of solar panels on the roof (vs attempting to retrofit them later at a much higher cost). Increasingly, logistics occupiers will rely on electrical vehicle (EV) truck fleets to transport goods through regional distribution channels, necessitating charging stations inside or near warehouses. Logistics facilities without onsite charging stations will be at a disadvantage if occupiers’ EV fleets need to go offsite for charging, thereby slowing the movement of goods within the supply chain and creating a bottleneck. Since high-throughput Industrial occupiers value energy efficient and modern logistics facilities, developers and owners of modern distribution centers that meet occupiers’ demands for efficient energy usage will be better positioned in the next decade as older stock could experience functional obsolescence.
Social
One manager that has been proactive in “offensive” on the “Social” front is DigitalBridge (DB) , a digital infrastructure manager investing and operating across digital infrastructure, including towers, small cells, fiber, and data centers, which are essentially specialized power-shell office assets. Despite not being a pureplay real estate manager, many of DB’s ESG policies and implementation are noteworthy.
Founder and CEO Marc Ganzi feels strongly about Diversity, Equity, and Inclusion (DEI) initiatives and the benefits of having a diverse workforce, not for diversity’s sake, but the diversity of thoughts and perspectives lead to better decision-making, problem-solving and ultimately – better outcomes. In partnership with Sponsors for Educational Opportunity (SEO), Big Brothers Big Sisters, The Toigo Foundation, Diversifi Ventures and other leading organizations, as well as working closely with young students from diverse backgrounds, DigitalBridge has implemented mentorship and summer internship programs where the majority of participants are women and minority students from different backgrounds and universities, including Historically Black Colleges and Universities (HBCUs). By casting a wider recruitment net on the belief that ‘talent is universal, but opportunity is not’ – DB believes people of color are underrepresented within investment management, not because of dearth of talent, but resulting from narrowly-focused recruitment efforts focused on ‘traditional’ pools of talent (Ivy League, elite private universities) where access to a diverse talent pool was more limited. Ganzi notes that such efforts have energized his firm as employees saw the authenticity of such efforts and broadened their talent opportunity set in a historically tight labor market.
A different example of a manager playing both “offense” and “defense” on the “Social” front is Pretium, a general partner focused on Single Family Rental (SFR) properties. Due to ongoing housing affordability concerns, SFR managers often find themselves addressing media and regulators about affordability even though private equity managers own only 2% of the entire housing stock in the U.S. As well, such managers can improve the product and experience for tenants through scale, technology, and standardized processes. Over the course of the past year, Pretium has been proactive in engaging with lawmakers and other stakeholder to educate and inform through the hiring of staff dedicated to community relations and policies. Instead of being reactive, they have begun to be more proactive in building relationships among stakeholders and educating them so that the SFR industry is portrayed more accurately.
Governance
Pointing again to DigitalBridge, we have examples of “Governance” changes being both “defensive and offensive”. In 2021, DigitalBridge announced a new Board structure to improve efficiency. Some newer board members are people of color with highly relevant telecommunications industry and investment management expertise. The company did not appoint those individuals to fill a diversity quota; rather, each individual brings a distinct perspective and skill set, improving DB’s governance. Likewise, the appointment of a woman as Chairperson of the Board, who brings several decades of C-suite coupled with investment management experience, points to DB’s emphasis on diversity, equity, and inclusion. Overall, the experience and attributes of DB’s most recently appointed Board Members aim to improve outcomes for the Company’s private investors and public shareholders and meet the Board’s oversight responsibility.
Summary
ESG does not have to be an amorphous fad that comes and goes as the latest investment trend. Rather, investment professionals with an intense focus on performance and steadfast focus on their fiduciary duties can absolutely adopt ESG frameworks in their investment processes. Understandably, skepticism around the effectiveness of ESG investment and methodologies has surfaced. Instead of retreating, the investment community could instead view such feedback as instructive input to evaluate and improve ESG investment approaches and processes. If we were to look back at commercial real estate as an institutional asset class, we would see their evolution over past decades and that how investors approached them has changed dramatically. Similarly, the ESG movement should adapt and evolve. Hopefully, the investment community will maintain an open stance and pragmatically apply ESG as “offense” and “defense” tools to achieve the right outcomes.
In this article, I provided examples of real-life scenarios and well-regarded asset managers applying ESG practices in both defensive and offensive manners. As profit driven investors who need to answer to their constituencies, including LPs and shareholders, they are invested in ESG practices not for the pure sake of it, but because they can improve their bottom line. No doubt, other investment professionals have conjured up and implemented equally clever and effective ESG practices, but I hope the examples cited provide ideas for considerations.
By applying the ESG Principles and tools made available by the NCREIF PREA Reporting Standards, the investment community can benefit from frameworks and analytical tools formed by the collective wisdom of senior real estate investment professionals for the betterment of the industry. Please visit ESG (reportingstandards.info) for detail.
Paul Cheng, CCIM is an investment professional focused on the real assets space and a member of the NCREIF PREA Reporting Standards Council. His views are expressly his own and may not represent those of current and previous institutions he’s been affiliated with.
SOURCE: PREA Quarterly Fall 2022
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