Real estate industry turning its focus more to ESG

Real estate managers no longer consider ESG a matter of changing lightbulbs and installing low-flow toilets in their buildings but are now weighing a lot more effects that environmental, social and governance factors have on returns.

In the past, real estate managers' interest in making their buildings more eco-friendly was driven by tenant demand, mainly in the office sector, said Elena Alschuler, head of sustainability for the Americas in the Baltimore office of LaSalle Investment Management Inc. Today, the accelerants are a combination of the regulatory environment and investor pressure, she said.

"Investors are starting to see that it (ESG) does have an impact on returns," Ms. Alschuler said. It not only impacts the expense side but the income side as well, she added.

Real estate managers like LaSalle are more focused on sustainability than social or governance aspects of ESG, Ms. Alschuler said.

There's a heavy focus on energy consumption and how to make properties more sustainable and less susceptible to climate risk, she said.

In real estate, the "S" and the "G" are not applicable in the same way as it would be for managers that invest in companies, Ms. Alschuler said.

Companies are getting the same pressure as real estate managers to be more sustainable and are looking to their landlords for help, she noted.

LaSalle is heavily focused on the long-term impacts of climate change.

"Climate change is a real thing," said Jacques Gordon, Chicago-based global head of research and strategy at LaSalle Investment Management. "Climate change and climate migration will be a major driver of the movement of people" from less developed countries or regions, which do not have the political or financial wherewithal to take measures to help allay the ravages of climate change, to more developed countries, he said.

The continuing impacts of climate change, mainly rising sea levels, could displace 214 million people around the world, according to a LaSalle study released in June.

Developed nations will have to deal with the "ripple effects of climate migration," the report noted.

LaSalle had $82 billion in assets under management as of March 31.

Aeon Investments Ltd., a London-based credit-focused investment company, predicts that real estate projects with poor ESG practices will have problems accessing financing, which could result in limited options and punitive borrowing rates in the medium term.

According to a white paper from Aeon in May, 35% of properties owned by real estate investment trusts are exposed to climate change hazards. Among potential climate changes risks, 17% are subject to inland flood risk, 12% to hurricanes and typhoons, and 6% to rising sea levels. Property owners that take these risks seriously, such as by future proofing their properties, are more likely to improve the risk-adjusted performance of their portfolios than those that do not, the paper said.

"The lending industry is gradually shifting towards rewarding a 'green premium' when financing ESG-led real estate projects," as some lenders start to embed the Loan Market Association's Green and Sustainability-linked Loan Principles into their lending policies, said Ben Churchill, co-founder and chief operating officer of Aeon Investments, in an email.

"To date, with insufficient evidence to support ESG assets outperforming the rest of the market, the lending industry has largely erred towards imposing stricter borrowing terms on those projects which clearly display limited ESG benefits, rather than rewarding those that do with better lending terms," but that "brown discount" approach is changing to a "green premium" as lenders move toward offering better financing options to borrowers whose assets meet ESG principles, Mr. Churchill said.

Additionally, some industry executives are starting to take steps to incorporate the social aspects of ESG into their investment practices.

The Urban Land Institute, for instance, is working to make real estate executives more aware of the impact their buildings can have on society. In May, the ULI released a report on the 10 best practices for prioritizing racial equity in real estate development. The report came out of a workshop of 32 real estate and racial equity experts.

The 10 principles start with embedding racial equity across all aspects of real estate development and include creating a community-centered development process and articulating a racial equity business case.

The 10 principles are not a checklist for real estate executives, but "a toolkit to take what they need" to embed inclusion into the real estate development process, said AJ Jackson, executive vice president, social impact investing at JBG Smith Properties Inc.,a Bethesda, Md. -based real estate investment trust.

The workshop and the report grew out of increased interest from ULI members and real estate industries executives on the role of real estate in promoting social equity, said Mr. Jackson, workshop chairman. They want to know "what it looks like and how do we make it actionable," he said.

And there's more and more institutional capital making investments around the racial equity theme, especially by sophisticated investors, Mr. Jackson said. Real estate executives are watching where the money is flowing, he said.

BlackRock, for instance, is developing investment strategies around racial equity and inclusion themes. The manager is currently raising a new multi-alternatives strategy fund, BlackRock Impact Opportunities Fund, with a $1 billion target to invest in businesses and projects owned, led by, or serving Black, Latino and Native American communities in the U.S.

And the real estate industry "has a profound impact on racial equity," Mr. Jackson said. "It drives so much of where people work and live" and has a major impact on communities, he said.