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ESG in Real Estate: Why it Matters Now More Than Ever

Brace yourself. This is a serious article! Because I, The Proptech Scout, hold myself to some ESG standards in my real estate development work and in running this blog.

ESG really emerged in 2019 as a relatively new term before exploding into prominence during the COVID-19 pandemic. Many institutional funds now require ESG policies for their real estate investments.

Environmental, Social, and Governance factors have become increasingly important to investors and consumers in recent years. But not without controversy. Let’s first what each ESG factor is.

What is ESG?

Environmental: This refers to a company or asset’s impact on the environment. For example, a solar power plant would have a positive environmental impact. A coal mine would have a negative environmental impact.

Social: This refers to a company or asset’s impact on society and it’s commitment to equity and diversity. For example, a company that provides job training for underprivileged youth would have a positive social impact. A company that outsources all of its manufacturing to developing countries would have a negative social impact.

Governance: This refers to how a company or asset is governed. Companies set governance standards for transparency and integrity in the decision making processes. For example, a publicly traded company with strong shareholder protections would be considered to have good governance. A privately held company with little transparency would be considered to have poor governance.

Controversy

ESG does face a significant amount of backlash. It’s politically divisive, with conservative critics calling it ‘woke signaling’ or a way for liberal agendas to regulate capitalism. A tweet from Elon Musk about the removal of Tesla from the ESG index sparked heated debates about whether ESG is effective at all. Critics further point out that fund managers like Blackrock charge higher fees on ESG themed portfolios due to higher demand.

Given its newness, ESG’s inconsistency and subjectivity still leave much to be desired. While there are quantifiable standards that can be applied to environmental impact, the social and governance aspects are much more qualitative.

When it comes to real estate, proptech, and my business, I’m not a huge fan of added regulation, reporting, and paperwork. Yet I sit firmly in the pro-ESG camp.

Why Does ESG Matter in Real Estate?

Environmental: The built environment has a huge impact on the environment- it’s responsible for 40% of all carbon emissions. I know first hand that building a sustainable building adds complexity and cost to construction. Every building I’ve worked on has either received LEED or WELL certifications or incorporated a variety of sustainable features like solar panels. But I also know that properties that are energy efficient have lower maintenance costs. Sustainable development can pay for itself if done correctly.

Social: Real estate projects have a significant impact on society- society exists in the built environment. So it’s important that all stakeholders (e.g., local residents, community groups, etc.) are engaged throughout the decision-making process. Dense urban centers are especially hard to develop in due to all the stakeholders involved. All the extra regulation made my job as an NYC developer incredibly difficult compared to other jurisdictions. But the regulations are there because profits are not always aligned with the well being of neighborhood.

I’ve considered how my projects mesh with the neighborhood by attending block association meetings, getting to know the neighbors, and talking to city council members. Going the extra mile to satisfy uninvested third parties has long term benefits. Properties located in areas with strong social and economic conditions are less likely to experience vacancy and tenant turnover during periods of economic uncertainty.

Governance: This is arguably the hardest aspect of ESG to quantify due to its subjectivity, and admittedly the one I’m most skeptical about. But with so many instances of fraudulent founders inflicting damage well beyond their investors, I would rather take a stab at applying ethical governance standards than none at all.

Does It Work?

There is an increasing body of evidence that suggests that properties with strong ESG profiles outperform those without such profiles over the long term. A recent study by JLL found that sustainable buildings outperformed conventionally managed buildings by nearly 30% over a 10-year period. And a separate study by S&P Global found that publicly traded companies with strong sustainability ratings outperformed their less sustainable peers by more than 2% annually over a 20-year period. But this should be taken with a grain of salt, as there’s still limited evidence in ESG performance.

What’s clear though, is that institutional investors are increasingly eyeing ESG factors when making investment decisions. And consumers are more likely to buy from businesses that they believe share their values and support sustainable practices. So in a sense, the demand for ESG factors is fueling its own performance.

How Real Estate Investors Incorporate ESG into Portfolio Strategies

There are many ways to incorporate ESG into your investment strategy, but here are three of the most popular:

  1. Focusing on Green Buildings – Green buildings are designed and built with the environment in mind, with features like energy-efficient lighting and appliances, water-saving fixtures, and recycled materials.
  2. Community Development Projects – These are typically mixed-use developments like affordable housing, public green space, and community facilities like schools and libraries. The benefits to the surrounding community tend to lead to the assets retaining their value better over time.
  3. Impact Investing – Impact investing is an emerging field that focuses on investments that generate both financial return and positive social or environmental impact. For example, you could invest in a green bond fund that finances energy-efficiency upgrades for commercial buildings. Or an affordable housing fund that provides financing for low-income housing developments.

How Proptech can align with ESG requirements

Proptech companies have a huge opportunity to help real estate companies and professionals hit their ESG goals. There are already a handful that provide data collection services to track building performance against environmental targets. Venture Capital allocates a disproportionately low percentage of funding towards ClimateTech. especially in the field of reducing construction and building emissions. But on the flip side, with proptech startups raising more every year, I’ve seen some sloppy investments in questionable business models. We need to see less of those.

Walking the Walk

This article isn’t an exercise in appearing socially responsible or to establish a liberal agenda. It’s about establishing and holding proptech to higher standards. I will prioritize the promotion of proptech companies that have ESG initiatives in place because I believe it enhances the built environment. And I have no problem criticizing proptech companies that lack ethical governance. This will become a more prevalent theme in my future content because not enough people in proptech or real estate are willing to call out bad behavior. Stay tuned. Proptech Scout out.