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Environmental Performance Investments Gaining Popularity Among REITs

Daniel Talero
Oct 01, 2019

Smart Home 5

The real estate sector is seeing rapid adoption of formal environmental performance frameworks that can guide portfolio-level integration, signal ROI to investors, and improve energy efficiency investment rationales. These frameworks are broadly focused on environmental, social and governance (ESG) policies and are growing especially quickly in the real estate investment trust (REIT) sector, taking sustainability investment in real estate to a new level. 

New ESG Frameworks, Similar Goals

Formal ESG frameworks vary, but all heavily emphasize environmental concerns. Weightings generally assign the environmental factor at 40% of an overall ESG rating, which includes design, execution, and disclosure of sustainability, carbon footprint, and conservation policies. Social factors account for 20% of the score, reflecting a company's quality of community involvement. Governance factors, such as board independence and performance of fiduciary responsibility, account for the remaining 40%.

One long-standing ESG framework that stresses environmental factors is the Global Real Estate Sustainability Benchmark (GRESB), which was established in 2009 by a group of pension funds seeking reliable data on investment ESG performance. In 2019, GRESB assessed 1,005 real estate funds and property companies, covering $4.1 trillion in real estate and infrastructure value. The framework now has more than 100 institutional investors as participating members, representing more than $22 trillion in assets under management (see figure). 

Yearly Growth in GRESB-Assessed Portfolios: 2010-2019

Yearly Growth in GRESB-Assessed Portfolios: 2010-2019

Note: AUM is in trillions USD. Only Institutional investors counted.

(Source: Global Real Estate Sustainability Benchmark)

ESG Is Producing Head-Turning ROI

The recent uptick in ESG participation isn’t a passing fad—real estate managers are realizing significant ROI from these investments. From 2005 to 2017, investment manager CenterSquare evaluated a hypothetical Pure ESG Portfolio composed of US real estate securities in the top quartile of ESG scores, finding it outperformed an Equity REIT Index by 402 basis points on an annualized basis. Investment managers increasingly see ESG data improving risk-adjusted returns and properties focused on ESG appealing to a broader and more attractive tenant and buyer pool, which leads to increased rents and valuations. 

Investor demand for ESG-evaluated assets is rapidly growing. There were $12 trillion in ESG-evaluated US assets under management at the end of 2018 and $30.7 trillion worldwide. These assets represent a 34% increase from 2016 according to the US-SIF Forum for Sustainable and Responsible Investing

Big Upside, Challenges Remain

ESG’s rapid adoption follows from its positive effect across the value chain. Taken with its structural benefit to the bottom line, ESG adds up to an attractive legacy initiative for the C-suite.

Data reporting is the main challenge to ESG‘s rise. While GRESB is seeing wider adoption, there still aren’t broadly recognized standards for scoring, terminology, and reporting across different industries. Organizations, such as the Sustainability Accounting Standards Board (SASB), are making progress—in 3Q 2018, SASB released 77 industry-specific accounting standards to help investors understand how material sustainability issues affect a company's financial performance. Such standards are crucial—the stronger the ROI case is, the more likely ESG is to make headway into growing private markets. If not for standards, ESG could remain limited to shrinking public markets that already have disclosure requirements.

Despite the challenges, the REIT sector is discovering the benefit of balancing sustainability and investor returns through ESG. If the trend accelerates and widens to other sectors, it could lend new luster to an old business adage—it is certainly possible to do well by doing good.