Three Benefits Of ESG In PE Real Estate Investments

Across the financial industry, investors and their stakeholders are utilizing Environmental, Social and Governance (ESG) criteria to screen investments, manage risk, enhance returns, and tailor portfolios to a group of increasingly socially conscious investors. In 2019, Bloomberg reported global socially responsible investments grew by 34 percent to $30.7 trillion in just two years.

While all components of ESG investing are important, the world is focused heavily on environmental sustainability efforts due to the significant financial risks posed by climate change. The World Economic Forum 2021Global Risks Report cited extreme weather events, human environmental damage, biodiversity loss, and climate action failure as the top environmental issues that pose global risks over the next decade. In its Weather, Climate & Catastrophe Insight 2020 annual report, Aon estimated that the global economic loss related to weather and natural events was $268 billion.

Real estate investors are already experiencing the negative impacts of climate change on their investment portfolios. Sea-level rise, droughts, hurricanes, and wildfires all present significant threats to damaging land, buildings, and infrastructure as well as create resource shortages and supply chain disruptions. Regulatory changes also have the potential to hurt real estate owners through insurance claims or legal damages if they are unable to keep up with requirements.

These threats are causing private equity real estate investment managers to increasingly measure their portfolios against environmental sustainability benchmarks and embrace ESG assessments. The good news is, there are multiple benefits to be gained by incorporating ESG into private equity real estate investment portfolios.

ESG Helps Manage Risk

ESG investing helps quantify risks that can not be measured using traditional financial metrics. ESG covers a broad spectrum of material impacts. For example, environmental criteria considers a company's energy and natural resource use, pollution, and treatment of the environment; social criteria includes issues such as company diversity and employee wellness and safety; and governance looks for problems such as executive corruption and fraudulent accounting.

In a nutshell, ESG standards like metrics, data, and benchmarking allows management teams to address threats before they happen through risk mitigation strategies, compliance objectives, and disclosures, helping companies engage in more effective risk management and enhancing investment value. This is particularly important for real estate investments that must always consider a long-term investment horizon in a fixed physical location. 

ESG Ensures Savings Opportunities and Greater Returns

ESG provides an opportunity to make large operational savings during the life of an investment. For example, investments in energy efficiency and waste reduction not only help meet ESG goals, they can also provide significant savings. 

An increasing amount of data suggests sustainable assets often outperform less sustainability-focused investment assets. For example, environmentally certified buildings have shown to attract premium asset valuations. Green buildings are perceived as more attractive to lucrative tenants and can demand higher rental revenue. And, green buildings also carry a 34% lower default risk. 

ESG Will Attract More Capital

Over the next 30 years, an estimated $30 trillion of wealth will exchange hands from the baby boomers to Generation Xers and millennials. Why does this matter? Millennials have a more sustainable mindset than previous generations. They are twice as likely to invest in companies targeting social or environmental goals, and 90 percent of them want sustainable investing as an option within their 401k plans. 

Knowing this, having investment opportunities with proven ESG policies and procedures in place will be key to attracting capital in the future. ESG policies also help companies and investors connect with the community and produce positive outcomes such as stronger brand perception.

How To Make the Shift to ESG

Real estate investment managers can begin to prioritize ESG by setting goals and strategies as well as developing a set of ESG metrics to track. From there, it’s important to create a system that begins digitizing and centralizing ESG data. Once information is digitized and accessible, companies and investors can gain an understanding of their sustainability performance.

Understanding where your investment portfolio stands allows for needed corrections, the ability to align with goals, and lays the foundation for the next step: benchmarking. Reporting and benchmarking framework examples include the Global Reporting Initiative (GRI), the International Integrated Reporting Council (IIRC), and the Taskforce on Climate-related Financial Disclosures (TCFD)—all designed to help organizations report their progress and achieve their goals. Lastly, many real estate investment managers and developers are obtaining green building certifications such as the LEED and BREEAM to demonstrate environmental accountability to both investors and tenants.