There’s an acronym that has been around for a while now which is getting more attention as we emerge from the pandemic: Environmental, Social and Governance (ESG) is becoming a more common topic around the design of new buildings, whether they are speculative in nature or for a specific corporate user. ESG metrics are becoming a key consideration for investors, and the concept is here to stay.
So what does the acronym mean? The Environmental component is easy to understand for our industry. All of the different programs that measure sustainability fall in this category and can be used as a metric. LEED, Green Globes, EnergyStar, Sustainable Sites, Well and Fitwel, are all examples. The Social component is intended to measure how the building impacts the surrounding community. It also measures labor standards which include working conditions, diversity, safety and social justice for the building users. Governance measures the corporate governance of the developer or building owner, considering practices that are not directly related to the asset itself. Board diversity, executive and employee pay, tax strategies, political lobbying and contributions, and other behaviors such as corruption and bribery are included in the analysis. There is currently no single industry-wide set of common standards to measure ESG, and methodologies can vary significantly. It is likely only a matter of time before analysts established standard that can be applied across industries.
It is interesting to think that the concept of leveraging investment criteria to impact behavior has been around for a long time. Apartheid, blood diamonds, free-trade coffee and ethically farmed cocoa are only a few examples where capital market investors have collectively tried, with varying degrees of success, to incentivize specific behavior.
In the 1960’s and 70’s when social responsibility was first introduced to the financial performance conversation, experts claimed that social or ethical agendas negatively impacted financial returns for companies. This mentality has evolved substantially since the late 1990’s. In 2005, the United Nations commissioned a report which concluded that investment companies have a fiduciary duty to integrate ESG issues into their analysis. ESG can now be a key differentiator to provide a competitive edge. Over 80% of S&P 500 companies today publicly report their ESG performance in some kind of metric.
What does this mean for real estate? We see more and more emphasis on investing in products and companies that demonstrate social responsibility. Research indicates that ESG funds and indices have outperformed standard benchmarks during the coronavirus pandemic, and the interest in sustainable investing is expected to grow considerably in years to come. Moving forward, it is not only building users who will demand healthier and more sustainable buildings that do the right thing for the community and the environment. Capital investors and lenders are now going beyond demanding high economic performance standards on the asset itself. Social responsibility and corporate governance will increasingly be scrutinized as capital markets determine where their money goes. It is no longer enough to deliverbuildings that are beautiful, functional, responsive tothe environment, on–budget and meeting market demands; developers stand to benefit from focusing on an ESG agenda.