Lower Emissions, Higher Returns: The Importance of Environmental Reporting in Real Estate Investing
By Linda Seggelke
Real estate investment trusts (REITs) are increasingly incorporating environmental, social and governance (ESG) factors into their asset analyses. What’s more, studies have shown a strong correlation between firms that report these non-financial factors and the profitability of property owners and operators.
Real estate plays a pivotal role in determining public and environmental health. In the United States, commercial and residential real estate accounts for around 40% of both total electricity use (or roughly 39 quadrillion Btus) and carbon emissions. More and more, investors consider these risk factors. As a result, they are seeking better reporting of the ESG performance of their investments.
For these investors, corporate governance has grown in primacy since the 2008 recession. Transparent operations, an independent board and reasonable executive compensations are sure signs of trustworthiness and quality. The same is true for social factors. Though a company that stresses diversity in the workforce, for example, is not inherently more profitable, it shows a maturity typical of well-managed firms.
So what of the environmental factor? It’s more than just climate change. The rise of globalization, the shift in population to urban areas and an increase in industrialization have all raised awareness of environmental issues. How companies address energy consumption, pollution and other factors is becoming paramount to the largest REITs.
Allocating resources for energy efficiency leads to lower operating expenses and, in turn, increased profits and capital. Furthermore, a company that stresses environmental stewardship as a part of its business plan is clearly focused on the future.
Amsterdam-based GRESB conducts an annual survey, the Real Estate, Developer and Debt Assessment, to track the performance of the real estate sector with particular attention to how ESG factors into operations. Their latest report shows that real estate companies and funds are improving across all aspects of ESG performance, including a 1.2% reduction in energy consumption and a 2% reduction in greenhouse gas emissions.
“In 2016, 90% of property companies and funds reporting to GRESB are integrating carbon management strategies into their investments,” said Nils Kok, CEO of GRESB. “These actions have contributed to a 2% annual decrease in carbon emissions, the equivalent of taking 704,464 passenger cars off the road.”
Over 750 real estate companies and funds participated in the assessment, representing more than 66,000 assets across 63 countries, with a value of $2.8 trillion. This is an increase from last year’s survey, which had just over 700 companies reporting. Around 75% of the reporting firms are private-equity investors while the rest are listed property companies.
“The 2016 GRESB data demonstrates that the global real estate sector is working to manage its carbon footprint, build resilience in the face of climate change and respond to more stringent environmental regulations,” Kok said.
Those entities that report to GRESB for seven consecutive years outperform their peers by an average of 12 points across all aspects of ESG. What’s more, a REIT’s focus on environmental, social and governance factors can lead to higher returns. “GRESB ESG performance data and trends matter because they show that, on average, property companies and fund managers are acting to improve sustainability performance,” said Jennifer Young, principal at the Townsend Group, a Cleveland-based real estate consultant and investment management firm. “Leading companies and funds are being rewarded with more efficient and more desirable properties—which may ultimately translate into better financial performance.”
Worldwide, the results showed that office companies and funds outperform other property types while listed property companies outperform private equity entities. There was a modest reduction in water use while properties are putting greater focus on occupant health and well-being.
Using the 178 companies and funds in North America as a snapshot, there were other interesting takeaways. On-site renewable energy generation increased from 284 GWh in 2014 to 383 GWh last year. There was also an increase in the average score for companies and funds. The GRESB assessment scores companies on a 100-point scale; last year, the average North American company or fund came in at 59 points, over the 54-point average in 2015.
Benchmarking the sustainability performance of REITs, along with social and governance issues, will help direct market forces and pressure these businesses to consider the environmental and social impacts and how they can improve financial performance. While carbon legislation, fluctuating energy supply and a greater awareness of efficiency by tenants and investors may slow down less progressive companies and funds, those that track and respond to ESG factors will have nimbler portfolios with higher returns.
Photo: Brad Hagan