The Growing Importance of ESG in Real Estate: Factors, Financial Impact, and Metrics

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Why ESG is becoming increasingly important in real estate

In recent years, the topic of ESG (Environmental, Social, and Governance) has been at the forefront of discussions in the real estate industry. ESG encompasses the long-term goals and commitment of companies to provide for sustainable, future-proof, and socially responsible built environments. Why is that so? On one hand ESG covers a wide spectrum of socially and politically agreed norms that direct our development towards a sustainable future. Furthermore, the last crises (first financial and now COVID and war) have forced a critical mass of entities and opinion-makers to accept ESG as their personal mission and readiness to sacrifice some short-term gains for joint long-term goals.

Factors driving the ESG trend in real estate

ESG trends are driven by several different factors, including regulatory and market pressure, social pressure, resilience, and the ROI. Having said that, ROI is being affected by all these factors and is becoming more multilayered variable. Even though a short-term ROI is usually lower due to additional ESG investments and reduced risk, investors can expect higher returns on the long run, due to cost, regulation and technology risk mitigation.

The critical mass of pro-ESG agents has been achieved. Every stakeholder on the market is now translating ESG measures into their products and services. An ESG-compliant building is, therefore, directly translated into tenants’ product.

A decade ago, having sustainable, energy-efficient and end user platform features in a building was still a luxury or nice-to-have. The problem was that those features could not be easily or directly translated into ROI. Nowadays the scissors are opening. The difference in the market value of ESG-compliant vs non-compliant buildings in reference to the additional investment required to fulfill ESG norms is spreading.

Regardless of the ESG trend we have to be aware that the stock of existing non-ESG compliant real estate is still enormous comparing to new developments. These non-compliant real estate will still be heavily transacted for the years to come however at a »brown rental discount«, whereas ESG compliant/certified buildings will sell at a »green rental premium« and higher liquidity. The message on the market is clear and sets the stage for viable future investments.

What you can measure, you can manage

Although ESG evaluations and metrics are still somewhat vague and can vary substantially when compared to different measurement standards, the metrics are improving, and we can expect them to be comparable to standardized financial reports in the next couple of years. ESG-related risks are becoming too material to be neglected by serious long-term investors and companies.

To name a few of ESG measurement standards/organizations:

  • MSCI – Climate Value at Risk Index
  • GRESB – global ESG benchmark tool
  • IWBI WELL – for healthier workplace
  • SDG – UN Sustainable Development Goals
  • TCFD – UK Task Force on Climate-related Financial Disclosures
  • PRI – Principles of Responsible Investment
  • SDFR – Sustainable Finance Disclosure Regulation
Source: World Economic Forum, 2019

The World Ecomonic Forum has compiled the map of ESG Ecosystem which aims to decipher the “who is who” and the dynamics of ESG reporting. Namely the complexity and non-transparency of the ESG ecosystem is challenging for investors when deciding about allocating capital to companies that score well on ESG criteria.

The future of ESG in real estate management

In summary, ESG compliance is becoming a critical factor in the real estate industry, as ESG-compliant/certified buildings are expected to sell at a premium and have higher liquidity. This gives a clear direction to developers and investors to prioritize sustainability in their projects and prove it through building certification and measurement standards.

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