All of these issues, of course, speak to the company's governance and while they may seem arcane and irrelevant to judging a REIT's investment profile, they are decidedly not. "We often speak to REITs about governance issues and it is something that is important to us," Jones says. REITs that have superior governance practices tend to trade at higher multiples, he says.

The Rise of ESG

Good governance is part of a larger movement among investors, namely an emphasis on environmental, social and governance issues. Granted, it may not have the same allure as policies that focus on the environment or programs that emphasize a company's social initiatives, but it is part of the package that is becoming increasingly important to investors—not just because they want to 'do good' but also because they want to do well with their bottom line.

There is a growing body of research that supports this belief. Quantitative equity strategists at BofA Global Research, for instance, found that companies scoring highly for ESG practices did better than those in their sectors that scored poorly. Namely, US companies with high (top quintile) ESG rankings in the S&P 500 index have outperformed their counterparts with lower (bottom quintile) ESG rankings by at least 3% every year for the past five years. The report also pointed out that in the US ESG metrics are the best measure for signaling future earnings risk—superior even to financial risk factors, like the level of a company's leverage.

In a separate study released at the beginning of the year, ISS ESG, the responsible investment arm of Institutional Shareholder Services, also found that there is a link between ESG and financial performance and delved into the reason why. "While one can argue that the relationship between ESG and financial performance is perhaps due to the fact that more profitable firms have the resources to invest in areas that positively influence ESG, it could also be that profitability rises as a result of a company better managing its material ESG risks, or it could be a little bit of both."

If it is a little bit of both, then this means that good-ESG initiatives drive up financial performance, which then provides the monetary resources to invest to be an even better-ESG firm, which then drives up performance again, and so on, ISS ESG said. "People may choose not to invest in a firm that has poor ESG, thereby limiting its access to capital and raising its cost of capital. Firms that get in trouble on the environment may be distracted by the regulatory headache (higher costs) and customers may avoid the firm (lowering revenue). If one does not treat employees right, this could lower morale, increase turnover, and therefore lower productivity."

Mindful of these and other findings, institutional investors have been embracing ESG as an investment strategy. Norway's $1 trillion wealth fund, for example, is excluding four companies for their vast emissions of greenhouse gases, or at least putting them on probation to force them to change, according to statements the chairman of its ethics watchdog made to reporters.

To name another example, in January of this year BlackRock announced it had joined Climate Action 100+, a group that pressures companies to act on climate change. Launched in 2017, Climate Action 100+ counts more than 370 institutional investors as members.

In another interesting development, at the start of this year Fitch Ratings announced the launch of a new integrated scoring system that shows how ESG factors impact individual credit rating decisions.

"Our focus is purely on fundamental credit analysis and so our ESG Relevance Scores are solely aimed at addressing ESG in that context," Andrew Steel, global head of Sustainable Finance at Fitch Ratings, said at the time. "The scores do not make value judgements on whether an entity engages in good or bad ESG practices, but draw out which E, S, and G risk elements are influencing the credit rating decision."

In a separate report, Fitch Ratings noted that 67% of banks screen their loan portfolios for ESG risks when lending to corporate borrowers.

Ultimately, though, results are what truly resonate and investors are reporting the ESG does indeed work. Terrell Gates, CEO of Virtus Real Estate Capital, embraces ESG as an investor because these income streams are more resilient. The company focuses on healthcare, education and workforce housing and the 'S' piece has been particularly key to its investment philosophy, he says.

"We benefit all stakeholders with this approach—the residents in communities, the broader city and our own investors with attractive risk adjusted returns."

What ESG Looks Like In CRE

As investors make their demands clear, CRE has followed suit adopting ESG in their own operations. In many cases, this was not at the prodding of institutional capital—the commercial real estate industry has known for a long time that environmental-friendly buildings perform better.

More recently they have been focusing on the governance and social pieces of the equation.

"This is a topic of increasing importance to REITs and CRE companies," Jones says. "There has been an exponential growth in the issuance of ESG reports, for instance."

There are many initiatives to point to in the CRE community, he continues. On the social side CRE companies are both looking within their employee bases and putting together social policies on how they run and manage their company, he says. They are also promoting diversity within the workforce and the board of directors and to develop and train employees to promote upward mobility. Outwardly focused policies look to have a positive impact on the communities where they do business. "It can be a number of different things, Jones says. "For a retail CRE company, for instance, it could have a policy of leasing space to locally-owned and operated retailers. That has both a social benefit and also a business benefit, as local retailers usually resonate with shoppers."

Indeed, there are a multitude of ESG strategies available to companies, says Uma Pattarkine, investment strategy analyst from Centersquare.

Strategies focused on employees include diversity and inclusion, a large umbrella that considers not only the diversity of the workforce across various management levels, but also considers any compensation gap that might exist between different groups. "Compensation gaps can be as direct as salary gaps or even equal maternity/paternity leave," she says. Other examples are wellness programs and incentives, employee development programs, ethics training and employee satisfaction surveys.

Community-focused initiatives can be broader community partnerships or focused on the key competency of the company itself, Pattarkine continues. "For example, Prologis has developed a community training development program that provides the skills for logistics and warehouse workers in the communities in which they operate—the graduates of these programs then go on to be employed by Prologis' tenants like FedEx."

Another example is Cedar Realty Trust, which has a range of social and governance initiatives it has put in place. "Our real-estate strategy's guiding principle is to enrich underserved neighborhoods through thoughtful, community-minded investments," says Bruce Schanzer, president and CEO. "Over the last few years, we've been actively migrating our capital into high-population-density submarkets within the DC to Boston corridor with the goal of creating diverse mixed-use destinations in underserved urban locales, specifically targeting neighborhoods regarded as 'food deserts.'"

It also uses ESG to guide its internal policies, says Robin Schanzer, EVP and COO. "Hiring and promotion are entirely merit-based—ensuring an equal opportunity for anyone wishing to join our team—and we require a diverse candidate pool before making any hiring decision. Our company also has an equal pay initiative to eliminate salary disparities between different genders and ethnicities."

As a result, 63% of Cedar's workforce is female, as well as many of our executives and mid-level managers, Schanzer says. "We also have a highly diverse board of directors: Of non-executive board members, 50% are either minority or female."

Opportunity Zones' Social Impact Mandate

When the Treasury Department first rolled out its initial guidelines for Opportunity Zones, institutional investors were excited, Derek Uldricks, president of Virtua Capital Management, said at the time. Why? They did not get the same tax benefits as taxable investors but many felt that an investment in an Opportunity Zone could check their ESG box. "They don't care much about the tax benefits; they just want to underwrite deals that have a social impact," according to Uldricks.

Fast forward two years later and Opportunity Zones are not only investing in ESG-friendly properties, but they are also making it easy for investors to track the impact.

As one example, Catalyst Opportunity Zone Funds has created a social impact scorecard to ensure it is meeting both community and investment needs on Opportunity Zone projects.

The impact score card and measurement framework does a few things, says Jeremy Keele, managing director at Catalyst. "On the one hand, it identifies community needs in a particular zip code or census tract. That could mean that local residents don't have healthy, nutritious foods from a grocery store or that there are affordability issues for housing. The second part is an impact underwriting assessment tool that allows us to understand how the project will address the needs. That receives an objective score based on a data set that we have access to."

In addition to weighing social needs when identifying and underwriting opportunities, the firm's model also tracks the ongoing needs and impact of the investment. "The third piece is an ongoing reporting and measurement tool and how the community is evolving over time and how our investment is moving the needle over time," says Keele.

Another example is NES Financial, which recently collaborated with Howard W. Buffett, who is Warren Buffett's grandson, to develop what it says is the first standardization technology for predicting ESG impact in Opportunity Zones.

"The ultimate success of this initiative will be measured by the positive social impact that results in these communities," says NES Financial EVP Reid Thomas.  As part of this strategy, NES began looking for an objective and consistent measuring methodology to track the positive impact of OZ investments. With  Buffett, it implemented the impact rate of return as part of its platform.

To evaluate the social, environmental and economic impact of Opportunity Zones, the impact rate of return evaluates magnitude, quality, time and cost. Thomas says it is essential to standardize social impact and OZs in a scalable way.

"Most of what is out there is subjective and requires extensive consulting, so we looked for something that could be implemented in technology, that's algorithmic, and does not place any additional cost burden on our clients," Thomas says.