Climate Change and ESG Impacts on Commercial Real Estate

As President Biden signs sweeping climate change executive orders, the commercial real estate industry is also ramping up the conversation around Environmental, Social, and Governance (ESG). Just this month, at the virtual MBA CREF21: Lending, Investing, Servicing and Technology Convention & Expo, I was on a CRE Finance Emerging Issues panel to discuss climate change and ESG impact on CRE, moderated by Michael Berman, President & CEO of M&T Realty Capital Corporation. One clear consensus amongst all the panelists was that ESG is here to stay.

The State of Affairs

ESG has been gaining more traction in the last six months, especially with investors who want to mitigate their risks and who see ESG not only as a matter of ROI, but as an evaluation methodology. ESG is now a risk management tool, and they want to mitigate their risks by targeting funds with good ESG performance (I’ll discuss ESG metrics a bit later).

The Environmental aspect is the most discrete factor here for property owners, who need to be aware of how their assets are going to be affected by near-future climate change and extreme weather events.  For example, is the building in a potential flood zone, and are there sufficient measures in place to guard against this? It’s a simple question, but the answer can have significant impact on a property’s valuation and costs.

While the climate change topic has been around for decades, Social and Governance are less established, which brings me to the next point.

What is Still Unclear

Currently, there is no standardization of ESG metrics, nor any objective scale to determine what is considered good versus poor ESG performance. Thus, there is no one way for investors to compare ESG across sectors. There is also not enough data for good prediction models, and regulatory policies are lagging. The fundamental challenge is we don’t have a consistent framework across the board, and not enough transparency, yet – although we seem to be heading this way.

But while this is the case for ESG as a whole, the Environmental share is slightly further ahead of the pack. Social and Governance are relatively new and thus less well defined, but when it comes to climate change and sustainability, we know that building green is not only good for the environment but great for the bottom line. There are simple, pragmatic ways to evaluate real estate for sustainability and resiliency, and yet, I see ESG being ignored during the due diligence phase when it can and should be considered.

A myriad of data points for ESG can be collected during due diligence. For example, resiliency assessments and mitigation strategies can be easily tacked on during data collection for Property Condition Reports / Physical Need Assessments. No one wants to lose valuable equipment or sustain property damages due to severe weather events, and we can all agree that tenant longevity is important. Both can be achieved with the right corporate policies and resiliency measures.

It’s worth noting here that ESG is just one among many considerations for investors. Investors can decide which data points are most important to them, and when it comes to ESG performance, whether a portfolio is above or below average may not always be the deciding factor.

Where We Are Headed

ESG will become more standardized and, as investors target more ESG funds and corporate policies become solidified, we’ll be getting more data and insight as well. In the meantime, we can compare individual assets and consider the potential natural disasters that threaten properties now.

Due to all these factors, the CRE industry needs to look toward building more sustainably and ensuring there are climate change mitigation measures in place sooner rather than later.

Again, ESG is here to stay, so it’s best to start collecting data and planning for it now.