ESG real estate / vencavolrab

This article appears in the April 2022 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.

Clients interested in investing in commercial real estate are now increasingly able to measure ESG performance of individual developers.

Karen Clarke-Whistler, principal with Toronto-based ESG Global Advisors and former chief environment officer with Toronto-Dominion Bank, said most large investors in Canada have sustainability ESG teams who view real estate as “an opportunity area” because of its well-developed ESG program and because “sustainable real estate is a really big component of green bonds and some of the new capital-market innovations.”

“For commercial real estate, 2022 will be the year that ESG transitions from the ‘what’ to the ‘how,’ or from the ambition to the execution,” stated Paul Morassutti, vice-chairman of California-based real estate firm CBRE Group Inc., in the company’s 2022 Canada Real Estate Market Outlook. “The ambition is a net-zero world by 2050 and the execution is about integrating ESG factors with financial factors into the investment process.”

The fact that almost 40% of annual CO2 emissions result from building operations and construction has spurred shifts in the real estate and development arenas, with many sector participants committing to more sustainable practices.

Developers and REITs are among those setting net-zero targets for their operations and for new buildings and developments.

For example, Toronto-based Dream Group, which comprises several public real estate trusts and companies, did so in November 2021, as did Toronto-based GWL Realty Advisors in January. CBRE made its first commitment to carbon neutrality back in 2007.

Montreal-based Ivanhoé Cambridge Inc. has committed to holding a carbon-neutral portfolio by 2040. In October 2021, the firm announced it was converting its corporate program of term loans and lines of credit, valued at $8.5 billion, by indexing them to its ESG performance. The firm stated this “ambitious initiative” enables the company to align its financing activities with its sustainable investment priorities.

Furthermore, municipalities such as West Vancouver, B.C., and large institutional investors are demand net-zero policies from suppliers and clients. This trend has enabled real estate to become more integral in investment portfolios that are shedding fossil-fuel investments as investors strive to reduce carbon emissions, said Thomas Mueller, president and CEO of the Canada Green Building Council. Through investing in real estate, “you can actually invest in carbon reduction and have a return on your investment,” he said.

The environmental component of ESG investing — such as reducing climate risk and carbon emissions — usually gets the most attention. But two years of the pandemic have highlighted the importance of social issues in the real estate sector. For example, the link between building design and health and wellness has become evident.

“We say we’re going to make great financial returns by focusing on social and environmental outcomes,” said Jamie Cooper, portfolio manager of the Dream Impact Fund. “The more sustainable our buildings are, the more amenities they have, the more that it feels as part of the community, the more desirable a place it’s going to be to lease space in, and we’re going to be more occupied and hopefully have higher rents as a result.”

Cooper said there’s increasing pressure from investment managers, banks and other funding institutions that want their investments to be “doing more than just earning a financial return.” Members of a teacher’s union, for example, are saying they want to see the money they are investing for their pension plan “being used to do good in the community,” he said.

Community engagement is a “huge issue,” Clarke-Whistler agreed. Having strong community support “can make or break a development.”

As an investor, Clarke-Whistler said, she would “be really looking at tenant satisfaction because that’s the integrator of everything.” Other social factors to measure include workforce diversity, customer engagement, safety management and community engagement.

Before the Covid-19 pandemic, tenant or occupant health and wellness focused on features such as fitness classes, bike parking and healthy food options. Now, the health issues are focused on “more technical building characteristics,” such as ventilation, light, indoor air quality, temperature and operating procedures such as cleaning protocols, according to The JLL Return on Sustainability white paper, released in January by Jones Lang Lasalle Inc., a Chicago-based real estate firm.

Noting that more people heading into the office are worried about airborne diseases, the JLL paper cited research from the Healthy Building Team at the Harvard T.H. Chan School of Public Health, which found optimized ventilation can improve productivity by the equivalent of US$6,500 per person per year.

ESG ratings and benchmarks

A stated commitment to ESG principles is nothing without metrics. Several third-party rating and evaluation organizations provide benchmarks and ratings for fund managers and investors who want to know how companies are performing on the ESG front.

Programs such as the BOMA Best sustainable buildings certification and Leadership in Energy and Environmental Design (LEED) are for individual properties. Institutional investors need more comprehensive, company-wide metrics, relying on organizations such as the Netherlands-based Global Real Estate Sustainability Benchmark (GRESB), which collects data from real estate funds, REITs, property companies, real estate developers, infrastructure fund managers and asset operators to rank their ESG performance.

GRESB reported a 24% increase in participants in its real estate assessment, to 1,520 global entities (comprising US$5.7 trillion in assets under management) in 2021.

Toronto-based Dream Group uses BlueMark for its third-party ESG audit, according to portfolio manager Jamie Cooper. The San Francisco-based Sustainability Accounting Standards Board (SASB) and S&P Global Ratings are two other organizations that evaluate the real estate sector.

The International WELL Building Institute and Fitwel are two prominent New York-based certification organizations that focus on the health and well-being of building occupants. Fitwel recognized Vancouver-based QuadReal Property Group at its Best in Building Health Leadership Awards for thought leadership and gave QuadReal the Fitwel Promise Award for most benchmarked projects of all time.

The Financial Impact of Healthy Buildings: Rental Prices and Market Dynamics in Commercial Office, a study by the MIT Center for Real Estate, showed that WELL- or Fitwel-certified healthy buildings pull in effective rents that are 4.4% to 7.7% higher per square foot than nearby non-certified and non-registered peers.