Sustainable/ESG Finance for Real Estate

Due to the large impact real estate has on the climate and on communities, and it’s long-term nature as an asset class, environmental, social and governance (ESG) factors are increasingly important–for the world and for investors, owners, and occupiers.

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New York Times has reported that “mutual funds and exchange-traded funds (ETFs) invested nearly $300 billion in sustainable assets globally in 2020, nearly double the previous year.” The authors go on to showcase the work of Invesco and Foresight who have started funds for green buildings they claim have provided strong returns.

Indeed, according to Justin Boyar at the Costar Group, “LEED buildings sell for 25% more, rent 20% more, and average 60 basis point cap rate compression to their non LEED peer”.

At minimum, ESG factors should therefore be considered when screening potential real estate investments, when calculating valuations and return on investment. The additional information can improve risk analysis and decision-making. See “Common ESG Issues” graphic on the right from the Principles for Responsible Investment. 

However, the potential for sustainable/ESG investing in real estate is much greater than simply screening for risks and seeing premiums on prices and fees. To meet necessary climate targets, we need to shift the $16t+ commercial real estate market to operating on clean energy, generating as little waste as possible and providing affordable housing to millions.

Therefore, ultimately investing in real estate is about how to meet the needs of investors while meeting the urgent need to protect the world’s climate.

Sourcing

After a potential investment is identified, some desktop analysis can be done on red flag ESG issues: financial risks related to regulatory fines, remediation costs related to contaminated land, or proximity to land affected by sea level rise.

If the deal progresses, deeper due diligence will allow more rigorous analysis of environmental, social and governance considerations.

Investing

ESG considerations can increase and decrease valuations. The investment memorandum should include any ESG risks and mitigation costs from the due diligence process. ESG data sources can include MSCI, GRESB, Measurabl and others. 

The presence of energy efficient equipment (e.g. HVAC or lighting) or clean energy (e.g. solar panels) may increase the valuation. The presence of contaminated land, lack of access to public transit, and poor energy efficiency performance may lower the valuation.

Owning

Careful consideration should be given to how building performance and occupant experience will be measured and monitored. The owning phase will involve property managers who should be selected and chosen based in part on their ability to help maintain ESG standards and performance. Tenant engagement in ESG is also important and consideration of emerging tools like green leases.

Finally, working to earn and maintain sustainability certifications might be worthwhile. See Certifications and Ratings.

Learn about sustainability and the courses in this major.