Pragmatic ESG: Playing Offense and Defense
Author: Paul Cheng Website: NCREIF PREA Reporting Standards Council
Although the environmental, social, and governance (ESG) movement has garnered support from policymakers, regulators, and investors globally, a recent emerging voice argues that the ESG pendulum has swung too far in one direction. Over the past year, several lawmakers, as well as investment executives, have pushed back against ESG, attempting to reverse course, and in some cases, even ban the use of any ESG methodology in investment decisions. Certainly, ESG, or any investment framework, should focus on the merits of an investment in terms of its ability to earn sustainable returns. In this article, I advocate that real estate investment professionals put aside any political leanings and look at ESG through both an offensive and a defensive lens. That is, ESG does not have to be a nebulous, “touchy-feely” fad that caters solely to a green coalition. Instead, applying an ESG framework to investment decisions can help investors boost their bottom line while mitigating risks along the ESG spectrum.
In my own journey over the past decade as a US public pension plan investment professional, I have witnessed the evolution of ESG in terms of awareness, acceptance, sophistication, evangelism, and now reassessment. This sort of reflection and reevaluation does not have to be viewed as a repudiation of ESG; instead, investment professionals can embrace it as a feedback loop to refine and improve their companies’ underpinnings and processes. In the early 2010s, only a handful of investment managers had an ESG focus, with European investors and endowments and foundations at the forefront. Managers that were signatories of the UN-supported Principles on Responsible Investment had proof of their ESG credentials, and for some, that was sufficient to “check the box.” In the mid-2010s, the ESG movement gained steam and was more widely accepted, which can be attributed to the 2015 Paris Agreement, which nearly 200 nations signed, agreeing to limit global warming by mid-century. That was a watershed event, and investment managers increasingly—and more visibly—applied ESG rigor in their diligence and asset management. This was evident in more-detailed assessments of climate-related risks and mitigations, with an emphasis on lowering emissions and energy consumption, as well as focusing on using sustainable building materials when possible. Managers and investors increasingly monitored third-party ratings, such as LEED1 certifications and GRESB2 scores. Certainly, the environmental slice of ESG was a focal point, given that it was accessible and more easily measured. Over the past several years, the S and G in ESG have moved to the forefront because of the growing awareness of racial injustice, gender inequity, and income and wealth disparities that have led to social unrest across the world, leading many institutions to focus more attention and resources on human capital and social impact.
Although the investment community may be swayed by changing political and ideological sentiments, I encourage the adoption of both defensive and offensive lenses in applying ESG frameworks to investment analysis, due diligence, and asset management processes. By defensive, I mean being proactive in identifying and mitigating factors that may present potential risks to the value of an asset. By offensive, I point to actions that better position an asset for future use as it relates to ESG considerations. Sometimes, actions can be both defensive and offensive. In addition to advocating for both these approaches, I reference ESG best practices and tools the NCREIF PREA Reporting Standards Council has created to help the investment community achieve better outcomes.
A case in point of playing defense relating to the environment portion of ESG is recognizing the impact seawater levels and water availability will have because of climate change. Beyond one-off anecdotes, many investors in Florida have increasingly factored in rising seawater in their development and acquisition activities, leading them to evaluate location and elevation, flood insurance, and technology that can mitigate flood risks. A similar situation is occurring in the American Southwest, where a decade-long drought has impacted some communities’ access to water. Some residential developments have dramatically reduced access to water—a situation that some developers and investors did not factor in during their development and purchase processes. In both situations, a failure to consider the impact of climate change can have a dramatic impact on asset usage and values.
An example of playing offense regarding the environment is CBRE Investment Management’s approach to logistics assets, specifically future-proofing logistics stock. Adopting a forward-looking stance, the firm emphasizes assets that have power availability, vehicle-charging capability, and modernity. Investors cannot assume that local power utilities can provide thousands of additional amps. Instead, they may need to construct warehouses that can bear the weight of roof solar panels (versus attempting to retrofit them later at a much higher cost). Increasingly, logistics occupiers will rely on electric vehicle (EV) truck fleets to transport goods through regional distribution channels, necessitating charging stations inside or near warehouses. Logistics facilities without onsite charging stations will be at a disadvantage if occupiers’ EV fleets need to go off-site for charging, thereby slowing the movement of goods within the supply chain and creating a bottleneck. Because high-throughput industrial occupiers value energy-efficient, modern logistics facilities, developers and owners of distribution centers that meet occupiers’ demands for efficient energy will be better positioned in the next decade as older stock experiences functional obsolescence.
One manager that has been proactive in offense on the social front of ESG is DigitalBridge (DB), a digital infrastructure manager investing in and operating across digital infrastructure, including towers, small cells, fiber, and data centers, which are essentially specialized power-shell office assets. Despite not being a pure-play real estate manager, DB has ESG policies and implementations that are noteworthy.
DB founder and CEO Marc Ganzi feels strongly about diversity, equity, and inclusion initiatives and the benefits of having a diverse workforce, not for diversity’s sake, but because diversity of thoughts and perspectives leads to better decision-making, enhanced problem-solving, and ultimately superior outcomes. In partnership with Sponsors for Educational Opportunity, Big Brothers Big Sisters, the Toigo Foundation, Diversifi Ventures, and other organizations, DB works with young students from diverse backgrounds and has implemented mentorship and summer internship programs in which the majority of participants are women and minority students from different backgrounds and universities, including historically Black colleges and universities. By casting a wide recruitment net on the belief that “talent is universal but opportunity is not,” DB believes people of color are underrepresented within investment management, not because of a dearth of talent, but because of narrowly focused recruitment efforts focused on “traditional” pools of talent (Ivy League and elite, private universities), in which access to a diverse talent pool is more limited. Ganzi notes that such efforts have energized his firm because employees see the authenticity of such efforts and broadened their talent opportunities in a historically tight labor market.
1Leadership in Energy and Environmental Design.
2Global Real Estate Sustainability Benchmark.
To access the whole article please visit the NCREIF PREA Reporting Standards ESG page for details.
Paul Cheng, CCIM, is a pension investment professional focused on the real assets space and a member of the NCREIF PREA Reporting Standards Council.