Neil Pegram, Vice President, Measurabl, Capital Markets Division
You’d be hard pressed to find a company that had a great pandemic contingency plan in place before 2020. And yet, here we are: One month away from 2021 and still reeling from the shock of the events of this year—all stemming from what would have been considered an unlikely non-financial risk on a map last year.
The real estate industry in particular is grappling with a massive shift taking place in the market. A year ago, real estate investors were still bullish on developing office buildings in downtown cores. Business was up, financials looked good—and although telecommuting was steadily becoming more popular, it wasn’t predicted to have an immediate impact on the demand for office space.
But in the blink of an eye, everything changed. A Gartner study conducted in May 2020 revealed that roughly 88 percent of business organizations worldwide have required or encouraged employees to work from home in the wake of the pandemic. What’s more, 98 percent of these workers said they’d like to continue telecommuting, at least some of the time. This shift in the way we work is not only going to affect the leasing and value of office buildings—but also decrease interest in small condos that lack the space for a home office, or multifamily buildings without access to private outdoor spaces such as balconies.
Of course, it’s incredibly difficult to predict the onset of a pandemic. But a global health crisis is just one of the many non-financial risks that can be assessed and prepared for by examining timely, comprehensive ESG data. It’s increasingly clear that real estate investors need accurate information on how their portfolios could be affected by physical and regulatory climate risks, and issues of social unrest and public health that can all wreak havoc on the stability of a company or asset.
Does that mean investors are putting just as much stock into ESG as they are in financial data? Not yet—but what we are seeing in the meantime is a shift in the way investors are viewing and requiring ESG data.
ESG Data Can Signal Disasters Waiting to Happen
From the investor’s perspective, the real value of ESG can be assessed in two ways: ‘How can we use the data to reduce risk?’ And, ‘Is the data material for decision making?’ Not every investor holds ESG at the same level of importance, but the majority that do take it into account have initially focused on risk mitigation. For example, in the commercial real estate industry, we’re starting to see investors weigh ESG factors to determine whether a building’s risk profile is too high. There are several risks that can be measured using ESG data, including:
- Physical climate risk, which goes beyond the question of how a company is impacting the environment, and delves into how climate change will affect their assets. Physical climate risk data looks at an asset’s level of exposure to threats like hurricanes, rising sea levels, heat stress, wildfires, and other climate events and stressors, and can be geolocation tagged to real assets.
- Regulatory risk, which can determine whether an asset adheres to local regulations and ordinances, many of which are evolving. For example, New York City has enacted Local Law 97, which places carbon emission caps on most buildings larger than 25,000 square feet by 2024. It’s expected to affect 50,000 residential and commercial properties across the city. Over the next few years, real estate owners will be in a race against the clock to update these buildings to comply with the new requirement.
- Social risk, an indicator of how the company’s operations affect employees as well as the larger community. Social initiatives include establishing fair hiring practices and eradicating racial and gender bias in the workplace, but it can also include more existential factors like protecting workers’ long-term health and ensuring that all of a company’s suppliers, contractors, and partners live up to its own standards for ethical behavior.
How are these risk factors measured? There are few existing standards to measure ESG performance, but that is changing, too. For example, real estate investors look to things like ENERGY STAR or Fitwell certifications as a proxy for good performance and management practices. ESG benchmarks like GRESB and CDP are also useful to examine, at least on an annual basis, how well a business or fund is doing compared with its peers.
However, these indicators represent merely a snapshot of an organization’s or asset’s performance. To get to the point where investors can use ESG data not just to determine risk based on an asset’s history, but to help make informed decisions about its future, ESG reporting will need to evolve in both frequency and depth.
Reporting Expectations Are On the Rise
Investors are expecting more data on the performance of their investments. To that end, we’ve gone far beyond the point in time when ESG information was just “nice to have.” Now, firms are feeling pressure from investors to disclose performance on a more consistent basis.
Think of it this way: Annual financial reporting is too infrequent for active engagement. Although investors cannot digest real time data, quarterly reporting is standard and necessary to understand a portfolio’s financial performance. So investors are beginning to ask, ‘Why is ESG data frequency misaligned with financials? When will quarterly ESG data become standard?’
Just as timeliness is critical, investors are also expecting ESG data that’s accurate, complete, and auditable.
The transfer of ESG data is evolving, as well—particularly in real estate, with its complex investment partnerships and long hold times. Many firms have begun to adopt technology solutions that automate and digitize their ESG information, storing it in one central hub rather than across multiple silos. This “meter to market” approach helps firms easily collect, manage, and analyze building performance data across their portfolios, and send that data to capital markets.
When environmental, social, and governance information is stored in one place, portfolio managers are able to give investors performance updates on demand. Firms that control their ESG data can better manage it and transmit material information directly to their investors and stakeholders by request.
Though ESG data might not be on par with financial data in the eyes of all investors, they are beginning to hold similar expectations around rigour. Soon, asset and portfolio managers will be reporting ESG data with roughly the same granularity, depth, and rigour as financial data—at roughly the same intervals. After all, you wouldn’t make investment decisions about 2021 based solely on financial data from 2019.
To meet investor demands, companies will need to rethink their approach to sustainability, dedicating appropriate resources, discarding manual approaches, and adopting a more efficient process for collecting actionable data—with technology connecting investors and doing much of the heavy lifting.
About the Author:
Neil Pegram is Vice President of Measurabl’s Capital Markets Division, which helps real estate owners, investors, and lenders leverage ESG data to optimize real estate transactions. Measurabl is the world’s most widely adopted ESG (environmental, social, governance) data management solution for commercial real estate. Before joining Measurabl, Neil was Director of Americas at GRESB, and has also consulted on and headed sustainability programs for large real estate organizations.