ESG, Real Estate and the Six Stages of Grief

Last week I spent a couple of days in sunny Vermont with our great IT partner Greenriver, who together with the GRESB Data Analytics team— have been working hard on building out the GRESB Portal for the 2016 data collection on real estate, debt and infrastructure. One of the exciting developments is that GRESB is slowly moving from manual entry of information to seamless data flows between many different data management platforms and our Portal. Good old Excel uploads also work, as well as semi-automatic data flow from the EPA Energy Star Portfolio Manager platform to GRESB. More on all of this very soon.
With my snow boots and down jacket still on, I then flew to Miami for the NAREIM Executive Officer Spring meeting – a powerful group of more than 60 investment managers convening to talk and think. In addition to hearing Alexandra Villoch, the CEO of the Miami Herald, talk about what change means to a business (the Herald has seen a 90% drop in traditional revenue streams, and has successfully used the remainder of this income to seed-fund new initiatives, such as an online platform, apps, etc.) and seeing 3 teams of smart students present in the MIT Case Competition for the transformation of the Port of Miami, I spoke about the role of ESG in real estate.
I’ve been beating this drum repeatedly, but given the time of the year with ESG reporting season almost upon us, I feel that reiterating the “why, what and how” of energy efficiency, sustainability, and real estate is useful for a broad set of stakeholders. So, here’s the outline of my talk:
I’m excited to discuss the important topic of natural resources and real estate. Here’s how these two come together:

  • First, we spend 90% of our time in buildings – homes, offices, shops, restaurants, gym, etc.
  • This results in:
    • Buildings consuming 14% of potable water
    • Buildings representing 41% of US energy consumption
    • Buildings and their occupants using 81% of all electricity generated in the US.

These issues are real and relevant for real estate owners through policies affecting buildings (stick/demand push):

  • Some of these policies relate to the negative externality that is brought by energy generation – carbon emissions
  • While politically sensitive, I still want to digress for 30 seconds and talk about the indirect implications of these carbon emissions for building owners:
    • Climate change (Governor Rick Scott will get me arrested….climate change does not exist in Florida)
    • Tidal flooding in Miami Beach (and…30% of Miami will be flooded by 2100)
    • Extreme weather events (drought or extreme precipitation)
    • California drought – reduction targets of 25% in 2015 alone
  • Ambitions to reduce energy consumption – in California by 50% in 2030
  • Construct “zero net energy” buildings by 2030 (in Europe by 2020)
  • Mandatory disclosure of building energy consumption in the majority of major metro areas across the country
    • The important role for certification and information provision
    • These certifications are used as carrots and as sticks (the UK has outlawed transactions of buildings rated inefficient – an EPC of F/G).

That’s the policy-oriented view, but at the same time, consumer preferences have started to change (carrot/demand pull):

  • Many tenants now demand, or prefer, LEED-certified “green” buildings. This includes the GSA (350 million sq.ft.), state and city governments, but also large blue chip tenants, as well as retailers and private individuals in multi-family homes
  • The diffusion of “green” certification is not trivial. Recent CBRE research shows that about 5% of buildings, but 20% of commercial office space now has been certified by LEED
    • As much as 38% in Chicago and 40% in San Francisco (Miami at 22%)
  • Buildings are increasingly seen as part of the broader CSR commitment of corporates
    • Focus on energy (retailer H&M, logistics company DHL, but also Facebook in renewable energy requirements for data centers)
    • Focus on buildings as a tool for productivity, as a tool to attract and retain talent – the new rage is about buildings as the key to health and well-being (If you think energy efficiency is scary, there is a whole new wave coming).

All of this may start to affect cash flows – rents, occupancy rates, operating costs, prices, and thus returns and risk for investors and lenders:

  • There is a growing body of academic literature that shows correlations between energy efficiency, sustainability and financial performance
    • US (2007, 2010) office markets
    • Single-family homes (California/Netherlands).

I’d like to elaborate some more on this based on recent research that I did with Avis Devine of Guelph, using data from Bentall Kennedy (download the paper here):

  • Data – 10 years of monthly leasing data on all commercial office buildings in the U.S. and Canada (300 buildings spanning 58 million sq.ft.)
  • Detailed information on rental rates, rent-free periods (or other allowances), occupancy rates, tenant satisfaction, energy consumption, 236,000 month/lease observations
  • I can’t show you the scary-looking formula here, but we then ran a series of analyses to investigate the impact of green building certification (including LEED, Energy Star, but also BOMA BEST, a Canadian scheme) on these performance measurements. We extensively controlled for age, size and quality of the buildings.


  • Rents – strong effect of Walk Score, small but measurable effect of LEED certification (3.7%), as well as Energy Star certification (2.7%). In Canada, results were stronger for LEED (10.2%), but no effects of BOMA.
  • Rent concessions (including rent credits, free rents, TI allowances, etc) – on average, rent concessions are 11% of the rent (!), but for certified buildings, these concessions are “just” 7%.
  • Occupancy rates – over the 2003-2014 period, going through the recession, LEED certified buildings were able to hold on to occupants a little better (4% higher occupancy rate), the results for Canada are again slightly higher, at 8.5%.
  • On the “why” of occupancy rates, we digged into lease renewal – for every lease, we track its renewal over time. We had this data for the Canadian part of the sample only, but the results indicated that, controlling for building characteristics, both LEED and BOMA best increased the likelihood of lease renewal, by about 3.4%.
  • One step deeper still, we then looked at tenant satisfaction scores, based on bi-annual tenant satisfaction surveys. The results, available for Canada only, show that tenants are on average quite satisfied, scoring 5.2 out of 7. Green-certified buildings have satisfaction scores that are 1/3 of a point, or 6% higher.
  • Finally, we looked at energy and water consumption – first of all, the collection and standardization of data was quite a challenge, and good data was available for a smaller number of buildings only. Results show that LEED-certified buildings consume less energy, about 14% in the U.S., mostly driven by LEED for New Construction, and about 28% in the Canada, mostly determined by existing building certification.

A lot of numbers, but Bentall Kennedy consolidated all economic effects into a building valuation model – check it out here:

So, if you believe these results, energy efficiency and sustainability factors should be taken into account in the investment process.
We talked about what tenants desire and policy requires, but another important stakeholder is the capital provider – how do investors and lenders incorporate some of this information into their considerations?

  • On the debt side, Fannie Mae offers a pricing break for green-certified multifamily developments. And there is an emerging fixed income product called “green bonds,” where issuers raise capital through a regular general obligation bond, with proceeds used for purposes such as green building or energy efficiency programs (e.g. Vornado, Digital, Regency).
  • On the equity side, over 50 LPs, including many of the largest national and foreign providers of capital, are using data collected by GRESB to better understand what investment managers and REITs are doing to improve their efficiency and broader sustainability performance.

GRESB was started in 2009 by a group of European LP’s, with significant holdings here in the U.S.

  • GRESB fills a niche – desire for portfolio-level measure of energy efficiency and sustainability practices.
  • On the listed equity side there are metrics such as those developed by MSCI and FTSE, etc.
  • It complements asset-level schemes such as LEED and Energy Star, focusing on the management and operations of real estate portfolios.
  • It includes policy practices, integration of sustainability into acquisition process, active measurement and improvement of energy efficiency and sustainability of assets, but also the interaction with tenants, the community, and importantly, suppliers.
  • GRESB runs an annual assessment on about 50 indicators. After the data has gone through a rigorous validation process, the data is scored with each company or fund receiving a GRESB Score, which is compared against peers in the same property type and region. In this way, ESG is made measurable.
  • You have the numbers in front of you – at this point GRESB has rated over 1,000 private equity real estate funds and REITs, covering, for example, all of the ODCE universe, 55% of the U.S. REIT market. GRESB works closely with NAREIT and PREA and its counterparts in Europe and Asia.

The GRESB data is now available to about 60 LP’s and their fiduciaries, including some of the larger fiduciary advisors. The big question is always “what investors want” with all this data (see my previous blog on this topic). Are they really looking at those sustainability policies and tenant satisfaction surveys?

  • For most of the investors, the simple answer is “no.” Most investors are in the education stage, understanding, perhaps like you, what sustainability means for their business. In that stage, there is often the desire to at least signal to GP’s or partners that this is a topic that is increasingly important. Reporting to GRESB, ticking the box, is then what matters.
  • But education will soon turn into awareness, at which point investors feel the desire to get an objective measure of the ESG performance of their investments. Like for financials, measuring ESG performance in a quantitative way allows for a simple, straightforward understanding of where GP’s or partners are. At this stage, the data empowers investors that are otherwise uninformed, creating transparency in the sustainability performance of the real estate sector.
  • The third stage includes investor requirements around performance and active engagement to reach those goals. That’s where an increasing number of more forward-looking investors and advisors are now. And perhaps the Europeans set the stage here – PGGM requires a 50 % carbon reduction in 5 years. APG requires investments to outperform their peers in the GRESB peer group (see another blog post on this topic).

But before we lose ourselves in what investors want, let’s go back to why energy efficiency and sustainability is a topic for real estate investment managers in the first place:

  • Policy makers currently perceive buildings as “the problem”. However, I see buildings as the solution.
  • Buildings offer an unprecedented opportunity to resolve major societal problems, and those that do that best will reap the benefits:
    • Reduce cost
    • Reduce risk
    • Increase returns.

So, in the same way that you may ask about the level of sophistication of investors on the topic of sustainability and energy efficiency, I’d like to ask you: where does your organization stand on this topic?
My colleague Dan Winters, GRESB’s Head of North America, often refers to the “five stages of grief” when it comes to GRESB and property companies and fund managers:

  • Denial (I’m ignoring GRESB)
  • Anger (I’m so over GRESB, I hate GRESB!)
  • Bargaining (Why does this not count towards my GRESB Score?)
  • Depression (I will be fired if you don’t fix this for me…)
  • Acceptance (Alright, let’s do this!)

I would like to add one more stage:

  • Embracing (Wow – integrating ESG leads to a better business!)

Because those companies and fund managers that are truly embedding and integrating ESG into their business are ultimately best positioned for the inevitable change that the future will bring.
This article is written by Nils Kok.

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