2020 is marked by urgent global sustainability issues that are deeply inter-dependent. Safe-guarding human health, climate action and stabilizing the global economy have risen to the top of our list of priorities.
In commercial real estate (CRE), investors recognize that high-performance buildings are correlated with superior operational performance, lower cost of capital, positive influence on stock prices and reputational value. However, the majority of our existing buildings require major efficiency retrofits to reach levels of high performance.
To capitalize on this opportunity, building owners, managers and investors are turning to ESG programs and are getting serious about disclosure. This article explains urgent ESG trends that CRE professionals need to act on now in order to stay competitive and become more resilient in this new decade.
Trend 1: Urgency of Resiliency Planning
With the existential threat of the climate crisis being yesterday’s news, the time is ripe to begin planning for resilience in a world warmer than 2°C. Physical risks such as resource scarcity, sea-level rise, flooding and extreme weather events are creating a distinct shift from companies asking, “How do our operations contribute to climate change?” to “How does climate change impact our operations?” Climate change is the top issue raised by investment firms like BlackRock are asking how they should modify their portfolios on a global scale. This means we will see a larger focus on resilience planning and implementation of measures to mitigate and adapt to those risks. CRE is particularly susceptible as about 35% of REIT properties are exposed to climate hazards according to recent assessments by GeoPhy and 427.
For asset owners and managers who are at the beginning stages of resiliency planning, here are some important steps that should be taken: (1) conduct a detailed TCFD-aligned portfolio risk assessment for building and regional-level risks including transition, social and physical risks, (2) adopt resilience policies and strategies, (3) create disaster preparedness plans to mitigate high-risk assets, and (4) benchmark your resilience program (GRESB Resilience Module). Learn more about resilience trends and planning here.
Trend 2: Low-Carbon Economy
Beyond physical risks, the climate crisis is also challenging our industry with transition risks. Measures such as carbon taxes and decarbonization are already being utilized across the global economy. Canada currently has one of the most ambitious carbon pricing programs in the world, and although the U.S. federal government has been slow to take action, over 150 U.S. cities, more than ten counties and seven states have already adopted ambitious 100% clean energy goals. More aggressive science-based carbon reduction targets will likely be established, which will require significant investments. Initiatives like the RE100 Coalition, where more than 150 large companies have committed to source 100% renewable energy, are examples of how business leaders are filling the gaps left by governments.
The growth of the low-carbon economy is apparent in the finance sector, where the rise of sustainability-linked loans, significant investment commitments for climate transition projects, and divestment from fossil fuels can no longer be ignored. Switching to a low-carbon economy also poses greater transition risks for buildings that are dependent on fossil fuels such as natural gas, as global pressure mounts for buildings to transition to cleaner energy sources. CRE firms need to position themselves for this new normal and to demonstrate the long-term resilience of their business models to investors. We are also starting to see asset owners uniting with a UN-convened Net-Zero Asset Owner Alliance to lead the global investment industry in driving economies to carbon neutrality by 2050. The growth of high-profile Net Zero commitments from big companies is influencing the creation of new certifications that recognize buildings with lower carbon emissions like the Living Building Challenge and the new LEED Zero certification.
Trend 3: Urban Densification & Occupant Health
The recent rapid onset of the coronavirus (COVID-19) has made prioritizing human health even more urgent. While dense urban environments can speed the spread of disease, buildings can also serve as barriers to contamination with proper ventilation, filtration and humidity to reduce the spread of pathogens. In addition to proper ventilation system care, buildings must be carefully cleaned and then consistently disinfected with products that are less hazardous to human health. It is important that we better prepare for future global pandemic crises as urban populations will continue to grow and encroach on natural environments that introduce new diseases to human populations through closer contact with wildlife. Sustainable urban development requires us to care for both: Our health and the surrounding environments in which we live.
In the coming decade, the focus on occupant health and productivity through workplace design and operations will continue to gain momentum. These emerging trends will positively influence the adoption of occupant focused green building certification systems like Fitwel and WELL.
Trend 4: Electrification of Everything
The low-carbon economy is inextricably linked with the global transition away from fossil fuels. This energy transition means a significant push for the electrification of both the building and transportation sectors which will, in turn, promote grid electrification. Combined with renewable energy generation, electrification provides a much more sustainable option for powering our buildings and communities.
Making the shift toward grid electrification includes the need for stronger governmental investments in the required infrastructure as well as mandates and incentives that accelerate the transition to electric options. Last year, San Francisco banned natural gas in all city buildings, passed a law to incentivize building electrification and paved the way for ordinances that limit the use of natural gas in new developments. As a result, leading CRE companies are adapting to this shift by building new building infrastructure such as installing electric vehicle charging stations and phasing out natural gas in favor of all-electric buildings and appliances.
Trend 5: Existing Building Retrofits
Markets go through normal cycles and after a bull market, we generally experience a reciprocal downturn. However, in recent weeks, the market has crashed sharply amid rising fears of coronavirus and panic in the oil market. During the last recession, many new construction projects stalled and large real estate portfolio owners focused their attention on reducing operating expenses at their existing assets. Over 98% of our building stock is made up of structures that already exist, and over 75% of them are over 20 years old and require efficiency improvements.
Existing building retrofits are a win-win solution to environmental and economic challenges. To maintain a healthy atmosphere, the IPCC estimated that carbon emissions must be cut by 45% from 2010 levels by 2030. In the U.S., existing buildings are responsible for 40% of CO2 emissions making it a prime sector in the fight for a more resilient and thriving future. Existing building retrofits are the fastest and most profitable method for creating economic development, new jobs, and to meet these aggressive carbon emission reduction targets.
Trend 6: Getting Serious About ESG Disclosures
We are entering a decade where the quality and comparability of ESG data will be paramount. Becoming fluent in leading disclosure frameworks, such as GRESB, TCFD, SASB, the SDGs and the GRI, will help companies start refining and communicating their ESG narrative to stakeholders. Although ESG ratings have been criticized for their divergent assessments of corporate performance, we will likely see sophisticated ESG profiles become as important as credit ratings.
One of the biggest challenges for investors to use ESG data is the lack of standardization, which is why certain industry-specific assessments like GRESB have become so popular among investors. The GRESB Assessment is now 10 years old and is moving from market development and industry adoption to a stronger focus on performance, which now represents 70% of the total GRESB score. “Integration” is a keyword for 2020, and performance indicators are increasingly holding participants’ feet to the fire.
Trend 7: Sustainability Breaks Out of Its Silo
Comprehensive ESG performance is also required beyond uniquely environmental performance and should demonstrate attentiveness to social and governance issues such as diversity, health and wellbeing and corporate citizenship. To deliver on these promises, sustainability experts and ESG practitioners are needed in roles up and down and across the whole organization to embed a culture of sustainability throughout business operations. All departments – including legal, finance, procurement, communications and investor relations – must be familiar with, or, better yet, be contributing to ESG strategy, policies, programs and performance.
The 11th Hour is Now
With these market drivers in mind, it’s evident why ESG issues have reached a tipping point. Investors are pressuring corporate leaders to improve sustainability practices and companies that have been delaying enacting sustainability should take immediate action. ESG programs, meaningful policies and data capture can take years to implement, and the longer companies wait, the greater the cost will be to catch up with competitors and industry leaders.
CRE organizations need to stay in front of these ESG matters that are most material to their business and stakeholders. Implementing ESG programs boosts companies’ ability to identify a broader range of risks and opportunities for value creation and improves resilience to disruptive events like global pandemics and market dips. For leading investors, a company’s approach to ESG serves as a proxy for management quality which is paramount for any firm that wants to address these evolving risks, stay competitive, create long-term value and prepare for urgent climate change impacts.