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The theme of this year’s World Economic Forum, “Stakeholders for a cohesive and sustainable world,” afforded the business leaders in attendance the opportunity to speak freely about their legitimate concerns regarding climate change for the first time in 50 years. As we’ve seen in the weeks and months since then, discussions over how to cope, adapt and move forward resonate loud and clear at all levels of society. The rate and scale at which I’ve seen a preference for environmental, social and governance (ESG) principled investing become the benchmark for profit-seeking firms and investors in the wake of Davos 2020 is unprecedented.
But how could that be? Neither climate change nor climate action is new. To find the answer, it helps to follow the money, or as CEO of private equity powerhouse Blackstone Group Inc. Stephen Schwarzman explains, “Ironically, it ends up being good economics.”
While this observation is neither new nor profound, its substance and timing are significant. Why is sustainability being placed at the top of the financial community’s priorities for what, to many, seems like the first time?
What was made clear to me during my recent visits with clients and investors in London, Paris, Singapore, Amsterdam, Tokyo, Toronto and other global financial and commercial hubs, where interest in ESG is expanding rapidly, is that investors are keenly aware that there are two key means through which sustainability and ESG-focused investing drives value for them. ESG strategies both improve access to capital markets and deliver financial returns while mitigating a portfolio’s exposure to regulatory risks. This is the approach smart investors are taking.
Like BlackRock chief executive Larry Fink communicated in his open letter to CEOs earlier this year, limited partners — the gatekeepers of equity capital — are telling investors that access to capital markets will be linked to their ESG strategy. If real estate investors want to raise money, then they are going to need a robust ESG strategy integrated into their investment strategy.
Adding a focus on sustainability and ESG lowers operating costs, increases cash flow and ultimately improves asset values. This is what good real estate and private equity investors have always done, but for some reason, this is a broad category of spend that the industry missed for decades.
The same shift is also underway in the debt markets, where adding an ESG lens lowers the cost of capital and increases proceeds. This is reflected in the expansion of green financing projects across the Americas, Europe and Asia. Last year the sustainable debt issuance reached $465 billion globally, a record volume in any one year and up a whopping 78% from 2018, according to Bloomberg New Energy Finance (BNEF). In the bond markets, too, there were a record number of issuances (479) for green bonds, for a total of $185 billion. Today, the cumulative issuance of sustainable debt exceeds $1 trillion.
A similar argument for de-risking assets can be made to real estate investors, developers and managers. Sustainable building regulations, including building energy performance standards (BEPS) like New York City’s Local Law 97 and Washington, D.C.’s Clean Energy DC Omnibus Act, are growing increasingly common, as policymakers mandate more exhaustive emissions reduction plans.
Knowing this, stakeholders in the building industry would do well to recognize that significant reductions in energy use and the associated greenhouse gas emissions will be required of their assets and portfolios in coming years. The best course of action would be to preempt regulatory changes and proactively invest in the technologies and practices needed to bring their assets into compliance with these anticipated rule changes.
Of course, that’s easier said than done, but it’s not impossible. Taking preemptive action requires real estate investors, developers and managers to proactively and regularly assess the baseline energy performance of their assets and portfolios. With this information, these stakeholders can develop asset-level energy plans and more accurately estimate the paybacks associated with various levels of energy use or GHG emissions reductions.
The recommendation for real estate investors, developers and managers considering capital expenditure is much the same. The full life cycle cost of investing in either upgrades to existing assets or acquisition of new assets must be taken into account, rather than just upfront costs.
Should such measures be undertaken, real estate investors can expect to see the value and life cycle of their assets increase. As a result, investors will improve tenant retention and ultimately increase the value of the asset on an absolute basis and vis-à-vis their competitive set.
There is a palpable sense of urgency among private equity and real estate investors and other stakeholders in the financial community to accelerate the focus of ESG into the full investment life cycle. At its core, ESG investing simply helps us turn a lens on parts of the real estate investment process that are critical to creating long-term value while addressing a community’s environmental priorities. And who wouldn’t want to do that?