The TEXPERS Blog

ESG and REITs: Sustainable investing for the long-term

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By Scott Crowe, Guest Columnist

An appropriate consideration of environmental, social and governance, or ESG, issues is important to making the right real estate investments. 

Real estate assets are one of the primary locations of energy usage (environmental), the cornerstones of our societal infrastructure (social), and capital intensive, with financial outcomes heavily influenced by transparency and alignment (governance). While ESG issues have been incorporated into listed real estate investment analysis to varying degrees in the past; investment managers should take the time to formalize an approach to ESG and real estate investment trusts. One concern that arises in ESG discussions is the utility of ESG to drive better investments; however, an analysis shows that factoring ESG elements into the investment process correlates with better returns for investors.

Put simply, ESG principals make good business sense. It stands to reason that better-managed firms with sustainable business practices should be rewarded by the market over time. As it pertains directly to real estate investment trusts, more efficient buildings are more profitable buildings. More sustainable buildings are more valuable buildings. In that sense, ESG considerations have an important role in the evaluation of a real estate investment trust investment strategy, as detailed below:

Environmental

Real estate’s capacity to mitigate environmental risks is evidenced in its energy usage. In 2016, real estate consumed more energy than both the transportation and industrial sectors, accounting for almost 40 percent of total energy usage in the U.S., according to data from the U.S. Energy Information Administration. Energy-efficient policies directly impact the bottom line, making efficient assets more profitable and sustainable. Additionally, tenants and consumers are increasingly demanding sustainability and are willing to pay premium rents for such assets.

When assessing the environmental factors of a real estate investment trust, investment managers should seek to capture the robustness of the company’s environmental sustainability policies addressing energy efficiency, conservation, and carbon footprint reduction as well as the execution and disclosure of those policies. As the company develops additional assets, brown-field development and mass transit-oriented development is considered environmentally friendly; so too is the company’s existing real estate portfolio. Heightened sustainability standards, such as attaining Leadership in Energy and Environmental Design and Global Real Estate Sustainability Benchmark certification, improve the score. Companies also receive superior scores for being leaders and advocates within the environmental sustainability space.

Social  

Real estate is the cornerstone of society; it is where people gather, live and work. As such, real estate’s impact on its community directly impacts the asset’s long-term sustainability and value.

A social assessment of a real estate investment trust seeks to capture the company’s quality of employee engagement and extent of community involvement. This category also considers policies regarding ethics, conduct, anti-corruption and anti-bribery for employees and contractors as well as the company’s commitment to community involvement, civic service and philanthropic efforts.

Governance

As a capital-intensive industry, appropriate governance of real estate assets and proper alignment of interests are key drivers of risk management and value creation when assessing a company’s potential for long-term outperformance.

Shareholder alignment and board independence measure the shareholders’ influence over the company and the board’s ability to carry out its fiduciary responsibility as the stewards of shareholder capital. Governance factors also measure the extent to which strategic efforts have been clearly identified and implemented to enhance governance of shareholder capital and the quality of governance disclosures.

ESG Trends by Sector

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ESG analysis, while long-standing, has evolved as the demand and focus on ESG products has continued to grow in the last decade. Managing ESG risks is not only important to real estate investing, but it also generates long-term value. While the concept of ESG might have been considered in the past as a deterrent to superior returns, data reveal that portfolios of companies with top ESG scores have significant alpha-generating potential.

The statements and conclusions made in this presentation are not guarantees and are merely the opinion of CenterSquare and its employees. Any statements and opinions expressed are as of the date of publication, are subject to change as economic and market conditions dictate, and do not necessarily represent the views of CenterSquare.

Scott Crowe

About the Author

Scott Crowe is the chief investment strategist at CenterSquare Investment Management. He joined the firm in 2015. He is a member of CenterSquare’s listed real estate, listed infrastructure and private real estate investment committees. In this capacity, he works with each team’s portfolio managers and investment professionals in the leadership of the investment process, with a particular focus on thought leadership by synthesizing real asset views across the business. Crowe is the portfolio manager of the Global Concentrated real estate securities strategy. He also works directly with CenterSquare’s clients, providing education and guidance on the market and helping them execute their investment goals.