More commercial real estate investors and lenders will adopt ESG principles into their strategies for a simple reason: climate risk is increasingly becoming investment risk. While there is an expectation there could be a short-term impact on the march toward ESG due to broader market volatility, a December 2022 report from investment manager Nuveen argues there are a number of reasons why ESG will remain front of mind for commercial real estate lenders and investors. Here are three things to consider.
1. Climate risk is investment risk
A December report from Nuveen believes the ESG principles will become a larger part of commercial real estate investment in the coming years, despite what could be a short-term slowdown due to current market volatility. “ESG roles have been integrated into governance structures and there has been a leap forward in the understanding of the link between climate risk and investment risk,” the report stated.
2. Legislation will accelerate change
A confluence of existing and pending legislation both in the US and further afield means the adoption of ESG principles will continue to grow. The report cited the EU’s Sustainable Finance Disclosure Regulations, the Monetary Authority of Singapore’s Guidelines on Environmental Risk Management for Asset Managers and the Securities and Exchange Commission’s pending climate disclosure requirements in the US. Additionally, the UK is working on similar legislation that aims to put into place similar requirements via its Sustainable Disclosure Regulations.
“These factors, combined with the reputational damage that would undoubtedly accompany a step down on ESG commitments, mean that ESG is likely to remain a significant focus for investment,” according to the report.
3. Performance data
With more than a decade of performance data for properties with green profiles, Nuveen notes there is a clearer picture of the impact of ESG. “There is also a greater body of data to show that greener buildings tend to outperform,” according to the report. Citing NCREIF office returns data, the report noted LEED Platinum-rated buildings outperformed their peers over one, three, five and 10-year periods. Additionally, real estate consultants JLL and Knight Frank have identified rental premiums of 10 percent to 12 percent for London offices with a BREEAM ‘outstanding’ rating.
Although commercial real estate and the global economy are facing another period of dislocation, Nuveen believes it is hard to compare the market of 2008 with the market of 2023. “It is hard to compare the ESG world now to that of 2008. ESG roles have been integrated into governance structures and there has been a leap forward in the understanding of the link between climate risk and investment risk,” the report stated. “Now that the costs of transforming buildings to be net-zero carbon have started to be incorporated into underwriting, they cannot be ignored.”