Managers remain split on pace of ESG integration into real estate debt landscape

The US trails the EU on adoption of ESG investment principles, with a consensus that more incentives are needed for momentum.

The state of environmental, social and governance investing across the commercial real estate debt landscape is expected to enter a period of stasis as financiers grapple with turning talk into action amid ongoing interest rate hikes and ever-present volatility.

Senior commercial real estate executives speaking at New York University’s InnovateESG 2023 forum on February 24 said that while there may be plenty of green opportunities to come within the next decade, the current US commercial real estate investor base is still treating the realm as a nice-to-have offering rather than an essential business staple when compared to European and Canadian entities.

Wants versus needs

During a panel on benchmarking US and global commitments to governance and sustainability, Sairah Burki, managing director of regulatory affairs and sustainability at the industry-representing Commercial Real Estate Finance Council, said there is a bifurcation in the treatment of ESG real estate investing internationally.

“In Europe and Canada, certainly the markets are valuing deals that are considered green and sustainable,” Burki said. “Here in the US, we continue to speak with our members who are on the banking side, the investing side; folks are not generally paying up for green deals yet. At the moment, it’s like a ‘good to do,’ ‘nice to have’ and in this particular moment in the cycle when things are so volatile, it is taking a back seat to just getting deals done as efficiently as possible.”

When looking at the overall sustainable debt issuance numbers, there was a perceived peak in 2021 at $1.5 trillion and subsequent decline in 2022 to $1.2 trillion, per BloombergNEF data, which Burki noted was partly driven by general political uncertainty and market volatility. “But a lot of folks are forecasting a rebound – maybe not the trillion-dollar-plus peak that we had in 2021, but a rebound from 2022,” Burki added.

No uniformity (yet)

The perceived lack of ESG financing momentum has been attributed by some industry participants to the real lack of parameters, uniform regulation and potential incentives from state and federal governing bodies.

Leah Fisher, senior vice-president for governance at real estate investment trust Arbor Realty Trust, said many financial institutions are awaiting granularity from such governing entities. “You do have this overarching push in the regulatory environment for accountability and transparency, but without very specific directives in terms of what folks are required to do,” she said. “I think you are going to have a lot [of firms] in the industry that are going to – for lack of a better word – look for a loophole.”

Fisher said such financiers are looking for a way around the lack of guidance for the sake of showing accountability to shareholders until the Securities Exchange Commission or a similar regulatory body lays out expectations on every level for counterparties, investors, partners and overarching commitments as a firm.

While it is nice to think about accountability and an ESG push at a broader level, Fisher noted that she still sees a divide between what is being pushed for and the incentives behind it. “At the end of the day, the question becomes ‘is it worth it?’ So I think that is really the challenge,” she said.

Importing better action

Gunnar Branson, CEO at Washington, DC-based international real estate investor trade association AFIRE, said the next 10 years will be a lot more exciting and opportunity-rich when it comes to ESG permeation across commercial real estate deals.

“Thanks to some aggressive work in ESG from the pension system in Canada, they are exporting their ideas and their strategies to the United States and really pushing institutional investors in the United States to pay attention,” he said.

Branson said such institutional investors abroad have raised the bar. Even in the US – where adoption is seemingly on a lag – standards have still improved compared to the practices of 20 years ago. “The problem is we’ve just scratched the surface and now the bar has been raised.”

Branson noted that improved HVAC strategies and management of solar gain have brought US development practices a long way, but to achieve carbon neutrality, developers must now pay special attention to a much broader range of issues including reducing embodied carbon in core building materials such as concrete and steel. “The carbon intensity of manufacturing buildings requires us not only to improve how we build, but how we modify what is already built,” he said.

From AFIRE’s recent survey data of institutional investors, 82 to 85 percent say ESG is central to their decision-making process when they acquire a new asset. “It’s not really that strange for pension plans to be thinking this way, for banks, insurance companies to be thinking this way, even though maybe they don’t say ESG publicly for fear of some sort of political backlash,” he noted.

Future use

Instead of disposing of or selling off assets lacking in ESG components amid the energy crisis in Europe specifically, Branson said an estimated 73 percent of surveyed investors are looking long term and planning to use redevelopment capital, technology or other existing processes to hold onto assets longer for the sake of getting better risk-adjusted returns.

“I think we are at another turning point right now where we are switching from fear and denial – frankly – to greed. This is how you make money,” Branson said.

Tenant demand for carbon-neutral and ESG-geared assets is visible and actionable.

Dana Roffman, an independent director and adviser currently working on Savills’ board of directors, said she has heard of instances with large institutional private equity firms where Fortune 500 tenants have turned down buildings because prospective spaces did not meet ESG expectations.

“They grade it and if you are below a certain level, they are not going to lease your space,” Roffman said. “It’s happening initially in the Class A buildings, but it is all going to trickle down and landlords are going to have to pay attention.”