5/7/2018 | By David Tobenkin
In his annual letter to CEOs in January, BlackRock CEO Larry Fink wrote that companies need to make a positive contribution to society or risk losing the support of one of the largest investment management companies in the world.
“Companies must benefit all of their stakeholders, including shareholders, employees, customers, and the communities in which they operate,” Fink wrote.
BlackRock isn’t alone among institutional investors looking beyond just financial statements when evaluating investment alternatives to the harder to qualify details that show that companies are being good corporate citizens—however that might be defined.
According to U.S. SIF: The Forum for Sustainable and Responsible Investment, more than $1 out of every $5 under professional management in the U.S. as of year-end 2015 (the latest data available) was invested according to some form of socially-responsible strategy. That totals more than $8.7 trillion—and still growing.
Across corporate America, social responsibility is often linked with a company’s environmental, social and governance (ESG) efforts. For their part, REIT executives focused on ESG confirm they are seeing increased interest in their company’s efforts in this area from socially-responsible investors.
“We are seeing a greater interest amongst investors in considering a company’s ESG factors as an indicator of short and long-term growth,” says Matthew Lobach, director of sustainability at Hersha Hospitality Trust (NYSE: HT).
Jill Ziegler, Forest City Realty Trust Inc. (NYSE: FCE.A) director of sustainability and corporate responsibility, says investors are eager for more data to help paint that corporate stewardship picture, and ESG data is a natural place they look.
“We think ESG performance fills that need and helps investors differentiate us from our peers. For example, many investors look at the carbon footprint of their investment portfolios, and we have data that helps them assess that,” Ziegler says.
In addition to a company’s own reporting, investors are increasingly factoring in how a company performs in ESG rating services, says Jessica Elengical, director and head of ESG Strategy, Alternatives, at DWS (formerly Deutsche Asset Management).
“Investors have increasingly begun to ask us not only whether we participate, but how well we perform,” Elengical says. “I believe that the focus on these types of assessment tools will continue to grow as the quality of sustainability data improves and the level of disclosure among REITs increases.” DWS submits information into the GRESB assessment for some of its direct real estate portfolios globally, and has achieved green star recognition.
Part of the challenge for companies, REITs included, in appealing to socially-responsible investors is that there is no one-size-fits-all definition. Socially-responsible investment reflects a given investor’s values, and those are not the same for every institution. Some firms may make decisions based on religious or political beliefs, others may be tied to charitable giving or sustainability practices.
“It is not as simple as just valuing the ‘S,’ or social, component of a company’s ESG program in a bubble. Not only can social include a wide range of areas, but many aspects considered part of a company’s overall social responsibility are also housed within other areas of ESG,” says Fulya Kocak, Nareit’s vice president of ESG issues. “Environmental stewardship and governance practices can also weigh in a socially-responsible investor’s thinking.”
Mario Lopez-Alcala, vice president at investment research firm MSCI, says the focus on a company’s ESG performance is not going away and represents a generational shift in investor expectations. MSCI produces ESG research, ratings and analysis for more than 1,000 institutional investors worldwide.
“Investors are changing,” Lopez-Alcala says. “Over the next two to three decades, the millennial generation could invest between $15 trillion and $20 trillion into U.S.-domiciled ESG investments, which would roughly double the size of the U.S. equity market.”
That trend is also being fed by the fact that it is becoming easier to measure and quantify ESG efforts, Lopez-Alcala says. The REIT industry is no different.
This is evident through wider REIT adoption of ESG benchmarking and scoring by the likes of GRESB, which is tailored to the real estate sector, and MSCI ESG Ratings, which is broadly applicable to all industry sectors, including real estate. In addition, financial indexes such as Dow Jones Sustainability Indices (DJSI), the use of reporting guidelines including Global Reporting Initiative (GRI), Sustainability Accounting Standards Board (SASB) and the Carbon Disclosure Project (CDP), all add to the ESG data picture.
“With better data from companies, combined with increasingly sophisticated ESG research and analytics capabilities, we are seeing more systematic, quantitative, and financially relevant approaches to ESG key issues. Better data and analytics have paved the way for numerous studies that explore ESG investing,” Lopez-Alcala says.
In order to keep up with current and future expectations, many REITs are going above and beyond traditional ESG objectives and setting very specific target goals.
For example, Iron Mountain Inc. (NYSE: IRM) counts among its ESG success stories the fact that it received a perfect score of 100 percent on the 2018 Corporate Equality Index (CEI), a national benchmarking survey and report on corporate policies and practices related to lesbian, gay, bisexual, transgender and queer (LGBTQ) workplace equality, administered by the Human Rights Campaign Foundation.
Digital Realty Trust, Inc. (NYSE: DLR), meanwhile, has set a goal to power its entire global portfolio with renewable energy. Aaron Binkley, director of sustainability at Digital Realty, notes that the company recently ranked sixth on the EPA’s Green Power Partnership Top 30 Tech & Telecom list for sourcing renewable energy.
“Sixth may not sound so impressive, but the companies above us were tech giants that had an average market cap of half a trillion dollars. We feel we’re punching above our weight a bit in terms of our responsible sourcing for renewable energy,” he says.
In order for companies to meet and ultimately exceed their ambitious ESG goals, it takes more than one dedicated ESG professional. Prologis (NYSE: PLD) has already surpassed its target goal for reducing greenhouse gas emissions by 2020, as well as several other long-term targets.
“We have a commitment from our employees across the board to really drive our ESG initiatives,” says Jeannie Renne-Malone, Prologis’ vice president for sustainability. She added that Prologis also launched its Customer Sustainability Advisory Council last year to regularly discuss ESG best practices and how the industrial REIT can work with its tenants to jointly meet their ESG goals.
With investors more closely monitoring ESG ratings and performance metrics, there are now a number of ratings and standards attempting to measure the value of individual companies and industries. Some of these include the Global Reporting Initiative, Carbon Disclosure Project, GRESB, and the Sustainability Accounting Standards Board. How are REITs faring? Estimates vary.
GRESB data shows relatively good performance by U.S. REITs compared to the overall performance of all segments measured by GRESB, says Dan Winters, GRESB head of Americas.
From 2013 through 2017, U.S. REITs have consistently outperformed the GRESB global benchmark average, while continuing to show collective improvements in ESG performance. U.S. REITs have equaled or outperformed global averages on each of the seven aspects that underlie the GRESB benchmark framework, Winters says. The GRESB global benchmark encompasses 850 participants covering both listed property companies and private equity funds from all regions worldwide.
For his part, Lopez-Alcala says MSCI’s research shows that considerable ESG work remains to be done relative to international peers.
“There is quite a bit of room for growth in terms of integrating ESG factors in the property industry in North America, but there are a few leaders there that are at the forefront globally on ESG.”
Race Against Rising Expectations
REITs actively disclosing in ESG efforts may wish to consider doing
so as soon as possible, given they may already be negatively impacted in the eyes of some investors because of their perceived inaction, Kocak says.
It is best to start now and take small steps, Kocak says. “While many REITs may not want to disclose their ESG efforts until they are more refined, they may instead be better off reporting what they are doing, even if it is not at the top level of performance.”
Kocak says companies need to be realistic and patient when starting out. “The REITs that are doing it well didn’t get there in a year and if others wait too long, it will be hard and expensive to catch up,” she says.
The good news is that many REITs may already be farther along the ESG path than they realize, Kocak says. She notes that REITs are generally already implementing ESG practices but many do not realize how much they are doing, such as the fact that human resources training and providing equal pay counts toward the “S” component of ESG, or that they already have strong governance as a best practice for a public company, rather than as an ESG effort.
Likewise, their property managers are likely paying attention to energy and waste issues, which are “E” components. “So, they may just need to formalize these efforts in a strategic way,” Kocak says. “Companies should disclose more on ESG practices on their website. Not just environmental practices but also social and governance.”
As part of such efforts, REITs need to be proactive in conveying to investors what is and is not feasible for ESG efforts within their REIT sector. “Some REITs cannot get their assets feasibility certified using LEED,” Kocak says. “And if stakeholders do not realize that, they may inappropriately penalize them, even if they are actually high-performing in the ‘E’ category.” Kocak says Nareit supports its members that are just starting their ESG journey or looking to take their ESG program to the next level by providing guidance through Nareit’s ESG education initiative JumpStart and annual ESG Forum.