As environmental, social, and governance (ESG) issues become increasingly important to REITs, an emerging area of focus is that of the sustainable and ethical practices that a REIT’s supplier companies might employ.
Supply chains can often be complex, encompassing all the steps involved in helping a REIT produce its products and services, and involving everyone from suppliers and manufacturers to distributors and retailers. They involve direct and indirect relationships, and for larger REITs, can easily span the globe.
“The major emissions for real estate companies are not within our own operations, but within our supply chain,” says Sara Neff, senior vice president of sustainability at office REIT Kilroy Realty Corp. (NYSE: KRC).
She says REITs are increasingly being asked by both investors and tenants to account for the ESG practices of their supply chains, including carbon emission numbers and human rights practices. But, “real estate is very behind when it comes to understanding ESG impacts in our supply chains,” she adds.
Indeed: According to Nareit’s inaugural REIT Industry ESG Report published in June 2019, only 22 of the top 100 U.S. equity REITs reported on their supplier screening policies in 2018.
Searching for Supplier Excellence
To remedy that, KRC sent out its first “supplier excellence” survey addressing a variety of ESG factors in 2019 to its critical tier one suppliers. Tier one suppliers are the suppliers a REIT directly does business with—for example, janitorial services for an office REIT like Kilroy. A critical tier one supplier, Neff says, is one that would cause a critical disruption if it were to fail for some reason.
Neff, who says REIT ESG professionals work collaboratively, actually received a template for Kilroy’s supplier excellence survey from industry colleague Michael Chang, director of energy and sustainability at Host Hotels & Resorts, Inc. (NYSE: HST).
Host also sent out its first Supplier Excellence Survey in 2019, asking vendors about their corporate responsibility programs, human rights policies, and whether they measure and manage greenhouse gas emissions and energy and water efficiency, among other questions.
“The genesis of our program dates back to 2012,” Chang says, discussing when the lodging REIT first introduced a Renovation Survey, a predecessor to Host’s Supplier Excellence Survey. Host’s Renovation Survey is mandatory for all of its major renovation projects with a budget of $5 million or more.
“We’d been engaging with our project managers, designers and suppliers to encourage the integration of sustainable materials and practices into our major renovations,” Chang explains. This could include products that are locally sourced, contain recycled materials or have sustainable certifications. Opportunities to increase sustainable attributes often applied when upgrading the furniture and fixtures, appliances, wall coverings, paint, carpeting, and mechanical and HVAC equipment.
“The suppliers that we’re engaging with on ESG issues are our strategic suppliers,” he says. “They’re our project managers, designers, architects, and suppliers of furniture, fixtures, and other major equipment.”
Neff said that after analyzing the results of its supplier excellence survey last fall, Kilroy sent recommendations back to some of its suppliers. For example, for those that didn’t have a human rights policy in place, Kilroy recommended that they write one.
Opening the lines of communication with your supplier companies is the first step, but a supplier excellence survey could also reveal ESG concerns within your supply chain.
Sunny Misser, CEO of AccountAbility, a global consulting and standards firm that works with organizations to advance responsible practices, says REITs have a fiduciary duty to protect the value and integrity of their assets and to remain accountable to the interests of their stakeholders—both of which can be compromised by a failure to manage ESG risks in the supply chain.
“Good governance should therefore include an effective oversight of the management strategies, systems, policies, and processes impacting the entire value chain,” he says. As part of good governance, Misser suggests that REITs might consider the following leading practices to address ESG risks in their value chain:
- Establish vendor ESG screening criteria that are aligned to the REIT’s own compliance standards and sustainability objectives; and determine thresholds for contracting considerations.
- Enforce regular compliance audits for contracted vendors against ESG policies, standards, and performance criteria thresholds, annually or biannually.
- Establish formal processes and protocols for vendor feedback for corrections and improvements, based on performance, noncompliance, egregious violations, or unlawfulness.
- Actively track, monitor, manage, and report supply chain risks and KPIs to guide informed decision making and improving performance.
As a REIT hires new vendors, aligning on values often matters. Neff says that Kilroy also added a meaningful vendor code of conduct to all of its new contracts to ensure that new suppliers meet minimum ESG standards.
Chang, meanwhile, says Host has had a business Code of Conduct and Ethics that set expectations on environmental sustainability and corporate citizenship, including human rights, for many years, and recently published its Supplier Code of Conduct and a Human Rights Policy with more specific guidelines on environmental and social sustainability.
Ultimately, supplier excellence surveys help a REIT engage with its suppliers to better understand their sustainability platforms and quality control initiatives. “Our main objective is to identify opportunities to collaborate with the suppliers to increase sustainability in our renovation projects,” Chang says.