Although the basic concept of ESG seems warm and fuzzy, it’s also now guiding the flow of tons of capital into multifamily real estate development. In its “2020 Impact Bonds Report,” Freddie Mac revealed that it poured $3.3 billion into a “Green” workforce housing bucket, $877 million into a “Social” affordable housing bucket, and $971 million into “Sustainability” affordable housing bucket. Many multifamily housing firms already have ESG policies in place while others are still trying to decode the acronym.
A Bit of History
The roots of ESG can be traced to academia and typically includes a nod to James S. Coleman, a sociologist who helped popularize the phrase “social capital,” in the late 1980s. His theories challenged the notion that corporations could only be ruled by market forces and that a value could be attached to a company that was doing good deeds.
The theory was advanced by John Elkington, a writer and entrepreneur, who in 1999 published “Cannibals With Forks: The Triple Bottom Line of 21st Century Business.” The book’s description states that it “passionately demonstrates how all businesses can and must help society achieve the three interlinked goals of economic prosperity, environmental protection and social equity.”
The concept began to gain traction in 2001 when HSBC, Citicorp and Unibanco in Brazil began using ESG research to guide their investments. In 2016, Freddie Mac launched their Green Advantage Program, to finance energy and water improvements on multifamily housing properties. Three years later, Freddie Mac rolled out $475 million in a green bonds program aimed at apartment building owners interested in making their properties more sustainable.
Who is Driving the ESG Train?
Following the money is the easiest way to understand what’s happening in the world of ESG. “Investors are definitely interested in ESG,” says John R. Williams, President and Chief Investment Officer at Avanath Capital Management, a multifamily owner-operator based in Irvine, Calif. “We have investors who invest with us simply based on our ESG approach and are very interested in the social impact component. They want to know how programs are working and measuring the success of these programs on residents. We have others who invest because of the returns, and the social impact is an added benefit. They understand that holistic investing often results in better performance.”
Interest in ESG reaches beyond the financers. “Over the last five to 10 years, there has been increasing focus on being good corporate citizens from all of our constituents, be it investors, developers, residents or partners,” says Rachel Woolf, SVP, Investor Relations & Operations with Blue Vista Capital Management, an investment firm based in Chicago. “The concept of stewardship is important to both real estate managers like Blue Vista and to our investors -- using business influence to help create an environment where positive economic and social changes are possible.”
The Big S
ESG is anchored to the sustainability leg of the stool as it represents measurable solutions for saving energy and money. Woolf’s firm invests in student housing through its affiliate, Peak Campus Companies. She points to specifying more efficient HVAC systems, lighting, plumbing fixtures and automated thermostats to boost sustainability ratings in student housing. Blue Vista also buys bulk energy where possible and has created programs for residents who want to learn how to reduce their energy usage. Achieving LEED standards in new construction is always a goal.
The Mortgage Bankers Association (MBA), based in Washington, D.C., has taken a keen interest in ESG and also cites the strong emphasis on environmental concerns. “ESG is about taking actions that investors or other counterparties find admirable and want to support,” says Bruce Oliver, AVP, MBA. “In the environmental category, this might include various levels of LEED certification, borrower commitments to certain principles or other indicators of likely positive or mitigating impacts on the climate. Lenders are working through an evolving and organic process of what ESG means to various counterparties.”
How Is it Measured?
Quantifying ESG in a standardized way is still a work in progress. Several major and familiar players in the financial market have developed their own measuring standards including Bloomberg, Dow Jones, Thomson Reuters, S&P Global, Fitch Ratings and Moody’s. GRSB based in Amsterdam, specializes in ESG calculations and boasts several partners from the world of commercial real estate including Yardi, Cushman & Wakefield, CBRE and Lord Green Strategies.
Avanath is currently working with GRSB on getting its first ESG score. “We were one of the first institutional asset managers to truly focus on ESG,” says Williams “It is something that we have been focused on since the very beginning. We are constantly looking for ways to improve and track ESG measures.” Besides making buildings more energy efficient, Avanath is also shooting for high scores by creating internal social programs focusing on health and wellness while actively promoting diversity.
The Insurance Angle
In addition to lenders, insurance companies have also been focusing attention on ESG issues. “At Avanath, we are recognized by the California Organized Investment Network, a program that facilitates insurance industry investments that provide solid returns to investors and yields environmental and social benefits to underserved communities,” says Williams. “This organization is a collaborative effort between the California Department of Insurance, the insurance industry, affordable housing, economic development organizations, community advocates and is a great example of insurers becoming involved in the ESG space.”
Blue Vista obviously owns lots of insured buildings and sees a logical connection to ESG. “As an owner of insured properties, the potential replacement cost of a building plays a big role,” says Ron Koretz, SVP, Head of Asset Management at Blue Vista. “The effects of things like climate change are costly to everyone, including insurers who may have to pay out large sums after natural disasters.”
What’s the Cost?
Multifamily housing owners and operators are skilled at keeping numerous balls in the air and responding to the needs of a wide variety of stakeholders. Incurring additional expenses for the sake of boosting scores in a non-standardized measuring system might not make much sense upon initial examination, but a lot of industry leaders are taking it seriously and saying it will pay off in the long run.
Core Spaces, a multifamily owner-operator based in Austin, Texas, is also working with GRSB to get its first ESG score. “I think there is an initial, short-term financial cost to boosting ESG scores, but it’s an investment, and it will create a return on investment if done right,” says Barry Howard, Chief Sustainability Officer, Core Spaces. “Whether it’s better tenant satisfaction scores, or environmental improvement through reduced utility costs, these things can be tracked and monitored to show the benefits.”
Where is it Going?
The sheer volume of capital and human resources flowing to ESG indicates it’s here to stay. MBA is playing an active role via advocacy to influence legislative policy. “CRE [commercial real estate] finance is a $4 trillion market that funnels capital from investors to property owners, identifying and assessing a wide range of risks and rewards,” says Oliver. “Therefore, as policymakers look to issues of climate risk and ESG, it is essential that they don’t constrict the flow of capital to commercial and multifamily finance by adding constraints based on risks that aren’t there of that are already accounted for.”
Bell Partners, an owner-operator based in Greensboro, N.C., has been watching ESG progression with an eye on their own efforts to be good corporate citizens. “We have seen the focus on ESG grow from a niche interest to a major factor impacting associates’ desire to join a company, residents’ retention rates at our communities, and investors’ general partner selection,” says Lili Dunn, President, Bell Partners. “For example, it is very common now to have ESG-related topics in investor due diligence questionnaires as well as employee and resident satisfaction surveys.” Bell’s ESG efforts include energy management programs combined with specific internal councils focused on diversity and sustainability.
Koretz at Blue Vista sees long term value in ESG from two possible sources: Lower operating costs and potentially higher resale prices. “Many ESG initiatives, such as energy and water efficiency, can have a direct financial impact by reducing operating expenses at properties over time,” he says. “If you are implementing ESG programs at a property that is intended to be sold, the financial benefit may not come from NOI, but through the exit value. From a firm perspective, the financial benefit may not be immediately apparent, but focusing on ESG and attaining good scores is important to our constituents, which in turn positively impacts our relationships with investors and tenants.”
Williams is bullish on the future of ESG based solely on the numbers. “We believe there is a direct relationship between ESG and profitability,” he says. “The misconception that you can’t have an impact and returns is simply not true. Many investors are realizing the same, including foreign investors. In fact, we closed our fourth fund at $760 million in equity commitments last year. Our original target was $550 million. More than 50% of capital came from foreign investors and 40% of capital was raised during the pandemic. This demonstrates the strength of us as an operator, as well as the strength of our investment model.”
Written by Scott Sowers, a freelance writer.