Small firms face significant risks by not embracing an ESG strategy, according to sustainability experts.
When it comes to helping the planet, having a smaller footprint helps. But when it comes to smaller real estate firms adjusting to an era of energy efficiency, sustainable construction and data reporting, being a mom-and-pop investor can make going green seem burdensome, or even impossible.
An industrywide shift toward ESG, short for environmental, social and governance, investing, aiming to encourage more sustainable investments and therefore require more environmentally friendly buildings, is putting increasing pressure on small real estate firms to adopt a greener investment and development ethos.
As banks and financial institutions increasingly factor sustainability into their evaluations and lending and investment strategies, employees seek out employers with green bona fides, and tenants search for office space with a lighter carbon footprint, firms may feel pressure from all sides.
“Employees and tenants will tell you if ESG is important to them,” Piermont Bank CEO and President Wendy Cai-Lee said. “Office and industrial will have a higher likelihood of tenants who care about ESG components.”
Despite the pressure, smaller firms are still slow to move, said Cai-Lee. The majority of the bank’s loans have some kind of ESG requirement. Major developers and multinationals have teams of experts and the money to invest in new, evolving sustainability strategies.
As the market increasingly asks for more sustainable real estate — JLL estimates $288B globally was invested in sustainable assets from January through November 2020, a 96% year-over-year increase — small firms that don’t pivot to ESG risk being marginalized from certain markets or opportunities. Small firms that are already more risk-averse, with tighter margins and fewer resources, can struggle to meet this increasing market demand.
“If your building isn’t set up to succeed, you’re at a distinct disadvantage,” said Marta Schantz, senior vice president of the Urban Land Institute’s Greenprint Center for Building Performance. “The risk of your building becoming financially obsolete is huge. I’d rather talk about the sustainability benefits of ESG, but if you don’t take action, you’ll simply be left behind.”
Part of the problem, according to Raphael Rosen, CEO of Carbon Lighthouse, a proptech firm focused on decarbonization in commercial real estate, is that smaller firms often have no idea where to start. To meet ESG’s environmental requirements, the end goal is creating investments that feature renewable power, energy efficiency, carbon offsetting and measuring emissions over time. But creating an operational framework for that shift can be daunting.
“The No. 1 issue is defining what exactly ESG is,” said Partner Energy President Tony Liou, whose consultancy focuses on sustainable engineering and real estate strategies. “Ask a dozen people, you get a dozen answers. We try to get clients to focus on it holistically. ESG isn’t a singular action you do and check a box and say you’re done. To be truly successful, it impacts all over your operations and buildings. Sustainability data is becoming more commonplace; those who don’t start considering it will be left behind.”
ULI’s Schantz said small firms likely don’t have existing expertise or capital budget, and may need to engage in some creative financing to figure out how to upgrade buildings. Larger firms can afford dedicated professionals, or even a team, that understands ESG requirements and portfolio opportunities. A lack of manpower often hinders smaller firms from embarking on the path toward ESG.
Schantz recommended smaller firms start slow, consult resources like ULI’s Blueprint for Green Real Estate and other local real estate organizations, such as new green building hubs emerging in places like Kansas City. Consultants can be helpful, especially for already time-constrained teams, but she recommends working toward a full-time expert and aiming to build capacity in-house.
Much of what’s expected to be a growing wave of more stringent building codes and regulations will be enacted on the local level, such as New York City’s Local Law 97, which will limit the emissions commercial buildings can produce. Small firms need to acquaint themselves with any local regulations, and then begin implementing ways to collect energy performance data inside their properties.
Data inevitably means technology, in this case, proptech or climate tech, which can be new and relatively untested. ULI’s Schantz recommended that smaller firms only utilize tech that’s been vetted by trusted names. She suggested looking at the tools utilized by Kilroy Innovation Labs, and those tested and approved by the GSA Green Proving Ground, a federal government resource that tests everything from HVAC to lighting, serving as a sort of Wirecutter for climate tools.
While small firms don’t need to make changes overnight, it’s important to understand the repercussions of not acting over time. Cai-Lee said that if a firm’s target demographic is small, nonaccredited tenants looking at 2K SF leases, they likely won’t have stringent ESG demands anytime soon. But anybody looking for marquee names or tech tenants will need sustainable property, and the data and analytics capacity in-house, to land these leases.
Liou said more and more firms, regardless of size, see skirting a sustainability program as a barrier to capital, one that puts a firm at a long-term disadvantage. It also delays a needed operational change, especially as more cities and municipalities enact more stringent energy and building codes.
“Money wants it today, but it could be part of the building code tomorrow,” Liou said. “When it does happen, it’ll happen fast.”
Source: “For Small CRE Firms During Sustainability Era, It’s ESG Or Obsolescence“