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What are the benefits of ESG to a commercial asset?

September 21, 2021

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As the proptech market fast matures, more commercial landlords are realising the importance of transforming their assets into smart buildings. In order to do this, and to attract and retain companies, they will need software that helps them set and achieve their ESG objectives.

A recent Metaprop report on global proptech investment confidence highlighted this very reality. In the minds of proptech investors, ESG solutions are among the biggest changes expected in the next 12 months.

“ESG solutions will be seriously considered and adopted by most of the real estate players,” one respondent said.

Research has shown that ESG factors contribute to long-term financial performance. ESG research can be used to identify companies that are well-managed and likely to succeed, and to flag companies with business models that are likely to face issues in the near future.

A growing body of evidence suggests that these principles translate directly to real estate assets and investments. Institutional investors are increasingly looking to ESG factors as a way to manage risks and to achieve long-term sustainable financial performance.

How does ESG create financial value for commercial owners and companies?

1. Higher profitability

Companies with high ESG ratings tend to be more competitive and generate abnormal returns. This can lead to higher profitability and dividend payments, especially when compared to companies with particularly low ESG ratings.

In real estate, ESG considerations result in significant operational savings, increased employee productivity, reduced absenteeism, lower servicing costs, and greater occupancy, tenant retention, rental yields and resale values.

2. Increased funding and lower cost of capital

Ensuring good ESG performance can also make it easier and cheaper for companies to receive funding, both from private and public financial institutions alike. Green bond initiatives such as those of the Bank of England and ECB show that ESG will increasingly assert itself over capital markets policies, with deep implications on the cost of capital.

Similarly, many of the pandemic-related recovery programmes like the Recovery Plan for Europe and the Biden’s Administration American Jobs Plan have been created with a big emphasis on sustainable buildings, infrastructure, and technologies. This suggest that, at some point, companies and/or real estate buildings with low ESG ratings may struggle to find financing at all.

A group of 35 big investors managing $11tn in assets recently called on global banks to stop financing carbon-intensive projects and to scale up their green lending. As time goes on, it is clear that this pressure will continue to mount.

3. Lower tail risk

Companies with high ESG ratings often experience a lower frequency of idiosyncratic risk incidents, the likes of which can result in major drawdowns, and sometimes involve civil or criminal liability, or major conflicts with stakeholders.

When it comes to real estate, a comprehensive ESG approach can also minimise large adverse risks. There are some distinct examples of idiosyncratic risk (such as the poor governance surrounding the tragic Grenfell incident), and there are undoubtedly some assets that will be particularly exposed to climate change and natural disasters.

However, the main tail risk for most real estate portfolios is likely to be the risk of accelerated obsolescence, due to regulatory requirements and consumer demand, which can lead to dramatic drops in occupancy and value, as well as suboptimal operational costs. ESG and PropTech can be particularly effective in future-proofing buildings and portfolios against this risk.

4. Lower systematic risk

Companies with high ESG ratings usually have lower systematic risk exposure, creating less volatile earnings and less systematic volatility. They also tend to experience lower betas and lower costs of capital. Specifically to real estate, researchers have found lower levels of asset volatility both in newly built green buildings as well as in green retrofitted-buildings.

In addition to looking at existing ESG ratings, investors can also consider changes in ESG ratings. This concept, known as ESG momentum, has been shown to outperform the general markets. UBS have published research showing how ESG momentum can be implemented into a traditional investment approach.

This post was created by our smart building technology partner, Metrikus. We have made small edits to update the content. For more information on ESG and smart building technology, download Metrikus' PropTech Guide to ESG.

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