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Are Real Estate’s ESG Commitments Too Good to be True?

Every year the Swiss financial publication finews.com asks its readers for their suggestions for their annual Swiss financial word of the year. In 2021 they had a clear winner: greenwashing. The word represents the false claims and empty promises made by corporations about their sustainability goals. 

Greenwashing has existed almost as long as the modern environmental movement. Westinghouse, an American electrical giant, fought back against anti-nuclear sentiment in the 1960s with a series of ads claiming the safety and cleanliness of its nuclear power plants. One ad showed a nuclear plant next to a tranquil lake, saying its plants were “odorless, neat, clean, and safe.” Westinghouse failed to mention the impact of nuclear waste and plant meltdowns that had happened in Michigan and Idaho. 

It wasn’t until the 1980s the term “greenwash” entered our vernacular, coined by an environmentalist named Jay Westerveld. He came up with the idea on a research trip to Samoa after sneaking into a nearby resort to steal some towels. The resort had left a note urging lodgers to re-use towels to help the environment, which struck him as ironic. “Wasn’t the same resort harming the local ecosystem by expanding and building more bungalows,” he thought. They likely didn’t care about the environment, but it all “came out in the greenwash,” he eventually wrote in a literary magazine essay.

More people than ever are eco-conscious and worried about climate change, and that’s led to increased scrutiny of greenwashing. Also known as “green sheen,” the phrase simply means a company that makes deceptive or unsubstantiated claims about their products or business practices helping the planet. Some greenwashing seems relatively harmless, like a toilet paper manufacturer making a vague claim about recycled paper. But in the world of commercial real estate, the stakes are much, much higher. 

Environmental, social, and governance (ESG) investing principles have become the industry’s hottest buzzword in recent years, and it’s hard to find a large commercial real estate firm that hasn’t incorporated the practices into its business. ESG investments are drawing massive amounts of capital worldwide, global ESG assets are on track to exceed $53 trillion by 2025, which would comprise more than a third of total assets under management, according to Bloomberg. Many real estate investment trusts (REITs), such as Boston Properties, have issued huge green bonds in recent years, and it seems everyone has jumped on the ESG bandwagon.

Several observers, including regulators, are asking if these green assets are too good to be true. The commercial real estate industry has especially been in the spotlight. There’s a growing emphasis on the built environment’s impact on climate change, as the industry is responsible for 30 percent of global carbon emissions and 40 percent of energy use. Decarbonizing buildings has become a rallying cry, cities and states are passing stricter emissions and energy regulations and a whole day at the recent United Nations climate change conference was dedicated to buildings. 

The real estate industry will be under increased scrutiny for a while, and it appears they’re making progress with sustainable investments and ESG emphasis. But the problem is ESG ratings, and possibly even green building certifications, are a mish-mash of subjective measurements. The alphabet soup of sustainability metrics relies on providers using their own data and definitions are often not clearly defined. Frequently the results aren’t independently verified or measured by regulators. So, when a REIT touts green awards and talks about its sustainable building portfolio, just how green is it? An example of this is the green bonds issued by some REITs, which are specifically earmarked for environmental and climate projects but don’t have very concrete standards.

“The entities define what a green bond is for themselves,” said Matt Ellis, Founder, and CEO of Measurabl, an ESG data management provider for commercial real estate. “There are green bond standards and guidelines, but it’s actually left up to second-party opinion like KPMG so, it starts to feel like a ‘choose-your-own-adventure.’ What’s stopping us from saying a bond is green and lumping it into a bunch of green building certifications that we were going to do anyway?”

The lack of concrete, objective standards for green bonds and other green finance has led to some people questioning if it’s all just greenwashing. And even the organizations that measure and rate green financial instruments have been scrutinized because of conflicts of interest and seemingly willy-nilly ways of categorizing what’s green and what’s not.  A recent Bloomberg investigation revealed that Morgan Stanley Capital International (MSCI), an investment research firm that provides widely used ESG ratings, may not actually measure a company’s environmental impact. Instead, the report said the ratings gauge the opposite, ‘the potential impact of the world on the company and its shareholders.’ MSCI’s CEO Henry Fernandez didn’t even deny it, telling Bloomberg that retail investors usually aren’t aware of how the ratings are designed and ‘they’re not as concerned about the risk to the world.’

Another ESG agency is the Netherlands-based Global Real Estate Sustainability Benchmark (GRESB), which collects, validates, scores, and benchmarks green data. The benchmarks are the global standard for ESG reporting in the real estate sector, and more than 100 of the world’s largest pension funds and investment managers use their data and analytics. The problem is the organization is investor-led, and they’re far from an outside arbitrator. Some say institutional investors don’t demand enough of the benchmarks, probably because it would hurt their bottom lines. 

The organization also doesn’t publicly disclose scores for the companies it ranks, though it released aggregated numbers in a 2020 survey. Many green bonds part of the ESG craze also use the money to finance buildings with green certifications, such as LEED. But even these certifications have been questioned by some. Several studies have shown LEED buildings do use less energy than their counterparts, but other studies show green buildings aren’t worth the hype. For example, a recent study by Carnegie Mellon University found that LEED-certified federal buildings aren’t using less energy, possibly because of trade-offs in how energy scores are developed.

But even though real estate ESG funds may not be as green as they seem, Ellis stressed that the property industry has taken great strides in addressing energy efficiency and emissions. “I think if you look at all green claims, the property business is the most measurable and doing some of the very best and most objective work on this,” Ellis said. “I don’t want people to think the property business is just sucking down green dollars. I just think we need to make sure the measurements are a uniform experience, and we’re not there yet. Regulation will help, and investor pressure will, too.”

It’s easy to take the cynical view that real estate ESG funds are nothing but greenwashing. But as Ellis pointed out, incremental changes are being made, and slowly, but surely, the property industry has become much more conscious of its environmental impact in the past two decades. Increased regulation in the U.S., Europe, and other parts of the world will undoubtedly sort out the vague and subjective claims made in ESG and create a more robust system. Investors may only care about the bottom line, but it will force their hand if fines and regulatory actions are introduced into the ESG ecosystem. More objective standards for measuring environmental impacts in ESG and green building certifications are also sorely needed, which will help reduce greenwashing claims. The term ‘greenwash’ is nothing new, it entered our vernacular a long time ago. And if commercial real estate investors and owners want to really make an impact, they’ll have to shed their subjective rating systems for something that doesn’t “come out in the greenwash” like other dubious eco-friendly corporate claims.

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