Although evidence to the contrary has been accumulating for years, a wide range of institutional money managers continue to express skepticism that incorporating ESG (environmentally, socially and governmentally sustainable) investments into their portfolios will help boost returns. A 2017 survey by RBC Global Asset Management of 434 institutional asset owners and consultants in the U.S., Canada, and the EU found that more than half of U.S. investors did not believe that ESG approaches to investments mitigated risk. Incredibly, 83% of U.S. institutional investors that responded to the survey did not believe that ESG could be a source of alpha.
This stubborn misperception of the ‘costs’ associated with ESG investing is summed up tidily in the title of another investor survey conducted by Hermes Investment Management, Responsible Investing: The Persistent Myth of Investor Sacrifice. Similar to the RBC survey of institutional asset managers, the Hermes study found that 52% of money managers did not believe that a focus on ESG issues produces better long-term returns for investors.
How can this be so? Perhaps would-be ESG investors simply believe it to be too good to true, but, difficult-to-believe though it may be, numerous academic studies and meta-studies have affirmed again and again that institutional investors, as well as ordinary investors, can have their cake and eat it too. One of the first groundbreaking studies to demonstrate the link between ESG considerations and higher investment performance was a 2012 paper by Eccles et al written for Harvard Business School. The paper found that “corporations that voluntarily adopted environmental and social policies […] termed as high sustainability companies […] exhibit fundamentally different characteristics from a matched sample of firms that adopted almost none of these policies.” On top of this, the authors found substantial evidence that “High sustainability companies significantly outperformed their counterparts over the long-term, both in terms of stock market and accounting performance.”
A 2012 meta-study conducted by Deutsche Bank uncovered a similar positive relationship between ESG and boosted performance, writing that they did “indeed find positive correlation in a majority of securities studies, particularly those that look at securities that rate highly with regard to CSR and/or ESG.”
This same institutional skepticism towards incorporating ESG considerations into investment decisions often carries through into real estate investing as well. The stakes could hardly be higher: according to a March 2019 study published in collaboration with the United Nations Environmental Programme Finance Initiative (UNEP FI), buildings account for roughly a third of global greenhouse gas emissions, while consuming 40% of global energy. Remaining under the 2-degree Celsius warming threshold compared to pre-industrial levels is of critical importance and will require “global average building energy intensity per unit of floor area to be at least 30% lower in 2030 than current levels.”
ESG in Real Estate Investing: The Reality on the Ground
Clearly there is a tremendous challenge and opportunity (on a global scale) associated with ESG real estate investing, the investment community’s skepticism about performance notwithstanding. While the problem seems monumental, even unsurmountable, when viewed through a global, macro lens, the solutions themselves will be implemented on a development-by-development basis: building-by-building, dwelling-by-dwelling, in collaboration with residents and community partners. The reality is that if we have any hope of changing institutional investor perceptions regarding ESG investing, it may be necessary to zoom in on what ESG considerations really look like “on the ground” and how doing good for people, planet, and communities really can be good for investors’ portfolios too.
Basic, environmentally-friendly upgrades to buildings can help lower greenhouse emissions while boosting returns for real estate investors. As investment managers of real property, we routinely enact a slew of energy-efficient upgrades to lower our costs and improve property performance, including the installation of energy efficient lightbulbs and solar panels, installing advanced water meters to help decrease water waste, and modernizing HVAC systems to further minimize energy usage.
ESG initiatives need not stop at the “E” (environmental) in “ESG.” Social programs enacted in partnership with local communities, in particular at Low Income Housing Tax Credit (LIHTC) properties that are therefore regulated, such as financial literacy programs, free Thanksgiving dinners and school supplies, and holiday gift drives for children, can help lower financial stress for residents while also boosting occupancy rates. This makes for happier, healthier residents (who are more likely to pay their rent on time and remain in their units), and better performance for the property itself. Real estate investors need not stop there. By voluntarily renting a portion of units in more affluent areas at below-market rates, real estate managers can help integrate less-advantaged families into neighborhoods with better services, including schools and healthcare, helping to break cycles of poverty and economic segregation, all while improving the overall occupancy of hard-to-rent units.
The Bottom Line
Study after study (and meta-study after meta-study!) has offered up many of the same conclusions regarding ESG investing: that incorporating ESG considerations into investment decisions is not just an exercise in “feel-good bleeding-heart charity,” it can actually improve returns. In spite of evidence to the contrary, in many cases institutional money managers and everyday investors continue to express skepticism that ESG considerations can actually translate into improved investment outcomes. This is unfortunate, but it does appear that when it comes to public opinion the tide may be turning. Institutions have been pouring more money into ESG-centric investments as of late, to the tune of some $4.73 trillion as of 2016.
As the recent UNEP FI report has made clear, there is a tremendous challenge and opportunity in ESG investing when it comes to real estate. By making simple, commonsense investments in energy efficiency and community engagement, real estate managers and investors alike can help reduce greenhouse emissions and water waste, while helping to ensure that lower-income residents can remain in their homes and achieve improved financial stability in the process. Counterintuitive though it may seem, these lofty-minded initiatives don’t just make investors feel good, they also offer better returns.
*The views and opinions expressed in this article are solely my own.