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How Do You Measure the Social in Real Estate ESG?

To categorize companies that are not only turning a profit but making a positive impact on the world. The idea that the long term success of a company benefits from a sustainable approach to business is really starting to move markets. JP Morgan recently reported that ESG investments may soon represent 44 percent of all global assets under management. 

Mainly when people talk about ESG, they are mostly talking about the “E.” It makes sense why: things like energy consumption, carbon emissions, or waste reduction can easily be calculated and reported. But being good for the environment is not the only important factor when it comes to sustainability. Our impact on the environment, after all, depends on whether or not our societies are in a place to protect it. The S in ESG doesn’t garner as much attention or dollars as environmental sustainability, but is a critical consideration when it comes to a company’s impact. 

Now social impact investing is getting a renewed focus since the pandemic started. About 51 percent of investors surveyed by BNP Paribas said the social impact is the most difficult to analyze and embed in ESG investment strategies. The study concluded that social data is more challenging to come by, and there’s a lack of standardization around reporting. Social bonds issued globally reached record-highs of more than $20 billion in 2020, according to a Bloomberg report. Big investors like KKR and Vanguard Asset Management took social impact investing mainstream by creating funds based on social concerns.

The hardest part of focusing on social impacts in ESG is the lack of consensus on what to measure. There’s a hodgepodge of factors that could be considered, everything from racial equity and diversity, public health and healthy buildings, supply chain forced labor, to community environmental justice. No company can suport all of these important causes so they often have to choose just one to peg their performance to.

The social impact of investments is especially important for real estate portfolios whose assets literally make up the building block of our cities. The property industry has always been seen as profit oriented and slow to change but when it comes to embracing a sustainable mindset owners and operators have shown their commitment to social causes. 

Building health is table stakes

The idea of social impact investing isn’t new, it’s been around in some form for decades and taken on various names like corporate social responsibility. What is new is that companies are held accountable for everything they do, not just financial performance. The reason for the new focus on the idea is more than just do-goodism, they claim long-term returns will be higher from investing in companies that pay close attention to their social impacts and that companies who engage in anti-social practices are long-term risks.

The pandemic put more focus than ever on building health and wellness, according to Joanna Frank, President and CEO for the Center for Active Design. The Center for Active Design was launched by former New York City Mayor Michael Bloomberg in 2012 to incorporate public health research into building design. The Center has since gone international and manages Fitwel, a healthy building certification system created by the Centers for Disease Control and U.S. General Services Administration. “We don’t want real estate owners to reinvent the wheel or think they have to start from scratch to optimize a building for health,” Frank said. “The answers already exist in the public academic research that the Fitwel certification is based on.”

The Center for Active Design did a recent global survey of investors to ask how they measured social impact, and Frank said the top three identified areas were indoor air quality, emergency preparedness, and tenant satisfaction. Frank stressed that while building health and wellness is a significant factor in the S in ESG, it’s not the only one. Many factors intersect, such as the location of a property and its walkability score. Frank explained that better walkability scores can be viewed as a social equity factor in a multifamily asset because it promotes health and well-being. The condition and maintenance of a building are also seen as social factors. A well-run, clean building instills trust and improves tenant satisfaction and well-being while deteriorating properties do just the opposite.

Healthy buildings were once a nice thing to have for property owners, but the market is driving increased demand for them. Commercial properties with healthy building certifications like Fitwel have rental premiums of 4 to 7 percent per square foot over non-certified peer buildings, according to an MIT Real Estate Innovation Lab study from 2020. The study also showed that 46 percent of building owners leased properties with healthy building certifications faster than other properties. In the office and multifamily sector, employees and tenants are driving demand for healthy buildings, even more so than investors. 

Eric Duchon, Global Head of Real Estate ESG at Blackstone, told the Center for Active Design in a recent report that, in the wake of the pandemic, tenants are asking more than ever about indoor air quality. Ninety-one percent of property owners surveyed by The Center for Active Design said tenant satisfaction was the biggest motivator for investing in health buildings. Using a healthy building certification also offers a pathway for property owners to track health impacts in their ESG efforts. These certifications can be placed alongside others like LEED for a broader view of the sustainability performance of buildings, covering everything from energy efficiency to health and wellness. “Before COVID, the social impact was reported only 11 percent of the time,” Frank said. “That’ll change now because the social impact and health and wellness are seen as a risk. Everyone wants to do everything they can to bring up their overall ESG scores, and that will help turn attention to social factors.”

Real estate’s role in racial equity

While the pandemic had us focus on health, another monumental change in 2020 shook the ESG world and turned our attention to the insidious effects of racism. The social justice protests in the summer of 2020 following the killing of George Floyd were a wake-up call for everyone, and also the business community. About 43 percent of companies in the S&P 500 publicly stated support for the Black Lives Matter movement following Floyd’s death, according to an S&P Global Ratings report. John Streur, chief executive of responsible investing firm Calvert, said racism was an ESG problem and that U.S. businesses have the responsibility to end racism at their companies. Streur called on firms to publicly disclose the racial makeup of their employees.

The effects of Black Lives Matter protests also touched on real estate, and though the headlines have died down, they will likely continue to be a concern. Real estate has its own history of negative discriminatory actions, notably in the practice of ‘redlining’ that still persists today. As recently as 2015, the Hudson City Savings Bank was ordered to pay more than $27 million in damages for not providing fair access to mortgages for Black and Hispanic borrowers in Pennsylvania, New York, New Jersey, and Connecticut.

For ESG investors, a focus on affordable housing and investments in social programs impact racial equity. More global asset management companies are targeting projects that increase the share of affordable housing units that serve Black and minority communities. For example, RBC Global Asset Management has recently invested in MLK Gardens in Englewood, NJ, to provide better-quality housing at more affordable prices. New Jersey ranks ninth in the country for the highest cost of living. The average monthly rent at the MLK Gardens development is $443 compared to an average of $2,560 for a one-bedroom rental in the same area. Residency at MLK Gardens is restricted to families who earn 80 percent of the area median income, and about 78 percent of renters there are considered “extremely low-income.”

Pulling off projects like this is far from easy, though. It can be difficult to get traditional banks to look at investments in low-income neighborhoods, so developers have to use so-called ‘capital stack gymnastics.’ For example, TriStar Real Estate Investment raised $12 million for an affordable housing project in Atlanta in 2017, getting a bank loan but also financing the project through federal tax credits and nonprofit foundational funds. Private investors who seek returns on these projects can threaten affordability for the tenants, leading to incremental rent increases. 

Even with help from municipalities and institutional capital, adding affordable housing is complicated, especially with high construction costs. Often, the easiest way for developers to provide adequate returns for new affordable housing is to reduce construction costs as much as possible. Some developers are using modular construction to do this for single-family homes for low-income families, which is upward to 20 percent less expensive than traditional construction because of assembly line efficiencies, according to a McKinsey & Company report. Getting the projects done and turning them into good investments is challenging, but will prove to be important for real estate firms looking to make a positive impact on racial equity.

Getting credit for social good

No matter what social impact is discussed in ESG investing, the central question remains how to standardize its measurement. The United Nation’s Sustainable Development Goals are among the most prominent frameworks for reporting social impacts. But a 2018 KPMG study said that only 10 percent of global companies used the UN framework to set specific and measurable business performance targets. That’s likely because the UN’s goals measure national and population-level statistics like reducing maternal mortality rate and mortality rates due to unintentional poisoning. Goals like this have little bearing on what companies, especially real estate, can accomplish with social impacts.

In the future, social impact outcomes for real estate companies could be quantified in ways that everyone could measure. For example, ‘social credits’ could be developed the way carbon credits work by measuring units of impact from things like diverse hiring or community organizing. A social credit could measure outcomes in hunger, education, and employment. A real estate company could prove it helped 500 families in its local community become ‘food secure,’ but they’d have to measure by providing evidence each family had quantifiable ongoing access to healthy food on an affordable basis. This type of quantification of social impact would allow for real estate and other companies to be compared and benchmarked. 

A social impact credit has been proposed by Jason Saul, founder and CEO of Mission Measurement, a company that measures social outcomes for governments and businesses. The company partners with organizations and has created the Impact Genome Project, a web-based platform that contains a massive base of social science research. Real estate companies looking to accurately track and measure their social impact scores could use data like this for more precise measurements.

ESG investors will drive the need for this social impact data. And the real estate companies that can provide clearer data showing an obvious impact on business performance will have the edge over others that have investors asking what social impact their money is really having. Social impact data is complex, and it’s much harder to quantify than environmental data. Rating agencies, as well, will have to develop specialized questionnaires, research, and independent verification to create standardized methods to track it. Tapping into available academic research and translating it into reliable social impact measurements will take time, but it’ll boost the confidence of ESG investors in social funds.

The pandemic shined a spotlight on the S in ESG, which had already been gaining steam in prior years. The pandemic boom in social impact funds may be beginning to fade, though. Social bond sales in Europe have fallen by 60 percent so far this year, and the numbers are similar in the U.S., according to data compiled by Bloomberg. Moody’s ESG Solutions expects worldwide sales of social bonds to fall by 25 percent this year as investors move their focus from the pandemic to long-term climate goals. One reason social bonds are expected to decline this year is that there’s less consistency on key performance indicators and disclosure, according to Scott Freedman, a fund manager at Newman Investment Management. Some companies also struggled to create enough viable projects to create a purely social bond at benchmark size. Also, the pandemic may have put social bonds in the spotlight, but as government spending on pandemic relief has slowed, social bond issuance slowed, as well.

Real estate’s reckoning with the S in ESG can come at any moment, whether through a racial justice protest or a public health crisis like COVID. Better measurement of social impact data will be needed, and as the ESG market grows, this will likely come down the road. Measuring carbon emissions is easy, measuring a building’s impact on a local community is more complex. But real estate doesn’t just affect the planet, it affects the people on it. We usually think of the “E” when talking about ethical investing, and it’ll likely continue to garner the most attention as we tackle the effects of climate change. But our impact on the planet depends on whether we have a well-functioning society in place to protect and nourish it. The “S” in ethical investing doesn’t stand for “soft.” Real estate’s role in social impact is just as consequential as the energy usage and emissions we’re, just not yet looked at so closely.

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