The Art of ESG

MULTIFAMILY EXECUTIVE

https://www.multifamilyexecutive.com/business-finance/business-trends/the-art-of-esg_o

Learn how multifamily owners and operators are managing the ESG hype—and growing from it.

By Aly J. Yale

A decade ago, the letters “ESG” were hardly uttered in the same sentence, let alone in talks of multifamily real estate. Today, it’s the acronym on everyone’s lips—and for good reason.

ESG—or environmental, social, and governance—issues are a top priority for investors these days. So much so that a whopping 96% of S&P 500 companies now report regularly on their ESG efforts.

“ESG has become one of the most compelling criteria for investing across all asset classes,” says John R. Williams, president of Avanath Capital Management, a real estate investment and operations firm based in Irvine, California.

Williams is right: But it’s not just investors that ESG efforts aim to please. They also can increase efficiency, improve resiliency, raise retention rates, and lend themselves to better long-term returns, too.

As Sam Adams, CEO of investment firm Vert Asset Management, puts it, “ESG used to be considered a luxury. Now, it’s an opportunity.”

The Rise and Power of ESG

ESG issues—although not always referred to by that acronym—have long been a concern for multifamily stakeholders. In recent years, though? A confluence of factors has made them top of mind—across all parties.

“Although conservation, green buildings, resident services, and fair business practices have been a focus in the multifamily sector for many years, attention to ESG has escalated significantly over the past decade,” says Catherine Lucchesi, director of ESG at Comunidad Partners, an investment management firm specializing in workforce and affordable housing. “Catastrophic climate events, COVID-19, social movements, shareholder activism, millennial influence, and globalization have all driven stakeholders to hold companies accountable for ESG.”

As Lucchesi notes, the push for ESG is coming from all sides. On the resident end, eco-friendliness and sustainability have been a growing priority for years. In fact, according to a study by Apartment Data, 61% of apartment renters are willing to pay higher rents to live in a more eco-friendly apartment.

"While ESG is increasingly important to stakeholders, including investors and government regulators, it is also a growing concern from a consumer point of view,” says Sara Neff, head of sustainability at Lendlease, a real estate investment and development company. “Owners and operators should incorporate more ESG strategies into their properties, appealing to residents who desire buildings that align with their environmental and social priorities.”

An increase in extreme weather events also is driving the ESG trend forward. According to the National Oceanic and Atmospheric Administration, since 1980, the U.S. has been hit with over 340 weather and climate disasters that caused at least $1 billion in damages. The total wreckage from those events exceeded $2 trillion. In 2022’s Hurricane Ian alone, more than $603 billion in apartments were at risk of storm damage.

“The real estate industry faces significant property-loss risk due to climate change,” Lucchesi says. “That has driven industrywide response.”

Of course, there are financial drivers, too. Not only can certain ESG efforts lead to higher rents, but they can improve retention, too. Comunidad, for example, credits its social programming, which includes things like homework help, virtual health care, and credit-building, as a big reason for its higher-than-average retention rate. According to Lucchesi, Comunidad communities have a retention rate of nearly 68%—much higher than the national average of 57%.

There are also the long-term impacts of ESG to think about—both on a property’s operating costs and its resale value.

“ESG-focused investments routinely see returns that beat those of the overall market,” Neff says. “Properties that are designed and operated within an ESG framework have better operational performance as well as higher relative valuations at the time of sale—meaning they are a smarter bet for both short- and long-term investment strategies.”

Meeting Expectations

Investors and residents demand ESG, but how are developments rising to the occasion? It can be challenging due to ESG’s broad and far-reaching scope.

In the multifamily sector, ESG can encompass all sorts of initiatives—and not just property-specific ones, either. It can mean choosing more sustainable construction materials, improving resident quality of life through health and social programming, or even creating a more equitable hiring process on the back end.

It’s a varied and wide-ranging set of issues that requires top-to-bottom buy-in, good data, and the right partners, experts say.

“ESG does not have to be a separate line item in a property’s budget if it aligns with current company policies,” Lucchesi says. “To be successful, the entire team should be aligned on value, mission, and goals around ESG.”

Bringing in experts is a common approach, too. Real estate investment platform Revitate has created a Social Impact Council to advise on its ESG efforts and also consults with the Urban Institute. Avanath uses ESG consulting firm RE Tech Advisors, as well as Energy Star, EcoSense, and various other energy experts. Some companies even hire dedicated personnel for their ESG efforts. As Williams puts it, “Every asset is going to address the specifics of their ESG programs slightly differently.”

Data is also vital to powering many decisions regarding ESG, particularly building-side ones. At Avanath, for instance, data has led to properties getting smart drip irrigation systems and more drought-resistant vegetation, among other updates.

“The evolution of the technology and data to implement and manage green development and operations has made it less expensive and more widely available,” Williams says. “Having quality utility data and a data management process are critical to understanding and evaluating building performance.”Of course, all these things—consultants, data monitoring, and dedicated employees—come at a cost, and, at a time when inflation is high, that can be a hard pill for some owners and operators to swallow.

Incentives offered by the Inflation Reduction Act can help offset some costs, but experts say it takes reframing these expenses as more than a line item—and more like a long-term investment.

“There is a common misconception that ESG efforts sacrifice profit for returns, and that is not the case,” says Lisa B. Merage, chief impact officer at investment firm Revitate. “When done strategically, they enhance them.”

Merage points to Revitate’s Cherry Tree fund, which aims to improve workforce housing in the Midwest, as proof. “By preserving affordability for residents, we tend to have higher occupancy, longer retention, and lower turnover,” Merage says. “Lower turnover means fewer costs and positive cash flow. High occupancy and steady cash flow lead to the enhancement of a property’s long-term value.”

Measuring Success

Monitoring and measuring success in ESG efforts is critical to improving them—but even that can pose a challenge. According to The Sustainability Institute, there are more than 600 different ESG ranking and rating standards to choose from.

“While each ESG rating organization has created its own standards for evaluating ESG performance, the measurement defines a company’s long-term exposure to environmental, social, and governance risks that are typically overlooked during a standard financial analysis,” Lucchesi says. “Scores are calculated by factors such as carbon emissions, social outcomes, diversity, equity, and inclusion, which are converted using analysts and algorithms into ratings that are then combined into an aggregated score.”

Many owners and operators also create their own ESG metrics, frameworks, and scorecards to monitor efforts. At Comunidad, for example, the company tracks 65 different key performance indicators to help drive strategy. Similarly, Avanath created Amplify, a full-scale ESG management platform.

“It aims to provide measurable benchmarks to set an industry standard for operators and owners within the affordable housing space,” Williams says. “This is vitally important as it allows us to demonstrate to investors empirically which programs and services are most beneficial.”

Though properties may diverge on which technologies and standards they use to measure ESG success, and prove that success to investors, Neff says having regular third-party audits should be the gold standard.

“The only way to reliably review ESG efforts is through regular audits by a knowledgeable and reputable third party,” Neff says. “We have third-party auditors to verify our environmental data, another provider to evaluate our social value creation claims, and a third to verify our carbon claims.”

ESG in the Future

One thing that everyone agrees on is that ESG isn’t just a flash-in-the-pan trend—for investors or for any multifamily stakeholders, for that matter. It’s here for the long haul, and multifamily owners and operators need to make honing their ESG processes a priority sooner than later. “In the future, ESG will be a necessity,” Adams says, “either via regulation or tenant demand or both.”