ESG myth and reality in real estate

Political myths

That ESG is wrapped up in modern culture wars is no myth.

Back in 2023, a Republican Congresswoman from Texas, said: “ESG is a form of virtue signalling where companies can proclaim how enlightened they are based on their environmental, social, or corporate governance actions … ” …continuing in the same vein.

But such detractors aren’t really talking about the ESG that is such an integral component of real estate investing, especially in the UK.

What started life as a risk assessment tool, and for some later became a marketing phrase, is for others now a political idea. In the eyes of some politicians, ESG represents how investors might consider non-financial issues or even social justice issues in their decision making. Such political pressure, at least in the US, has led to large asset managers reducing their support for ESG resolutions.

However, political or not, environmental, social and governance each include risks which investors need to manage.

These myths, and this fog of (culture) war, must not obscure the necessity of objective, rational risk assessment of environmental, social and governance issues for managing long-term investments.

For example, the International Valuation Standards say that ESG are the criteria that together establish the framework for assessing the impact of sustainability and ethical practices, financial performance or operations of a company, asset or liability. All three pillars collectively impact performance in the wider market and society.

And they are fundamental to the valuation process in real estate, as thousands of professional investors in the UK well know.

Myths in etymology

If there are myths that ESG is under serious threat, similar myths confuse and conflate its terminology. Take ESG and sustainability.

ESG is the focus. It’s the input framework for evaluating and reporting risks, particularly in the context of financial performance.

Sustainability, on the other hand, is a very different concept. It is the output practice. It’s the implementation of energy efficiency, or biodiversity measures making an asset greener, or future proofing against climate change.

Misconceptions around terminology persist. The three components of ESG are not separate. They are necessarily intertwined. If a company or asset has an environmental programme but lacks a governance structure, that programme is not going to be accomplished. Likewise, a social initiative must also be governed properly for results.

This overlap is vital because you must solve multiple issues to achieve necessary goals. If you think about it, it’s the reason the E, S and G have long been lumped together.

But misunderstanding doesn’t stop there.

Implementation myths

For example, the concept of a mythological green premium may mask the real risks inherent in ESG. It presents sustainability as an optional value enhancement. However, it is more common to see investors reducing pricing to account for expenditure to improve sustainability leading to discounting and accelerated obsolescence.

It is also more complex. Definitions of net zero buildings can be broad. While we know that EPCs and energy efficiency affect transactions in aggregate, it can be difficult to determine the pricing of more advanced net zero buildings as this is a newer concept with a lack of transaction history. Sometimes there will be a lag in recognising pricing changes in the market because buyers do not disclose such their decision-making.

A further myth is that decarbonisation is an avoidable cost. National Net Zero targets, within the Paris Agreement, are set in stone. They are law. They are going to happen. The controllable variable is timing, because anyone leaving it too late to address decarbonisation in their real estate will face rising labour costs.

The good news is that carbon transition risks, if managed properly, are an opportunity to reposition buildings within the market and attract better tenants or better investors.

Biodiversity also has its own myths. Contrarily to what one may think, it is closely intertwined with climate change – not separate from it – and few biodiversity related frameworks are now in place. Those that are, are voluntary.

The last big ESG real estate myth is that social value is a cost. The term refers to implementing targeted benefits to society as part of existing real estate activities. These might include creating a sense of community, enhancing social cohesion, fostering inclusivity and improving the local environment. It’s different to social impact, which refers to the intentional social outcomes and changes resulting from real estate activities (including property development, management and investment) on communities and individuals alongside generating a financial return.

Social value can in fact be an investment. Investors are always trying to position assets within communities, because the tighter a community is around a building, the more value can be generated. Noma in Manchester or Granary Square in London’s King’s Cross are good examples.

Perhaps we shouldn’t be surprised that people sometimes apply their own definitions to ESG – with its changing rules and practices – or that it becomes a lightning rod for ideologues. It is essential to the preservation of life on earth.

Ultimately, the words you use are up to you, the fact remains that investors must manage the risk.