Driving change: The increasing role for ESG data in real estate

With COP26 due to take place in Glasgow this year, ESG is taking centre stage in all aspects of the economy but especially in the real estate sector. ESG data itself is undergoing rapid evolvement and disruptions. How are all these changes impacting the real estate industry? This article will illustrate the challenges brought by ESG data, and identify how RE5Q is poised to lead the trend.

Environmental, Social, and Corporate Governance (ESG) is undeniably gaining significance for business activities in all areas, notably in the real estate sector. Real estate contributes to 40% of global energy consumption and 36% of CO2 emissions, an impact far larger than its share in the economy (Figure 1). Not only are we now seeing greater demand for sustainable buildings from those who directly use them, but also a more important role for ESG data to quantify and report.

Figure 1: Real estate contribution in the economy and environment (Pictet Asset Management)

There are several driving forces behind the increasing importance of ESG data:

1. Increasing regulation

From 2015 to 2018, ESG regulations more than doubled in mainstream markets affecting multiple market participants globally. For instance, the two major investors in the real estate market, pension funds and insurers, are obliged to publish their ESG investment criteria

Apart from government bodies, over 35 stock exchanges globally have issued ESG reporting guidelines. It is widely believed that rules will become more and more stringent in the future, and likely that commercial buildings will face a requirement on Energy performance Certificate (EPC) rating above C in the next decade, which might lead to an increase in ESG expenditure. In addition to regulations, government bodies are also encouraging ESG through financial incentives. The €750-billion EU recovery fund among other recovery packages around the world in response to the pandemic, is targeting a shift to ‘Green’ (Figure 2).

Figure 2: Public Money Commitments to Fossil Fuels, Clean and Other Energy in Recovery Packages, USD Billion, as of 26 Oct 2020 (Wartsila)

2. Correlation between financial performance and sustainability

Fuerst et al (2011) found a positive correlation between Corporate Financial Performance (CFP) and Corporate Social Performance (CSP). Table 1 provides a summary of major academic research results. Weak ESG performances can also lead to lower corporate valuations, by increasing financial and regulatory risks and the expected capital expenditure for ESG improvement. From an investment point of view, ESG fund started attracting increasing inflows from 2019 (Figure 3), and 75% ESG funds at present outperform the benchmark. Investors’ favour over Green assets/ funds led to ESG assets being traded at a premium.

The financial impact of ESG decisions will become even more prominent, compared to ethical considerations and other motivations (Amel-Zadeh, 2017). This results from the rising demand for sustainable buildings by investors and tenants, a trend reinforced by changes in social, demographic, and ideological aspects over the years. Currently, client demand or product development are major reasons for investors’ use of ESG data in decision making. In the first half of 2019, ESG assets experienced a 15% growth to $52 million, and their proportion is expected to continue growing in the coming decade. More than 80% of industry executives agreed that ESG buildings would face growing demand from tenants.

Table 1: Literature review (Savills Investment Management)
Figure 3: ESG Fund’s Monthly Inflows (Wall Street Journal)

3. A shift from certificate to ESG data metrics

While the period between 1990 and 2020 is labelled the Golden Age of Certification because of the dominance of certificates such as LEED and BREEAM, the certificate system is expected to fade out because of their lack of flexibility and scalability. Instead, data metrics that enable continuous monitoring and updating of ESG performances will lead the market.

In other words, while the current market approach to ESG is qualitative, building-level ESG data will make it quantitative. This transformation places high demand on the accuracy of data measurement and reporting, which brings a challenge for market players as the data platforms often struggle to meet the rapid updates in ESG metrics. The difficulty to measure the actual data for both EPC and social performances further complicates the picture.

More challenges come from the communication of ESG data. Asset owners have data for their own properties, but potential investors often cannot easily extract private or even open ESG data. ESG investment mainly follow three strategies, namely single theme, exclusionary, and best in class. They differ in performances, but investors are not always able to distinguish between portfolios due to the non-standardisation and low transparency of relevant ESG data.

The communication issue is aggravated by the setbacks brought by COVID-19, which made it impossible to stick with some of the original ESG goals. For instance, the outdoor air flow must be increased in buildings, which causes a rise in energy cost for air conditioning. Effectively communicating the changes in ESG data to tenants and investors can be difficult but indispensable for asset owners or managers. Differences in market focus and government involvement across countries and authorities bring more complexities to the picture, especially for global market players to compare and make decisions.

In response to the various data challenges, it is helpful to build an integral and standardised data platform which allows for flexible applications of both ESG data and other KPIs (e.g., financial). The first step to achieving this is collating reliable granular data for properties, and there are two basic channels for this, namely building management systems (BMS) and equipment monitoring empowered by sensors. The former is often more handy but lacking comparability, while the latter ensures standardized data flow, but demands more initial setups. 

RE5Q helps solve the data challenges. We not only hold abundant hyper local ESG data at building level, but also integrate hundreds of data sources using AI, operate an IOT platform that collates sensor data and source previously submarined data. .

In addition, ESG data is built into the auto-valuation model (AVM) of RE5Q, so the impact from ESG is digested and internalised for the insight of users. These offerings enable users to efficiently access, integrate, update, and communicate ESG data information with relevant parties, to adapt to the new phase of real estate ESG.