ESG: Where Are We Now?

Environmental, social and governance factors hold greater sway in the multifamily housing industry.

The rise of environmental, social and governance (ESG) factors has accelerated in the worlds of finance, politics and the multifamily housing industry. It has accumulated new designations and labels along the way including green finance, social impact investing and mission-driven finance.   

The roots of the concept stretch back to the 1980s as academia became interested in “social capital,” the notion that added value could be attached to a company that was doing good deeds. The concept appealed to investors looking for places where they could earn a decent return while also helping humanity.   

The U.S. Government Sponsored Enterprises officially invested in ESG in 2016 when Freddie Mac Multifamily launched its Green Advantage Program. The program has proved successful and now touts its advantage over non-green programs by claiming almost $28 million in reported annual savings, which equates to roughly $48,900 per loan, and $191 per unit on projects that qualify for the program.

The Multifamily Radar Screen

In addition to the availability of green financing, owners and operators are seeing ESG creep into their world in a variety of other ways, including resident interest. “It is very much top of mind for our residents,” said Kelly Vickers, VP, ESG for Boca Raton, Fla.-based Mill Creek Residential. “We see it showing up as demand for a sense of community, walkability, active design, wellness- inspired amenities, energy and water efficiency and EV charging stations.”

The insurance industry also has a vested interest, especially from a sustainability perspective.

“Our insurers are definitely interested in ESG and want to know how committed we are as an organization,” said John Filipowicz, VP, Compliance and Risk Management, Mill Creek Residential. “Our commitment shows and has enabled our risk team to be transparent with our brokers and carriers, which promotes teamwork, open communication and positive outcomes.” 

As extreme weather becomes the norm, the dangers of developing or operating at-risk buildings are affecting premiums. “Climate risk is increasingly becoming a factor for insurance companies concerned about the potential for structural damage caused by extreme weather events,” said Sara Neff, Head of Sustainability, Americas, Lendlease, based in Sydney, Australia. “ESG has resonated with investors for some time, not just for optics, but because assets that prioritize environmental, social and governance factors frequently outperform traditional investment vehicles and are projected to grow in value.” 

Getting Tested

As ESG goes mainstream, the definitive mechanism for defining and measuring it remains unsettled. Major players in developing standards for ESG include the Global Real Estate Sustainability Benchmark (GRESB), Dow Jones and Bloomberg. The credit ratings agencies all have their own scales, and the Securities and Exchange Commission also has a finger in the pie. Yardi, Cushman & Wakefield and CBRE have also all become stakeholders in setting ESG standards.  

Stoneweg US, based in St. Petersburg, Fla., is working with Freddie Mac as an Impact Sponsor cohort, which includes tapping funds offering an ESG premium. They are also working with GRESB on scoring their Varia US properties, showing a 33% year-over-year improvement in their scores from 2022. They are also seeing benefits in terms of employee retention.

“We’re leading with strategies that hinge on resident satisfaction,” said Thomas Stanchak, Director of Sustainability, Stoneweg US. “We are prioritizing people, recognizing that a focus on sustainable and socially responsible living reduces turnover costs and vacancy losses.”

Avanath Capital Management, based in Irvine, Calif., takes ESG seriously by deploying multiple programs and policies to ensure their buildings are as energy efficient as possible. They are also heavily involved with social programming efforts including after-school programs.

“The Avanath Affordable Housing Renaissance Fund has filed for the GRESB since its inception and achieved a 2022 GRESB score of 80, demonstrating an increase of 16 points over its prior year score,” said Ken McMackin, SVP, Portfolio Management at Avanath.

What’s the Cost?

Naturally going the extra mile comes with extra costs but many owner-operators see it as an investment that pays off. “While implementing sustainability initiatives that result in higher ESG scores may require a financial commitment, the benefits, both financially and otherwise far outweigh the monetary costs,” said McMackin. “Doing the right thing is not only worth the price, but also results in measurably higher performance at the property level.”

For a smaller company interested in launching an ESG initiative, numbers must be crunched but getting the stakeholders up to speed is also a vital piece of the puzzle. “Carving out budgets for programs that are new to any organization can be a challenge, said Julie Blank, COO of New Standard Equities, based in Encino, Calif. “Educating board members, investors, the executive suite as well as other employees is a step companies may not be prepared for when embarking on their ESG journey.” 

Leveraging existing initiatives is another option. “On the property side, landscaping with native or drought-tolerant plants or even zero-scaping is easy on the budget, reduces water expenses and makes an impact on the environment,” said Blank. “Employee wellness programs fall within the umbrella of ESG. Even the company handbook has ESG related initiatives. These all count.”

The Future

McMackin said the multi-pronged appeal in ESG related goals will keep the movement alive, especially in the affordable housing market. “Investors, lenders, and development partners in the affordable housing space are drawn to companies with higher ESG scores,” he said. “As the industry evolves, not focusing on ESG may create significant disadvantages in raising capital. Neighborhoods and municipalities are more amenable to housing operators who focus on sustainability, resulting in less NIMBYism and greater acceptance of our communities.”

The return on investment makes ESG policies a winning strategy for many owner-operators. “Operationally, ESG-related improvements result in better building performance, which leads to improved Net Operating Income,” said Neff. Our joint venture partnerships require that our investment management portfolio be net zero upon operation, which aligns with their own investment goals.”

Neff also points to recent analysis from Morningstar showing that ESG-aligned funds posted 22.5% year-over-year returns, edging out the 21% returns of the S&P 500 during that time. The ESG funds outperformed traditional funds over the long term as well, with 49% three-year and 73.2% five-year returns, compared to 43.3% and 61.1%, respectively, for non-ESG-aligned funds. 

“Boosting ESG scores may involve upfront financial costs, but long-term benefits can outweigh the initial financial outlay,” said Cass McFadden, VP, Global Head of Sustainability, Cortland, based in Atlanta. “While the case for operational efficiency via reduced energy, water and waste usage is often a clear demonstration of financial benefits linked to ESG initiatives, other initiatives may require deeper analysis and buy-in.” 

The firms fully invested in ESG are playing the long game. “Viewing ESG as a strategic investment rather than an expense is key,” said Stanchak. “Properly managed, these initiatives yield long-term value, both financially and in reputational business practices. It's a patient approach, but the ROI becomes evident over time once the fundamentals are completely in place.”

Multifamily has always been by its nature sustainable by virtue of developing, building, and operating energy efficient buildings. Some owner-operators think some of the other ESG components may already be losing some cachet. 

“Sustainability has been a primary focus of the industry for decades motivated by the desire to control costs. I don't see that changing,” said Miguel Gutierrez, COO, CAPREIT, based in North Bethesda, Md. “Several diversity, equity and inclusion (DEI) initiatives seem to be fading as many companies, such as CAPREIT, are highly diverse and provide equitable merit-based opportunities for all without the need for special programming.”

Playing Politics

Politics turned adopting ESG principals into a loyalty test by punishing financial underwriters and investment firms who were accused of steering money away from the fossil fuel industry, whose members typically rank lower on ESG scales. Laws have been passed to limit any influence ESG might have on investment decisions that are supposed to be totally fiduciary in nature. The effects of the new laws are still being explored as the winds of ESG blow stronger.

“At Lendlease, our partners have remained committed to ESG despite the recent political turmoil, and the robust business case for ESG has meant little to no decrease in investor enthusiasm for ESG assets,” said Neff. “Not only are investors pursuing opportunities with robust environmental and social commitments, but they are doing so at an ever-increasing pace because it is the responsible business decision and because these investments are proven to outperform over time.”

There are also potential downsides to not adopting ESG-friendly policies. “The regulatory landscape continues to evolve and become more stringent, requiring companies to prioritize ESG factors to remain compliant and avoid potential penalties or reputational damage,” said McFadden. 

“Consumers have become more conscious of the impacts of their purchasing decisions. The younger workforce increasingly seeks employment opportunities with companies that share their values, namely environmental stewardship and social impact. Many businesses have already successfully incorporated ESG considerations as part of their long-term value creation, demonstrating sustainable business decisions and profit can co-exist. Given these factors, ESG is here to stay.”

Scott Sowers is a frequent contributor to units.