Defining social & governance metrics for commercial real estate
Defining social & governance metrics for CRE
In the last few years, the demand for tracking and prioritizing ESG (Environmental, Social, Governance) metrics in commercial real estate has surged. Companies, funds, investors, and governments around the world are focusing on environmental management and sustainability reporting as they make efforts to address climate change, institute stricter policies and regulations, increase transparency, mitigate risks, and make sound business decisions.
As a result, ESG has become a strategic requirement for portfolios in order to develop and preserve long-term value in a rapidly changing environment. To date, the commercial real estate industry has been focusing heavily on environmental criteria due to the climate change conversation. However, it's also important to consider social and governance issues in order to manage relationships with and create value for stakeholders, as well as define leadership and management philosophies, practices, policies, internal controls, and shareholder rights.
Tracking ESG metrics can help companies assess their exposure to a range of environmental, social, and governance risks. These metrics go beyond typical financial analysis by taking into account non-financial statistics such as board diversity or the number of health and safety accidents that occur in a given year. When used alongside other ESG data, these metrics can provide a full picture of a company’s health and sustainability.
Understanding social & governance
Commercial real estate has been historically focused on the “E” issues surrounding ESG, since environmental issues have the largest and most easily quantifiable impact on portfolio risks and opportunities. Increasing temperatures, sea level rise, and an onslaught of natural disasters caused by climate change present significant threats to physical safety as well as financial risks such as insurance, regulations, and maintenance or repair costs.
Yet, implementing and investing in a complete ESG strategy that addresses social and governance issues can increase asset value and intrinsic value, lower operating costs, increase access to long-term finance, and boost brand reputation and culture. The issue? Social and governance measurements are more nebulous than environmental metrics, and they must be tailored to the industry and company collecting data.
Tracking S&G: Where to begin
When defining ESG metrics, businesses should begin with a deep stakeholder awareness. Understanding where various stakeholders fit into the chain allows you to pinpoint the most important concerns for each target group.
Typically, these groups can be broken down as follows:
- Vendors/supply chain
Once these umbrella groups have been identified, it’s important to address the social and governance impacts for each, including, but not limited too:
- Diversity & inclusion
- Community engagement
- Employee satisfaction & retention
- Training & workforce development
- Data privacy & security
- Corruption & fraud
Defining social metrics
Unlike the "E", the "S" in ESG is more difficult to quantify at the asset level. The social risks faced by a company are linked to both social capital and human capital.
Beyond simply providing a place to work, social metrics encourage businesses to investigate how their assets provide value to and contribute to the welfare of the communities in which they are located. Human rights and labor management, including those of suppliers and other partners, are also addressed in social concerns, as is human capital management.
In fact, the Securities and Exchange Commission of the United States designated human capital management as a substantial material risk in August 2020, and increased disclosure requirements will soon be part of standard financial reporting.
Examples of social metrics include:
- Supply chain issues such as product safety, fines/litigation related to product safety, and number of product recalls
- Data security issue such as the number of data breaches per annum and fines related to data security
- Labor practices such as employee health and safety, harassment incidences, and diversity and inclusion
Social questions that can help guide data collection include:
- How are you compensating for the skilled labor shortage?
- How are you addressing uneven wage growth?
- How are you building the skills of your workforce?
- What percentage of your leadership is involved with charitable organizations?
- What is the diversity percentage of your board or employees?
- How many people with disabilities do you employ?
- What percentage of your revenue is reinvested back into the community?
- Are your vendors evaluated against specific standards?
- Do your vendors follow a code of conduct?
- What percentage of your portfolio has been assessed for social risks?
- Do you track employee satisfaction?
- Do your employees engage in volunteer activities on company time?
- How many discriminatory or health and safety complaints are you receiving on an annual basis?
Defining governance metrics
Rather than focus on specific assets or even portfolios, governance issues center on how a company is founded and led, as well as how decisions are made. Good governance practices directly impact an organization’s ability to build investor, tenant, and community trust. Corporate governance structures that use ESG frameworks are more able to detect changing conditions that could have a detrimental impact on operations, such as stakeholder opposition, boycotts, fines from the government, and lawsuits.
Examples of governance metrics include:
- Business ethics issues such as revenues in countries with high corruption risk and fines or litigation related to business ethics
- Management remuneration such as the percentage of executive pay performance-based (salary versus bonus)
- Board/ownership structure & composition, including age/gender/expertise diversity on board and the percentage of equity owned by the board
- Accounting and transparency regarding earnings quality and the absence of key disclosures
Governance questions that can help guide data collection include:
- What does your executive compensation structure look like and is it tied to ESG benchmarks?
- Does your company have a Code of Business Conduct and Ethics?
- How transparent are you with stakeholders?
- Is your company's consumption data publicly available?
- What kind of reporting practices are in place?
- Does your company share your commitment to ESG annually?
- Do you have a risk management committee?
- Do you have an anti-bribery policy?
- Do you make use of green leases at your assets?
- Does your company regularly evaluate and implement affordable solutions, capital improvements, and new technologies to improve energy, waste, and water performance?
- How does your company handle the audit committee and auditor decisions?
- Does your company have clear policies in place to address corruption and prevent fraud?
- Does your company have a business continuity plan in place that includes cybersecurity considerations?
The demand for transparency
Companies today must answer to a variety of stakeholders, including investors, consumers, employees, and nongovernmental organizations, who wish to assess a company's global influence. This makes the need for deep transparency a critical requirement for businesses and funds.
One consideration for social and governance metrics is that the underlying information can be very qualitative in nature. Wherever possible, ask questions that yield quantitative data and numbers you can track year over year. When this isn’t possible, consider assigning a “quality score” to the company’s policies and procedures, allowing them to compare the company to its peers.
ESG analysis & reporting tools can provide useful insights and assist stakeholders develop long-term value. Ultimately, ESG initiatives assist firms in becoming more resilient and improving overall performance, while ESG reporting and disclosure assist enterprises in gaining access to financial markets and maintaining their operating license.
ESG materiality assessments
With investors inquiring more and more frequently about what your company is doing in regard to responsible investment, how you treat employees and vendors, your dedication to sustainability initiatives, and other activities that fall under the ESG umbrella, it’s important to have answers to these questions.
An ESG materiality assessment empowers you to easily report on your current state and outline future initiatives while taking into consideration your business goals and risks. Download our guide to creating and extracting the maximum strategic value from an ESG materiality assessment.