Challenging ESG Groupthink: Results, Pragmatism, and Critical Thinking

I grew up in the planned city of Columbia, Maryland. My dad is a mechanical engineer who moved my family from Princeton Junction, NJ when I was two and a half so he could take a job with the Rouse Company. My mom is a social worker whose thoughtfulness about people developed in me a keen interest ?in psychology, neurology, and evolutionary biology. When I was little, my dad often gave me bedtime math problems to solve instead of bedtime stories. I loved math from a young age and won competitions in 4th grade and 11th grade, taking pride in beating all the boys in my classes. Now I’m proud that my 8-year-old daughter loves math??.

After high school, I took a gap year abroad and then enrolled in the University of Maryland’s architecture program. I thought that I wanted to combine the technical with the creative, but I wasn’t much of an artist and I wasn’t passionate enough to justify the studio all-nighters I saw older students pulling. I realized that what I actually wanted was to combine technical with social. My Sociology 101 course was heavy on anthropology and I was rapt. I switched my major and took a lot of economics to supplement the sociology. Had I known more about business back then, I might have majored in finance.

I left undergrad desiring “real-world” experience and landed the most corporate job I could find, with a company called Corporate Executive Board (NYSE: CEB). There, I worked on CEB’s Supply Chain Executive Board, Quality Executive Board, Real Estate Executive Board, and nascent Sustainability Leadership Council. While I was at CEB, a mechanical engineer friend from college told me about LEED and lent me his LEED Reference Guide for “pleasure reading”. Soon after, the U.S. Green Building Council's LEED team had an opening for an associate with corporate experience, and my resume fit the bill, with corporate right in the name of my first employer. At USGBC, I worked on corporate and investment real estate, hospitality, and LEED technical development for hotels and international projects.

Three years in, a recruiter reached out on LinkedIn about an opportunity to start an energy and sustainability department for public REIT First Potomac Realty Trust (NYSE: FPO), whose VP of Construction had been hearing from trusted colleagues that there was real business opportunity in this trendy new focus area. I dove into utility bills and we concentrated on measuring and reducing energy spend by improving design and procurement practices, completing lighting retrofits, and implementing demand response, real-time electricity monitoring, and operational improvements. In a billion-dollar portfolio, we found enough savings to pay for 14 of me.

After a year at the U.S. Department of Energy working on the Obama Administration’s 13-billion-square-foot Better Buildings Initiative, I became sustainability director for a private real estate investment manager with 50 times the asset value of FPO.?I quickly learned that prestigious global responsible investing frameworks reward companies for perfunctorily checking hundreds of boxes confirming low-impact details of corporate policies more than they reward them for focusing on the sustainability activities that create significant value or substantively mitigate risk.?By pursuing actions that allowed my firm to earn more points, we raised its PRI grade from a B to an A+ and increased its GRESB peer rankings as much as 43%, claiming the top spot in one category.?

This exercise developed my expertise in sustainability scoring systems but didn't improve the energy, risk management, or wellness performance of my new portfolio.?With 0 and 2% of PRI and GRESB points awarded based on energy and emissions performance improvement, which takes significant organizational effort but also reduces opex and risk, improving actual sustainability performance was the least efficient way to boost sustainability scores.?I later crunched the numbers and saw that GRESB collected information on over 750 micro-topics.?Responsible investing frameworks were diverting firms’ sustainability resources from the most value-creating activities.?This realization led me to my current path of helping investors and companies cut through paper-pushing to maximize tangible sustainability value.

My favorite research is Cambridge University Professor of Real Estate and Urban Economics Franz Fuerst's 2015 paper “The Financial Rewards of Sustainability: A Global Performance Study of Real Estate Investment Trusts,” in which he reported findings that one of the seven aspects measured by the GRESB assessment was strongly correlated with significantly higher returns on assets (ROAs) and returns on equity (ROEs) while the other six out of seven aspects showed insignificant or negative associations with higher operational returns.?The one GRESB aspect for which Fuerst found a significant association with higher returns was the Performance Indicators Aspect, which evaluates year-over-year portfolio environmental performance data including the energy and water consumption that directly impact operating expenses and emissions. Fuerst’s research elucidated the indispensability of performance measurement to ESG alpha.

In early 2021, researchers from ETH Zurich, a public research university founded by the Swiss Federal Government in 1854 to educate engineers and scientists, published what they termed “sobering” findings that companies that report according to TCFD “cherry-pick to report primarily non-material climate risk information”.?What they found is essentially that companies tend to disclose qualitative narratives about climate risk management while neglecting to disclose performance data.?The authors concluded that “firms' TCFD support is mostly cheap talk”.?

Investors can counteract this tendency to avoid material performance information by maintaining disciplined focus on performance measurement and improvement. The good news is that measurement of ESG performance preceded the coining of the ESG acronym and often occurs independent of ESG.??

Measuring occupant satisfaction using surveys is a long-standing practice that predates ESG and helps real estate managers create value and reduce risk.?Employee survey results can likewise be used to strengthen tenant experience value drivers like property personnel engagement, well-being, and management capacity as well as factors that influence those value drivers such as inclusion, training and development, and culture.?While no dataset can perfectly represent all the nuances of complex topics like tenant or employee satisfaction, surveys have evolved and improved over time, and expanded to include more information on occupant and employee wellness.?Glassdoor data can be a useful addition to employee survey results, rounding out the picture with information that traditional surveys may not capture.?Though tenant and employee surveys existed before and independent of ESG, they provide key ESG performance data that are essential to ESG value creation.

Similarly, many investors request personnel information including hiring, promotion, departure, and diversity statistics for general diligence purposes.?This performance data can help investors and managers identify risks and opportunities related to talent engagement, inclusion, culture, and retention.?Oregon State Treasury real estate investment officers had a practice of collecting such data as part of their diligence processes well before the Oregon Investment Council formally integrated ESG into its investment policy.?While not related to ESG or diversity questions, this performance data has led Oregon officials to, without shaming or penalizing managers, ask questions like, “Why do women not seem to last longer than a few years at the mid-level?”, as Oregon State Treasury Real Estate Investment Officer Sam Spencer, CAIA recounted in a September 2020 NAREIM interview.?Performance measurement allowed Spencer’s team to initiate more impactful conversations about pivotal ESG value creation opportunities like retention of mid-level women than would ESG policy or program information.

There is also a strong history of environmental performance measurement in the U.S. and Australasia.?The U.S. federal government’s voluntary ENERGY STAR for buildings program has been helping North American building owners and managers measure and improve environmental performance since 1999.?Likewise, the National Australian Built Environment Rating System (NABERS) originated in 1999 and helps building owners and managers in Australia, New Zealand, and, as of November 2020, the United Kingdom measure energy, water, waste, and indoor environmental performance.?These programs’ narrow focus on performance measurement concentrates resources on measuring and improving performance - improving indoor environments and reducing operating expenses, energy and water cost risk, and negative environmental impacts including climate emissions - the tangible win-win outcomes that ESG at its best delivers.

Focusing on our measurement roots - the history of ESG measurement that preceded the rise of ESG itself - and extending the measurement approach to new ESG factors is the path to ESG value creation.?For example, for the aim of?driving risk mitigation activities that can increase resilience and protect asset value, assessing?physical climate risks and integrating risk information into management processes is far more effective than developing a climate risk policy.?Similarly, public policy risk and opportunity are best managed not by target setting but by evaluating the distance between current property performance and potential regulatory thresholds, projecting compliance and noncompliance costs, and gauging possible incentives for outperformance.?And for creating value and reducing risks,?auditing?and increasing tangible wellness features like automated external defibrillators and stairway usability is far more efficient and effective than adopting wellness policies.

Laser focus on measuring and improving performance is the key to manageable, effective, profitable ESG.?Tracking performance metrics like those above, integrating them into due diligence and management processes, reporting on them at internal and investor meetings, and communicating benefits to occupants all support efficient continual improvement of ESG performance, which creates and protects value.?Focusing on key performance indicators concentrates resources on efforts that increase net operating income and reduce risk to drive sustainable long-term returns.?The social and economic instability of the last year make it more important than ever for ESG to efficiently deliver financial and societal benefit.