Updated: Jan 15, 2020
Environmental, Social, and Governance (ESG) 101
Nova is excited to announce a series of articles that will cover important areas in Environmental, Social, and Governance (ESG) criteria as it is increasingly becoming a popular way for investors to evaluate companies. The first article introduces what ESG is and the importance of ESG to Nova’s clients.
What is ESG?
ESG Investing is the consideration of environmental, social, and governance factors alongside financial aspects in the investment decision-making process.
ESG is rapidly growing in importance across the entire spectrum of the financial community. The practice of ESG investing began in the 1960s as socially responsible investing (SRI), excluding stocks or entire industries from portfolios based on business activities such as tobacco production or involvement in South African apartheid.
Today, ethical considerations and value alignment are key motivations. However, the adoption and use of ESG factors across all forms of business, and in particular the commercial real estate sector, are rapidly growing and evolving.
ESG data analysis is used by investors to evaluate the future financial performance of companies and help avoid companies and properties that may pose a greater financial risk. Companies that use ESG standards are often seen as more conscientious, less risky, and more likely to succeed.
E – Environmental
This takes into account a company’s energy use, carbon footprint, waste, pollution, natural resource conservation, and even treatment of animals. It may also include environmental risks a company might face.
S – Social
The social criteria is based on the company’s working conditions (e.g., health and safety) and business relationships, including relationships with employees, suppliers, customers, and the communities where the company operates.
G – Governance
This refers to whether a company uses accurate and transparent accounting methods and avoids conflicts of interest and illegal practices.
Why is ESG Important?
ESG integration in the decision-making process has evolved beyond what is socially responsible or morally aligned with investor values. Understanding and integrating ESG consideration can provide investors and companies with a competitive advantage and lead to long-term financial performance.
ESG has multiple benefits for most of Nova’s clients who are owners, operators, and investors, which expand across internal operations and the real estate assets in which they invest. Nova typically does not get involved in the day to day operation of clients’ businesses; however, Nova is closely involved in the due diligence procedures and the individual assets clients evaluate for potential investment. ESG has many benefits; however, Nova believes that the following will have an impact on clients’ operations:
To begin, ESG, when done correctly, is synonymous with risk mitigation—it is effectively a go/no go screen for a project. It allows Nova and its clients to identify well managed, well run assets, to discount sites with unacceptable operations or liabilities, and to identify ESG improvement measures that will, in general, increase a site’s value. This scope is typically wider than a standard Environmental Due Diligence scope.
Second, investors are looking to put money into companies that employ ESG assessment. Nova is seeing this become more prevalent at an extraordinarily fast rate. Nova clients that employ strong ESG policies and procedures can find that this helps them raise equity.
Third, ESG is becoming more commonplace in the industry and is dictating whether or not Nova’s clients are investing in assets that have poor ESG. As this becomes the new norm, the value of poor ESG rated sites will likely be affected and the appetite to finance poor ESG sites will diminish, thus resulting in lower site valuations, less competition to refinance an asset, and increased CAPEX costs to improve the asset’s ESG rating.
Last, but definitely not least, assets with good ESG ratings typically generate good returns. Nova clients say that higher ESG ranked assets attract better tenants, which drives higher rents. They also have reduced building operating expenses and improved building condition, which, as a result of all of the above, creates a higher exit value.