Focus on ESG: What it Means for REITs

Over the past 18 months, shareholder focus on environmental, social and governance issues - known collectively as “ESG” - has increased significantly. Once the target area of specialty investors, ESG issues are now a higher priority for mainstream investors. Investors across all asset classes are focusing on more complex issues surrounding the linkage between ESG issues and financial performance, capital allocation and long-term planning. This newer ESG investing is premised on the view that strong ESG companies are:

  • less likely to encounter corporate scandal
  • better positioned to react to emerging risks
  • strategically positioned to capitalize on new and expanded opportunities

ESG research is no longer used just for exclusionary screening and selection based strategies, but is becoming an integrated component of the investment decision and weighting process for some investors. 

ESG is not a new concept for REITs. In recent years, REITs have focused significantly on environmental and sustainability issues, such as energy and water use, carbon footprints, waste management, accessibility to mass transit and certifications relating to environmentally-friendly development standards. Nareit estimates that most REITs are publicly reporting their sustainability efforts, either through website disclosure or publication of a stand-alone sustainability report.

Drivers of Growing ESG Focus

Proponents of ESG issues believe that consideration of ESG factors improves financial performance, leading to enhanced shareholder value. In 1995, the estimated dollar amount of assets under management for managers focused on socially-responsible investments was approximately $629 billion. In 2017, the estimated assets under management for investors who have committed to incorporate ESG metrics into investment decision making was estimated at $70 trillion.

A second driver of increased demands for ESG disclosure is trust – or rather, lack of trust. In a 2017 investor perception study, 87% of the institutional investors who participated indicated that they must trust management and 66% said they must trust the board, before making or recommending an investment. In addition, 93% of the respondents responded that keeping them consistently well-informed impacts trust. More than a majority of these investors agree with the notion that current disclosure requirements are not sufficient to maintain investor trust. While the Securities and Exchange Commission has periodically requested comment on the need for mandatory disclosures of ESG matters, there are no specific disclosure requirements unless a particular event is material under the federal securities laws. In the absence of mandatory disclosure requirements on ESG matters such as climate change, human capital management and diversity, expect investors to continue to use traditional shareholder engagement to push companies to expand their public disclosures on ESG issues.

ESG Third Party Research and Ratings Firms

Institutional investors use third party ESG ratings and research reports when evaluating investment decisions. A number of specialty research firms produce benchmarking reports or scorecards on public companies, rating factors across a wide range of environmental, social and governance areas and making peer comparisons. These reports are used by institutional investors to compare the performance of individual companies when making investment decisions. For REITs, the Global Real Estate Sustainability Benchmark, or GRESB, is the most widely known ESG research firm. However, numerous other groups, including MSCI Global Intel, Sustainalytics and Bloomberg Intelligence, also produce research and benchmarking reports in the REIT sector. Institutional Shareholder Services (ISS) also recently initiated publication of environmental and social components as part of its QualityScore reports on all public companies. While many third-party research firms use some aspects of the Global Reporting Initiative framework—one of a handful of recognized proposed sustainability reporting standards—there is no uniform set of criteria used by all firms, so company ratings on specific ESG metrics can vary widely among firm reports.

Integrated ESG Reporting

Most public company reporting on ESG metrics is done through publication of a separate sustainability or ESG report made publicly available on a company’s website. As with third party reports, there is no uniform reporting framework for these disclosures and ESG matters disclosed vary among companies within the same industry. It is also important to note that, regardless of how robust a company’s disclosure may be, third-party research and rating firms are increasingly leaning on other available sources of information that have become even more accessible and accurate in the era of big data. The result is that companies have less ability to narrate their own story on ESG issues. In 2017, the Sustainability Accounting Standards Board (SASB), a non-profit organization that develops and maintains sustainable accounting standards for public company disclosure of what SASB has determined to be financially material information to investors, published an exposure draft of standards for industry-specific key performance indicators that could be integrated by public companies within their existing financial reporting frameworks. Public company support of the proposed SASB standards has been mixed, with many commenters noting that the standards seem to be an attempt to redefine materiality and require disclosure of items that may not otherwise be determined to be material under the federal securities laws. SASB is expected to publish a response to public comments and revised drafts of the disclosure standards later in 2018.

Emphasis on ESG in the 2018 Proxy Season

ESG has been a top priority for institutional investors in the 2018 proxy season. BlackRock CEO Larry Fink’s January 2018 letter to CEOs set the tone, emphasizing the importance of a diverse board and stating that public companies must show how they make “a positive contribution to society.” Following publication of this letter, BlackRock sent individual letters to a number of public company boards, including REITs, with no or only one female or diverse member, reminding them of BlackRock’s expectation that public company boards should include at least two women and asking that this position be shared with the Board.

BlackRock and a number of other institutional investors have changed their voting policies and updated their 2018 engagement priorities to include more emphasis on environmental and social matters, particularly focusing on boardroom diversity and climate change. These changes reflect trends in shareholder proposals generally, with environmental and social proposals dominating the proxy landscape in 2018. In particular, proposals addressing political spending, board and workplace diversity, climate change, and sustainability disclosure are all key themes from the 2018 proxy season so far.

As reported by The Wall Street Journal, REITs have been in the spotlight on several ESG topics in 2018, including a Wells Fargo Securities report on gender diversity on REIT boards and an activist withhold campaign launched based on a dual class share structure.

Key Takeaways for Publicly-Traded REITs
  1. Review your current process for sustainability/ESG reporting. Given the expanded focus on ESG disclosures, public companies should examine their ESG reporting structures and existing disclosures. Compare your disclosures with peer companies. Identify your ESG disclosure team, which should include representatives from operations, legal, communications and other internal stakeholders who collect information, prepare reports and respond to requests for information. All responses to requests for information on ESG measures, whether from third parties or institutional investors, should be reviewed for factual accuracy and consistency. If ESG metrics are included in a company’s financial reports filed with the SEC, companies should ensure that they have appropriate disclosure controls and procedures relating to those metrics.

  2. Know what ratings firms are saying about your company and look for opportunities to improve. Obtain copies of reports prepared by third party rating and research firms. If your company does not have a direct contact with GRESB and other influential rating and research firms, contact the firms and persist until you establish one. ESG research firms purport to use public company data and questionnaires as the basis for their reports, so having a contact to verify the accuracy of data for your company prior to the issuance of a research report is critical. Many investors are looking beyond current ESG scores at upward ESG rating changes referred to as “ESG momentum,” so look for opportunities to show improvement, even if it’s just additional disclosure aimed at getting more credit for current practices.

  3. Shareholder engagement. Understand the positions on ESG topics of your institutional shareholders and engage on ESG metrics as part of your regular investor outreach program. Even in engagements where ESG is not expected to be the primary focus, be prepared to discuss key ESG performance metrics.

  4. Take advantage of opportunities. Take advantage of the ESG momentum to tell your story and take credit for positive ESG factors. ESG issues impact all companies, but certain industries – including real estate – have voluntary implemented programs and taken steps to address ESG issues. REITs with robust sustainability and other ESG efforts should highlight those efforts proactively and use them as opportunities to distinguish the company and its operating and strategic priorities as potential drivers of shareholder value. This may not eliminate outsider pressure from shareholders but will shape the discussion and position the company more favorably with investors, research firms and others on critical ESG issues.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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