Are Real Estate’s ESG Commitments Too Good to be True?

Every year, the Swiss financial magazine asks its readers for their suggestions for their annual Swiss financial word of the year. In 2021 they had a clear winner: Greenwashing. The word stands for the false claims and empty promises made by companies regarding their sustainability goals.

Greenwashing has been around almost as long as the modern environmental movement. Westinghouse, an American electronics giant, fought back against anti-nuclear sentiment in the 1960s with a series of advertisements claiming the safety and cleanliness of its nuclear power plants. An advertisement showed a nuclear power plant next to a calm lake and said its facilities were “odourless, orderly, clean and safe”. Westinghouse failed to mention the impact of nuclear waste and meltdowns in Michigan and Idaho.

It wasn’t until the 1980s that the term “greenwash” entered our vernacular, coined by an environmentalist named Jay Westerveld. The idea came to him on a research trip to Samoa after sneaking into a nearby resort to steal towels. The resort had left a note urging renters to reuse towels to help the environment, which it found ironic. “Hasn’t the same resort damaged the local ecosystem by expanding and building more bungalows,” he thought. They probably didn’t care about the environment, but everything “came out green,” he eventually wrote in an essay for a literary journal.

More people than ever are environmentally conscious and concerned about climate change, leading to increased scrutiny of greenwashing. Also known as “green shine,” the term simply means a company that makes misleading or unsubstantiated claims about its products or business practices that help the planet. Some greenwashing seems relatively benign, like a toilet paper manufacturer making a vague claim about recycled paper. But there is much, much more at stake in the world of commercial real estate.

Environmental, social and governance (ESG) principles have become the industry’s hottest buzzword in recent years, and it’s hard to find a major commercial real estate company that hasn’t integrated these practices into its business. ESG investing is attracting huge amounts of capital around the world, with global ESG assets on track to surpass $53 trillion by 2025, which would represent more than a third of total assets under management, according to Bloomberg. Many real estate investment trusts (REITs) like Boston Properties have issued huge green bonds in recent years, and it seems everyone has jumped on the ESG bandwagon.

Several observers, including regulators, are wondering if these green assets are too good to be true. The commercial real estate sector is particularly in focus. The impact of the built environment on climate change is becoming increasingly important, as industry is responsible for 30 percent of global carbon emissions and 40 percent of energy use. Decarbonizing buildings has become a buzzword, cities and states are adopting stricter emissions and energy regulations, and a full day was devoted to buildings at the recent United Nations Climate Change Conference.

The real estate industry has been under increased scrutiny for a while and appears to be making strides with sustainable investing and ESG emphasis. The problem, however, is that ESG ratings, and possibly even green building certifications, are a mishmash of subjective measurements. The alphabet soup of sustainability metrics relies on vendors using their own data, and definitions are often not clearly defined. Often the results are not independently verified or measured by regulators. So when a REIT advertises green credentials and talks about its sustainable building portfolio, how green is it? An example of this is the green bonds of some REITs, which are intended specifically for environmental and climate projects but do not have very specific standards.

“Companies are defining for themselves what a green bond is,” said Matt Ellis, founder and CEO of Measurbl, a provider of ESG data management for commercial real estate. “There are green bond standards and guidelines, but it’s actually left to the opinion of second parties like KPMG, so it feels like a choose-your-own adventure. What’s stopping us from saying a bond is green and cramming it into a bunch of green building certifications that we would be doing anyway?”

The lack of concrete, objective standards for green bonds and other green finance has led some to wonder if this is all just greenwashing. And even the organizations that measure and rate green financial instruments have come under scrutiny due to conflicts of interest and seemingly arbitrary methods of categorizing what is and is not green. A recent study by Bloomberg found that Morgan Stanley Capital International (MSCI), an investment research firm that provides widely used ESG ratings, may not truly measure a company’s environmental impact. Instead, the report says the ratings measure the opposite, “the potential impact of the world on the company and its shareholders.” MSCI CEO Henry Fernandez didn’t even dispute this, telling Bloomberg that retail investors don’t typically know how ratings are constructed and “they don’t worry that much about the risk to the world.”

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Another ESG agency is the Netherlands-based Global Real Estate Sustainability Benchmark (GRESB), which collects, validates, scores and scores green data. The benchmarks are the global standard for ESG reporting in the real estate sector, and more than 100 of the world’s largest pension funds and investment managers use their data and analysis. The problem is that the organization is investor-led and far from being an external arbiter. Some say institutional investors aren’t asking enough of the benchmarks, likely because it would hurt their bottom line.

The organization also doesn’t release results for the companies it rates, although it did release aggregate numbers in a 2020 survey. Many green bonds that are part of the ESG craze are also using the money to fund buildings with green certifications like LEED. But even these certifications have been questioned by some. Several studies have shown that LEED buildings use less energy than their counterparts, but other studies show that green buildings aren’t worth the hype. For example, a recent study conducted by Carnegie Mellon University found that LEED-certified federal buildings do not use less energy, possibly due to trade-offs in the development of energy ratings.

But while ESG real estate funds may not be as green as they seem, Ellis stressed that the real estate industry has made great strides in tackling energy efficiency and emissions. “I think if you look at all the green claims, the real estate business is the most measurable and does some of the best and most objective work at it,” Ellis said. “I don’t want people to think that real estate is just sucking up green dollars. I just think we need to make sure the measurements are a consistent experience and we’re not there yet. Regulation will help, and so will investor pressure.”

It’s easy to take the cynical view that real estate ESG funds are nothing but greenwashing. But as Ellis pointed out, incremental changes are being made, and slowly but surely the real estate industry has become much more aware of its environmental impact over the last two decades. Increased regulation in the US, Europe and other parts of the world will no doubt weed out the vague and subjective claims in ESG and create a more robust system. Investors may only care about the bottom line, but it will compel them as fines and regulatory measures are introduced into the ESG ecosystem. More objective standards for measuring environmental impacts in ESG and green building certifications are also urgently needed, which will help reduce greenwashing claims. The term “greenwash” is nothing new, it has long been part of our everyday usage. And if commercial real estate investors and owners really want to make a difference, they need to ditch their subjective rating systems for something that doesn’t “come out in the green” like other dubious claims made by green businesses.