On-Demand: ESG and Real Estate | The Impact on Your Bottom Line (Part II)

LM: Hi, Amy. Thank you so much for having me here. Thank you. Thank you for the opportunity.

Amy Menist:           We're really looking forward to it. So before we actually really get started, can you take a moment and can you share with everyone what your experience is and explain what your role is as managing director of ESG?

LM:  Sure. I've been with the firm for the past two months. Today is my second month. And the objective and the idea and the vision that we have for the practice at EisnerAmper is to create a mechanism to support our clients on both sides of the ESG equation, so to speak, the financial impact of ESG and the sustainability side.

So how you can be a sustainable business, have your practices and also manage your risks, manage your opportunities, and at the same time, do good for the environment and for the society? It's about having a sustainable practice, sustainable business in terms of profitability, at the same time helping our clients to do good for the environment and the society. So it's about managing the stakeholders of a company. That's what ESG is about. So that's what the practice is going to help our clients with. It's managing stakeholders.

I've been doing this for the past 20 years. Been a risk manager for financial institutions. I worked in many financial institutions here in the US, in Europe, also in South America, so I have some experience in terms of implementing ESG practices as a capital provider, as an investor, and also as a consultant. I worked for the World Bank in the IFC in impact finance. I worked in regions that my projects were related to how the impact of that specific project will be in the society or in the environment. So true projects that will improve the climate or improve the society and the population to have better access to finance and then improve their conditions.

I've been working with this topic for quite some time. I started in late 90s with doing ESG ratings. I'm a quant background, so statistician and physicist, so I started working with environment and social risk ratings back then when data was nothing like what we had today. In terms of concepts, in terms of standards, we didn't have back then, so we're still building. Now we are in a much better position, so ESG today is a must. ESG as a cost center is a competitive advantage. If you don't have it, then you're losing your opportunity.

Amy Menist:           Absolutely. I couldn't agree with you more. And with that being said, I think it's a perfect segue into our first real question. Okay, LM. So research has shown that real estate companies that implement ESG policies have a direct correlation with diminished financial risk and higher financial returns. Can you please explain how the implementation of sustainability initiatives could improve a real estate company's financial position?

LM:  So, think like that. Put yourself in the company place. I'm now own a real estate company, or I'm managing a REITs, which is a trust. I'm managing this firm, this company, and around me I have multiple stakeholders. I have my clients, I have the tenants, I have the society, the regulators, the owners, the investors. So the general public. My board, my staff, my people, people that work in my firm. So I have all these stakeholders. So if I think about what are the elements that I have to do in order to make sure that I'm good employer, so I have attract the best staff, or I bring return to my shareholders, and I can also do good for the society and for the environment. All of these elements are good for my business.

LM:  Think about my firm as a coin with two faces. The first part is an external environment. Everything that happens in the climate, everything happens in the environment, in the society, that impacts my profitability, my ability to grow my business, to go to different products or different markets. All of these elements that will impact my ability to reach my objectives. And also my internal governance. So how my board is composed, if I have enough diversity and inclusion, if my staff is happy and engaged, if I am managing my risks properly, if I'm complying with the law. All of these elements of governance, they have to be in place as well. ESG, seen on this first side of the coin, is managing risks and seeing opportunities to mitigate those risks, so that my bottom line, my balance sheet, my income statement, my cash flow remain financially healthy.

On the other side of the coin is what I do for the environment. So if I think of a risk, for instance, for example a physical risk, a physical risk is a climate change risk. That could be severe weather or a hurricane or a drought or a wildfire. And my real estate, my investment, is in a location that is prone to wildfires, or my real estate is in California or is in a drought location in United States. So there will be some risks that I will be exposed to, my real estate, that if I cannot generate enough inflows from my tenants paying the rent, if I don't guarantee this, I won't be able to do all the disbursements and then making the return to my investors. That will be a risk for me.

So I have to be able to identify those risks, find out where they are, map them, usually by geolocation of assets and by identifying climate maps, and then defining the exposures that you have for that specific risk and the opportunities. So what are the things that you can do in order to mitigate that? We can have a better structure of your real estate. You can have some certifications. All of the things that you can do in terms of mitigates to reduce the likelihood of those risks happening. Because if one of those risk happen, I will cease to receive the payments from my tenants, I won't be able to give the dividends to my investors, or to pay back the loans or the debt that I have with my creditors.

So all of these elements, all these improvements, all these benefits, all the retrofits that I do for my business of my buildings, of my real estate, I'm doing so that I can manage those risks from happening. I can prevent those risks from happening. And if I do that, I guarantee my bottom line. So it's true that if anything that I do for sustainability, for the good of the environment and the society pays back, so it pays off in the end, because it's also a good for my bottom line.

So if you think about all this two sides of the same coin, you cannot think of managing your business. Any business. Real estate is one example of that. But in the case of real estate, you have to identify the risks that you're facing, link that with opportunities, and invest in those opportunities so those risks are mitigated. And those risks are the ones that are going to affect your bottom line.

Amy Menist:           Absolutely.

LM:  Sustainability is used as an opportunity to mitigate those risks that you're exposed to, increasing the likelihood of success. Your bottom line would be secured.

Amy Menist:           Perfectly said, LM. And Lexi, I think it's a perfect time to jump into our first polling question. I'm curious to know. Where is your company currently at with its ESG initiatives? Are you still exploring, not yet started but plan to, do you have plan and objectives in place but not yet executed? Is there a full ESG program with governing bodies and multiple initiatives underway? Or is this just not a priority at this time, and you're just doing a little research?

Let's give everybody a quick moment. Okay LM. I see about half of our audience has submitted their answers, so I'm going to jump to the next hot question here. So this is a big topic these days. The SEC announced a climate disclosure proposal, which could require real estate companies to include climate related information in its financial statements, such as its climate related risks, its risk management processes and its current greenhouse gas emissions. If this proposal is approved, how will this impact the real estate industry?

LM:  Yeah, that's a very good segue of what I was talking before.

For the SEC rule, and they were very clear in their rule and when they are writing the proposed rule, it's not implemented yet. When it becomes implemented, so it becomes a rule, it's going to follow what's the TCFD, which is the Taskforce for the Climate Related Disclosures, is telling us to do. It's like a process towards compliance.

There are four steps, so four basic elements that if you follow those, you're going to get compliance and then you're going to get compliance for the SEC rule. And of course it's a phased approach. I wouldn't expect that if you don't have the four elements in place that I'm going to talk about now, I don't think that it's expected that you have them ready. It's a process. It's a maturity model that you're going to get into for the next two or three years. Takes time.

The first thing that I would do, if I'm a public real estate company or a REITs, what I would do, I would do a gap analysis. There are very good frameworks that we can use. One of them is the TCFD recommendations. They are very clear. There are 11 elements of disclosure within the four pillars. If you follow those and you have those as a benchmark, you can self-assess your company, where you are in terms of those disclosures and those elements. And those 11 elements are exactly the same elements, almost verbatim, from what the SEC is asking.

The first one, the first pillar, is governance. You have to be able to show that your board is aware of climate related risks. And in this case, it's climate centric. So it's not ESG in general, but I wouldn't separate those two, because they are very much connected. For climate related risks, the board of directors of your company have to be able to embed those in the decisions that they make. And you have to show that. They have to be part of the meetings that they have, they have to be part of the committees that they participate, the charters. You have to show that they are aware and knowledgeable of climate related risks, who in the board is knowledgeable of that, and then tell what kind of knowledge this board member has about climate related risks. And this is at board level. So you have a series of requirements for the board.

The second thing is for management. So, how the strategy and the decisions that the board makes will cascade down and are executed by management. Exactly the same requirements that the board has, management will have more in the execution phase. So in the execution part, you have to show, you have to disclose to the SEC where the management committees are taking place, how often they are, and have to show how climate related risks and opportunities are used in order to execute the strategy that is determined by the board.

All of this has to do with governance. Governance has two very clear elements, board and management. The second pillar is strategy. The registrants have to identify and assess the impact materiality of all of these risks, physical and transition risks, that will impact the real estate company or the REITs. They have to identify all of those. If it's a physical risk, that's what I was talking about, the geolocation of your assets. Sometimes you have to go to the level of ZIP code. And then associate those to a climate map or a climate condition, if it's acute or if it's chronic. So acute having very localized and very immediate impact. Chronic, sea level rise, for instance, a chronic one, going to be a long term. And that's why the SEC is asking for you, for the companies, to assess those risks in the short term, medium term, and long term, and include those in the strategy. So we have to disclose that too, how you do that. What's process of including those risks in the strategy, in your outlook in your business, and what kind of changes and impacts that are causing in your strategy.

To give an example, you can change your strategy to go to a specific region or a specific market based on a risk assessment that you made on transition risks. Maybe you are going to expand in a region that transition risks are high. So you have a high likelihood of a policy, a change of technology, or a change of consumer behavior that is impacting your specific strategy. All of this has to be identified and assessed not only in the short term, but also in the long term.

That's where the SEC asks us to also include scenario analysis, because you have to see, okay, how resilient my strategy is for a scenario of 1.5 degrees Celsius of global warming, two degrees Celsius of global warming, three degrees Celsius of global warming. If you have an increase in temperature, the sea levels will rise even more. You have problems of drought, you have more severe weather. So that will impact directly in my bottom line. So I have to show that too.

That's only the second pillar. The third pillar is risk management. Risk management, when you did the second pillar, you described, you identified the risks and the opportunities. Now you have to describe the process of identifying and assessing the risks and opportunities, and how those impact in your financial statements, in your balance sheet, your income statement and your cash flows. You have to explicitly show that link between the risks and opportunities and the balance sheet income statement and the cash flows. All these financial statements that are the bottom line. We have to show this link. And that's for risk management.

The fourth and last pillar is related to disclosures of greenhouse gases, Scope 1 and Scope 2. So why it's important? You think about what Scope 1 and Scope 2 and Scope 3 of greenhouse gases have to do with my bottom line. There's a strong correlation between my GHG emissions, how much I have in terms of CO2 equivalent, how much I impact the environment and the society in that sense. And my bottom line is exactly the dependency on transition risk and physical risk. So there is a direct link between the CO2 emissions with the financial materiality, and that's why it's in there.

So if you follow these four steps, maybe the step zero is the self-assessment. You start with the self-assessment with a very clear framework, TCFD. Then you have the governance strategy, risk management, and the final disclosures and the metrics. If you follow these, of course saying is easier than doing, and so of course the implementation is huge, but it's what the SEC is asking.

Amy Menist:           Perfect.

LM:  So the bottom line is that's all these elements is in the 500 pages of the SEC rule.

Yeah. It's going to be interesting

LM:  it's a huge undertaking.

Amy Menist:           Yeah, it's going to be interesting to see how this actually develops. And actually, Lexi, I believe this is a perfect timing to jump to our second polling question.

For those of you attending, does your company currently include any disclosures within its financial statements about their sustainability efforts? Yes, no, "I don't know"? I'm so curious about this one. I want to know where people sitting with this right now. Are they taking the initiative to include disclosures in their financial statements? Not a requirement yet. Okay. Let's give people a moment.

Okay LM, I see over half of our attendees have answered. I'm going to take the opportunity to ask you another question. For real estate companies, access to funding and finance are crucial. However, investors and capital providers today are strongly considering a company's ESG policies prior to making an investment decision. How can a company's ESG policies influence investors, and what can the companies actually include in the financial statements to better attract said investors?

LM:  I can say it from personal experience. I was a capital provider and an investor in the past.

I wouldn't lend money that easy to a client that was not ready with good disclosures and good set of initiatives in terms of ESG. I think that cannot be seen anymore as a cost center. Sustainability and ESG practices in your firm cannot be seen as a cost. It's an investment. It's a competitive advantage. It gives you better access to finance, gives you better access to capital markets.

So today I was a banker and I know that I had targets. My bank was very active in social and corporate responsibility and climate change. We're signatories of a bunch of Accords. And we had targets to use sustainability linked metrics in our funding, in our products. So there is an availability in the market, in capital markets, of instruments that will help consumers and real estate owners and REITs and companies to have better prices, better discounts on fees, based on how good they're doing in terms of ESG.

So you can go back to your banker and tell them how much of my ESG practice brings value to my relationship with my banker, or relationship with my insurance company. So I could get at a better price in my insurance if I have a better management of my physical risks. You can show this relationship, And I know that the insurance companies now, with the principles of responsible insurance, exactly the same thing that you have, the principles of responsible banking and principles for responsible investment from the United Nations, we have exactly the same thing for insurance companies. They have a process they have to put in place in order to underwrite an insurance. The bankers, exactly the same thing.

So we follow a process that we look at the ESG practices, we embed ESG practices in our decision making process. And I'm talking as a capital provider, I was in the past, the same thing for investors. If you are in the private equity world, or if you are investor trying to find an equity to invest, this investor will look if you're asset manager. Will have a very clear set of processes and principles that will embed ESG practices. And they will look for, in their screening, in their investment decisions, include those practices in there, and then they will be more targeted to companies that are better ESG managed, or they have better ESG or more advanced in terms of ESG initiatives.

And this has to do with disclosures as well. So if you're disclosing, you reduce the information asymmetry that banks will have with their client. If you reduce this information asymmetry, you have better rates. You have a discount. That's the principle. So there's a lot of money on the table that being a good ESG, a good corporate social responsible good corporate citizen, could bring you. A lot of value that is there available for you in the capital markets. Private lending practices, investment practices, are embedding ESG in their decision making. So if you don't do that, you are missing this opportunity. You're missing this opportunity to have a better access to finance. That's the message.

Amy Menist:           Right. Completely agree with you.

Now, I know we're running a little quick on time, little short on time but I'm going to ask one more quick question. And this is to kind of build off of a comment that we also just received.

Somebody just said that the ESG requirements are becoming a little bit more intrusive and complex, which can be a little bit of a deterrent at time. And as a result of the initiatives under place, governmental policies are being implemented with net zero target set for 2050. So how can real estate companies recoup the initial investment of implementing ESG and sustainability efforts to meet these new governmental goals? And are there any incentives real estate companies could use and benefit from to help lower the initial cost of the investment?

LM:  Yes. Access to finance is key. All the investments that you did, sustainability investments that you did in your buildings, retrofit, or any improvement that you made, it's a good message to your banker. It's a good message to the investor. It's a good message to the market analysts and insurance companies that you have a sustainable business, your business is going to be resilient for the future.

So me as a banker, I'll prefer to invest my capital, which is extremely expensive for a bank, in you than in somebody that I cannot see that same commitment. So ESG practice, yes, I totally understand, I hear you. They can be burdensome. And now, especially with regulations, they can sound burdensome. But we have to change this view. We have to change this mentality, that it's not a burden, it's an investment. It is a competitive advantage. The market is telling you that.

If you read PRI, principles of responsible investment, or PRB, principles responsible banking, and now insurance have just been released, you'll see that the financiers, the people that attain the capital, the investors, they are looking for that. So if you don't get into that boat, you're going to be missing a huge opportunity.

Again, it's a process. It's a phased approach. Your company is not like magic, it becomes compliant or becomes there's no compliance, but it becomes a better corporate social citizen or have a better ESG practice. It's not overnight. Takes time. So it's a process. If you follow the TCFD, it's a good way of getting there. And the SEC is giving you the pathway.

So things are getting easier now, because now we have pathways, we have standards. We know a little more what we are talking about. Different from 25 years ago, when I started in late nineties, that we had to figure out standardization, we didn't have SASB , we didn't have TCFD. We had Kyoto Protocol, we had Equator Principles. There were good, very good guidance, but now we have in a much better position. That's why I think that, I have a conviction actually, that ESG and climate change management is imperative. It's no longer a "nice to have," it's a must have.

Amy Menist:           Couldn't agree with you more. And not only is it a must have, but today, if you play it in the correct way, it can actually increase your bottom dollar and it can actually help with your market and your marketed trends.

So I hate to cut you off LM, I know this has been quite the lovely interview, and I've learned so much, and I believe so many of our other attendees have as well. And I know we didn't get a chance to do a Q&A, but if anybody has any questions, please feel free to leave them and we will try to get back to you at our convenience. And I will definitely pass this over to Lexi. Thank you all so much for joining us today.