Ask an Analyst: Talking About ESG & CRE Implications With Paul Fiorilla

Paul Fiorilla is Director of Research at Yardi Matrix. His research covers all facets of commercial real estate and he recently published a report highlighting different environmental risk levels across metro areas in the U.S. MBA Newslink interviewed him about the implications of recent environmental, social and governance trends.

MBA NEWSLINK: ESG is perhaps 2021’s biggest buzzword. What’s changed about how CRE is interacting with these investment trends?

Paul Fiorilla

PAUL FIORILLA: The industry dabbled with ESG for most of the last couple of decades. Property owners took steps to improve energy efficiency and some investors made ESG strategy a requirement for the managers they hire. But the emphasis on ESG has taken huge steps over the last couple years, largely driven by the growing number of environmental disasters–floods, hurricanes, fires, drought, etc.–that directly impacted our industry.

Weather-related incidents are not just taking place in some corners of the country. Every region and major market is vulnerable to environmental risk that is being exacerbated by global warming. There is a realization that if we don’t act fast to reduce carbon emissions, the industry is not only going to feel a pinch in the bottom line, but we’ll be spending too much time dealing with environmental mitigation. And investors increasing are deciding they will only use managers that have an environmental strategy.

The same dynamic is playing out with the “S” and “G” parts of the equation. We’ve talked about those things for years, but events such as the killing of George Floyd produced a wake-up call to many in the industry. I think the industry realizes that it is in its own interest to become more inclusive. As the worker pool becomes less white and male, our staffs should better reflect the population to attract and retain talent.

NEWSLINK: You’ve written about New York’s LL97 and potential impacts on commercial real estate. What’s the law and your perspective on the implications for New York property investors?

FIORILLA: The 2019 law sets thresholds for carbon emissions for buildings of 25,000 square feet or more, an initial standard that takes effect in 2024 and a steeper limit required by 2030. The law imposes a fine of $268 per ton of emissions on owners whose buildings do not reach the prescribed level.

There is no question that the law is well-intentioned and that reducing the city’s carbon footprint is critical, but there are some problems. The law applies only to larger buildings that represent about 5 percent of the city’s commercial properties and half of the city’s emissions. LL97 also categorizes buildings by property type, rather than by energy use, so sparsely occupied buildings are subject to the same standards as buildings that are heavy consumers, such as properties with a trading floor.

Moody’s Investors Service did a study that found that only a small percentage of properties would face serious fines, but companies will be spending a lot of time and money on compliance. We all need to deal with climate change, but in the end, the most important element to reducing carbon emissions will be developing alternate sources of energy.

NEWSLINK: How do you envision other municipalities may address similar concerns, if at all? 

FIORILLA: Roughly 30 cities have now passed benchmarking laws that require owners of large properties to submit data on water and energy consumption. Those municipalities range from gateway markets including New York, Los Angeles and San Francisco to small cities such as Fort Collins, Colo., and South Portland, Maine. As time goes on, I expect pressure from constituents and growing climate-related events will prompt other cities to pass similar laws, especially those run by Democrats.

It’s unfortunate that action on climate change has become a partisan issue. I’m struck by a statement I heard recently by Stuart Mackintosh, Executive Director of the global consulting firm Group of Thirty, who sounded the alarm about the threat posed by climate change: “We are at a tipping point of a dystopian future,” he said. “This is not just about temperatures gradually increasing and getting hotter and hotter and more difficult to live in, this is about hitting tipping points where the climate will shift to a new reality which will be much more dangerous and much more difficult to live in.”

NEWSLINK: You’ve developed a report scoring metro areas on their environmental risk profiles. What were some takeaways from this exercise?

FIORILLA: The biggest takeaway is that the industry must take environmental risk seriously. In our report, we graded metros by a dozen metrics having to do with natural disasters, pollution, water quality and investment by state and local governments. Most every metro has some issues with one or more of the categories about weather, pollution or water quality, so the attention paid by governments to mitigate problems is critical.

Another takeaway is that the mitigation efforts necessarily involve a coordinated effort by the public and private sectors. An example is coastal flooding from rising sea waters. Building owners can do what they can to protect their own properties, but solutions in cities such as Miami or New York must involve governmental measures to protect the entire coastline. Building owners have a responsibility to implement energy-saving measures, and the private market is developing alternate sources of energy, while it is up to governments to incentivize alternate energy methods, develop the necessary infrastructure and devise effective policies. Every stakeholder has a role.

Finally, we urgently need to improve the way we measure environmental risk. Commercial real estate has seen an explosion of technology and data measurement tools that help us make investment decisions. Measuring environmental risk, however, is in its infancy. What specifically are we looking for? Some of the answer is a scientific question that we aren’t qualified to judge. How do we measure risk by location/submarket? Plus, there hasn’t been enough history to gauge what works.

NEWSLINK: We continue to see owners using the C-Pace program to finance deals and energy-efficiency enhancements. Do you anticipate continued usage growth from the CRE community despite substantive concerns from many lenders about lien priority?

FIORILLA: The U.S. Department of Energy says that more than $2 billion of C-Pace loans have been financed in 2,400 properties. I expect use of C-Pace will grow. For one thing, the number of jurisdictions that have C-Pace laws should increase. Currently, only 22 states and Washington, D.C. have C-Pace programs.

One growth factor is the increasing number of property owners that will face municipal mandates to improve energy efficiency. C-Pace will help finance renovations that help those property owners comply by making improvements that include high-efficiency HVAC systems and solar panels. Another source of growth will come as the number of deals increase and people become more familiar with the program and see it working.

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