REITs and ESG: Why Social Responsibility Makes Business Sense

August 26, 2019

By Patrick J. Seul

Why REITs Should Commit to ESG

In recent years, investors ranging from large institutional investors to individuals have become more focused on investing in companies that meet specific environmental, social and governance (ESG) criteria. As a result, many businesses have increased their focus on improving their ESG profiles. Although management teams often see these pursuits as beneficial for moral and ethical reasons, many are also beginning to recognize that they provide strong financial incentives. Those incentives are particularly apparent in the U.S. REIT industry.

Given their continuous demands for additional capital, REITs are especially sensitive to sustainability-focused investors showing a strong preference for investing in companies that meet specific ESG criteria. In the highly competitive REIT industry, REITs simply cannot afford to lag behind their peers with respect to ESG matters and risk alienating potential sources of capital. Furthermore, REITs on the cutting edge of ESG issues are positioned to attract more investments and seamlessly adapt to the standards imposed by different funding sources.

Committing to improving their ESG profiles also enables REITs to take advantage of long-term savings. Establishing a reputation as an eco-friendly business can create brand loyalty and a positive public image, particularly with tenants that are eager to bolster their own ESG profiles. That brand loyalty can lead to greater tenant retention, saving the REIT significant re-tenanting costs in the future. In addition, keeping abreast of changes to compliance and sustainability issues can help investment portfolios remain stable when new regulations and ordinances are passed. Because cities are passing new environmental ordinances more frequently, companies that are doing the bare minimum will face new compliance costs frequently, while companies that are looking ahead and proactively self-imposing heightened environmental requirements will better avoid expensive redevelopment projects.

How REITs Can Boost Their ESG Profiles

Once a REIT has decided to commit to ESG, the question remains as to what the REIT can do to materialize that commitment. Because commercial and residential buildings account for approximately 40 percent of the United States’ total energy consumption, REITs are uniquely positioned to improve on environmental issues. Specific examples include seeking LEED certification on their properties, adopting eco-friendly building techniques, issuing “green bonds” to fund sustainability projects, implementing eco-friendly water systems, ensuring easy access to sustainable waste management for tenants, reducing emissions at buildings, installing efficient lighting and encouraging sustainable commuting at properties through electric vehicle charging and bike storage.

For social issues, REITs can improve by supporting and contributing to community organizations while matching employee donations, ensuring their workforces are inclusive and diverse, maintaining a safe working environment for employees accompanied by a living wage and encouraging employees and officers to volunteer in the community through company holidays. In particular, REITs can support organizations and initiatives aimed at improving living conditions, homelessness, community development and health and wellness.

Finally, REITs have the opportunity to improve in terms of corporate governance. For instance, REITs might improve by increasing transparency toward investors and the public (particularly with respect to related party transactions and potential conflicts of interest), implementing clear policies to avoid fraud and bribery, identifying and nominating diverse board candidates, declining to support political causes and candidates that do not align with the REIT’s values, compensating executives in a way that values long-term, sustainable growth while avoiding “golden parachutes,” having a positive relationship with the SEC and other government officials and avoiding conflicts of interest on the board of directors. While there is no single best corporate governance structure, ESG-minded investors tend to prefer structures that are democratic, transparent, equitable and focused on long-term growth.

Learn more about Fredrikson & Byron’s REITs industry practice.

REITs and ESG: Potential Initiatives

Environmental• LEED Certification
• Window Film
• Energy Efficient Lighting
• Eco-Friendly Water Systems
• Tenant Training on Recycling/Composting
Social• Supporting Community Organizations
• Adopting Policies Incentivizing Employee Volunteering
• Prioritizing Hiring and Retaining a Diverse and Inclusive Workforce
Governance• Improving Board Diversity
• Increasing Transparency
• Aligning Executive Compensation with Long-Term, Sustainable Growth
• Limiting Related Party Transactions