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Risk Management: A Highly Beneficial Result of ESG Implementation

When it comes to implementing an ESG (Environmental, Social, Governance) program, some owners/investors view it as a requirement for appeasing investors and meeting certain regulatory requirements. However, many have begun to prioritize ESG considerations into investment decisions because it is an invaluable tool for responsible and comprehensive risk management. Regardless of whether you’re involved in buying or managing CRE properties, understanding the many risk factors you may face is critical if you want to protect and maximize the short and long-term value of your properties and overall portfolio.

As we’ve seen over time in CRE, change is a slow but continuous part of the business. The effects of climate change — and the risks that come along with it — are a significant factor both in the near term and long term. When looking at a property or portfolio, the impacts of climate risk can be twofold:

  • physical risk, which relates to potential damage to properties
  • transition risk, which relates to evolving guidelines or regulations (“regulatory” risk) that can challenge the property owner’s ability to remain in compliance or compete in the marketplace.

In each case, the risk management aspect of ESG takes on greater urgency and importance as the full implications of climate change become clearer. So, it’s important to recognize and address both.

A Closer Look at Physical Risk

“Climate change has become synonymous with financial risk,” according to Joe DiTizio at EBI Consulting, which maintains a dedicated ESG practice area. “With climate change, increased intensity and frequency of natural disasters and rise in global average temperature have led to a surge in physical damage to properties. Investors need to know their assets’ vulnerability to climate risk and what steps can be taken to mitigate that risk and increase resiliency.”

Property- and portfolio-level risk takes a variety of forms. Depending on the region where properties are located, different factors related to physical risk come into play, including wind, flooding, seismic and wildfire. Climate change will likely continue to exacerbate physical risk, which can affect a property or portfolio financially in numerous ways, including:

  • repair from building damage creating unanticipated capex
  • business interruption impacting cash flow
  • increased vulnerability to the effects of climate change undermining property values

Risks Associated with Regulatory Changes

Another leading category of risk is transition (regulatory) risk, created by changing strategies, policies or investments as society and industry work to reduce dependence on carbon and its impact on the climate. The Task Force on Climate-related Financial Disclosures (TCFD) says that this may take the following forms: policy and legal risk, technology risk, market risk and reputation risk.

As an example of policy and legal risk, the SEC recently voted to approve proposed climate risk disclosures that would require public companies to release information on:

  • climate risks likely to have a material impact on the business
  • how those risks have and are predicted to impact the business
  • how the company plans to address these risks

The TCFD says that technological improvements or innovations that support the transition to a lower-carbon, energy-efficient economic system can have a significant impact on organizations. “To the extent that new technology displaces old systems and disrupts some parts of the existing economic system, winners and losers will emerge from this ‘creative destruction’ process,” says the TCFD.

Health and Safety Issues Also Present Risk

Other areas of risk that fall under the heading of ESG-related risk management include the health and safety of occupants and indoor environmental quality. These two areas are related but not synonymous. When leasing properties, prospective tenants increasingly want to rent and occupy spaces that prioritize their mental and physical health. Factors such as ensuring there are good health and safety protocols, common areas such as fitness centers, and key building features such as good natural light, all play into the appeal of a space, the prices that owners can charge, and the value of the overall property.

Moving from Risk Awareness to Mitigation

It’s one thing to be aware of potential issues and another to do something about them. Understanding the risks, then taking appropriate action, is the key. While benchmarking a property’s performance in areas related to sustainability or resilience is helpful, it’s only a measure of the status quo. An owner needs to take a forward-looking approach to fully grasp potential negative impacts of climate and transition risk.

How can an owner/investor turn awareness of these risks into actionable measurements? GRESB (Global Real Estate Sustainability Benchmarks), a worldwide standards organization which EBI supports, has set down guidelines for measuring potential risks. These guidelines comprise a checklist which answers questions such as “Has the entity performed asset-level environmental and/or social risk assessments of its standing investments during the last three years?”

Performing these assessments is only the first step. When it comes to implementing solutions that address these risks, partnering with an experienced ESG consultant provides a cost-effective solution for those who lack internal experience and resources.

EBI Consulting works with clients to evaluate risk factors and recommend remedies. The risks may be imminent or may have the potential to create problems at some point in the future, but regardless, knowing the risks and having a plan to deal with them is key to each client’s long-term success.

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