Issue link: https://digital.shearman.com/i/1293427
CHALLENGES We have, of course, all been living with the COVID-19 pandemic for several months now. Its impact on commercial real estate has been enormous, particularly in the hospitality, retail and multi- family sectors. It has been virtually impossible for appraisers and investors to settle on any reliable measures of value, given the virtual standstill in the market and the inability to assess the duration of the COVID-19 pandemic and its longer-term impact. One of the many deleterious effects of the COVID-19 pandemic has thus been the deferral or rethinking of capital projects and their anticipated positive environmental and societal impact. There are longer-term challenges as well. Not all investment markets are created equal. Rent demand or ultimate value appreciation in a gateway city may well justify the additional cost of constructing a Class A office building or multifamily housing which satisfies LEED or other sustainability measures. But what of secondary and tertiary markets? Will local demand or anticipated capitalization rates on exit support the additional expenditure? Building regulations in major cities may well mandate a level of sustainability consistent with LEED or equivalent standards. Land use regulations in those markets may also require minimum green space or community space, thereby legislating some degree of positive social impact as a condition to new development. However, a few jurisdictions have legislated away from LEED compliance by adopting other less stringent industry standards. Can local builders be expected to voluntarily go the extra mile if a commensurate return is not assured? Public companies have led the way in reporting ESG initiatives. 78 of the top 100 REITs by equity market capitalization report owning green certified buildings, and as shown in the chart below, more than 50% of the REIT industry report on levels of carbon emissions and energy usage and community development programs. 8 But, as noted earlier, REITs still represent a small, though significant, percentage of the commercial real estate industry. Institutional investors certainly have the clout to demand similar disclosures from investment fund sponsors; however, the balance of the market still lacks transparency. And how reliable are measurements of more subjective social impacts? How can developers, investors and lenders assess social impact, such as local job growth? Perhaps the demand for objective criteria will lead to enhanced technological tools akin to those being developed for opportunity zones — in effect the social benefit equivalent of a LEED certification. 8 Percentage of equity market capitalization of the top 100 REITs. "REIT ESG Dashboard," https://www.reit.com/investing/reits-sustainability/reit-esg-dashboard. Percentage of Top REITs Reporting ESG Initiatives Level of carbon emissions Energy usage Community development programs 51% 51% 72% Shearman & Sterling LLP 40 | Impact Investing in Commercial Real Estate