Inveniam’s Response to IVSC’s ESG and Real Estate Valuation Perspectives Paper

Environmental, social, and governance (ESG) criteria can be used as a non-market strategy by companies to differentiate themselves from competitors. ESG criteria can manifest in different ways, often as climate change or other kinds of environmentally related risk. Social and governance policies of firms also fall into the ESG category.

Recently, ESG has captured the attention of those in the financial services sectors. It seems that ESG is mentioned daily in the media. Discussions often focus on risks related to climate change:

• “Green” rent premiums for buildings with environmental features that command premiums;
• “Brown” discounts for buildings with environmental features that command discounts; and
• “Net zero” carbon emissions that focus on the entire lifecycle of buildings.

Moreover, as the October 2021 International Valuation Standards Council (IVSC) perspectives paper entitled “ESG and Real Estate Valuation” highlights, growing demand for more robust, reliable ESG metrics is being addressed differently across the world. In some countries, air quality with a focus on particulate matter is a higher priority, whereas in others aggregate carbon emissions rank higher.

Overall, the IVSC article suggests that ESG related market behaviors “can be best measured using the Income Approach. As ESG recognition in the market matures and there are more transactions of buildings with varying and transparent levels of ESG involvement, the Market Approach [i.e. the Sales Comparison Approach] may become more applicable.” Put more simply, the Market Approach relies on a variety of data points (observations) that have different values of different variables. [Without variation, you can’t have a variable!] As an example, the report suggests that buildings with better ESG ratings may have higher rents, lower vacancies, and shorter vacancy periods between tenants. In turn, these items should increase the prices paid by investors to acquire the properties in question. To answer these questions, enough sales of comparable properties must exist to utilize techniques such as paired sales analysis or multiple regression analysis.

In general, we agree with the report’s conclusions. Arguably, the biggest limitation of the Cost Approach is that cost does not necessarily equal value, a point well documented in the valuation literature. Regarding the Income Approach, the IVSC report highlights items (e.g. vacancy rates, rental rates, vacancy periods between tenants) that can be influenced by ESG factors. Yet, the paradox is that the “best” of the three valuation methods for measuring ESG related market behaviors (the Income Approach) involves so many items that it is difficult to isolate that which impacts ESG-related rents, prices, or other variables. The list of related items in the IVSC report that could co-move with ESG related market behaviors include income, non-recoverable operating expenses, vacancy rates, capitalization rates, discount rates, terminal cap rates, and capital expenditures.

As a cutting-edge leader in trusted data, Inveniam provides the infrastructure required to credential, structure, and deliver data in a robust, traceable manner that preserves provenance. This technology enables real-time processing of credentialed data accessed via roles-based permissions. This means credentialed data about a building goes to the right people in real-time. With roles-based access, data are only presented to those with permission. Credentialed data, backed by Inveniam’s immutable audit trail, is key to establishing credible ESG metrics and monitoring activities. Apex Group Ltd. is one example of a firm that has created a process allowing companies to compute their carbon footprint. Apex and Inveniam understand that trusted data are the center of any ESG solution. More granular measurement and assessment of data enables more effective ESG strategies.