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Does Investing in ESG Pay Off? Evidence from REITs

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Abstract

This article investigates the impacts of environmental, social, and governance (ESG) performance on a firm’s valuation, cash flow, and risk. Using newly available GRESB ESG performance data from 2019 to 2021 for global equity real estate investment trusts (REITs), we document that REITs with higher ESG performance scores have lower firm value and lower operating cash flow. Moreover, we show that strong ESG performing REITs exhibit higher firm risk. These results suggest that REIT management may overinvest in ESG activities at the expense of shareholder value. We are the first to our knowledge to provide evidence of overinvestment in ESG for REITs.

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Notes

  1. See an article Harvard Law School Forum on Corporate Governance, titled “SEC regulation of ESG disclosures”, at the following website: https://corpgov.law.harvard.edu/2021/05/28/sec-regulation-of-esg-disclosures/, and an article from Morgan Stanley Investment Management, titled “Sustainable finance disclosure regulation”, at the following website: https://www.morganstanley.com/im/en-be/intermediary-investor/about-us/newsroom/press-release/sustainable-finance-disclosure-regulation.html.

  2. See an industry report from Global Sustainable Investment Alliance (GSIA), titled “Global sustainable investment review”, at the following website: http://www.gsi-alliance.org/wp-content/uploads/2021/08/GSIR-20201.pdf.

  3. See an article from Financial Times on October 22, 2020, titled “The fallacy of ESG investing”, at the following website: https://www.ft.com/content/9e3e1d8b-bf9f-4d8c-baee-0b25c3113319.

  4. For example, see PIMCO’s climate bond fund: https://www.pimco.com/en-us/investments/mutual-funds/climate-bond-fund/inst.

  5. We use the terms corporate social responsibility (CSR) and Environmental, Social, and Governance (ESG) terms interchangeably as the literature uses both terms. According to The Sustainable Agency, CSR is a company’s framework of sustainability plans and ESG is the assessable outcome of the firm’s sustainability performance. (https://thesustainableagency.com/blog/esg-vs-csr/)

  6. More details about the ratings can be found from the following website: http://www.gresb.com/.

  7. See An and Pivo (2020), Brounen and Kok (2011), Chegut et al. (2014), Eichholtz et al. (2010, 2013), Fuerst and McAllister (2011), and others. Harrison and Seiler (2011a, b) offer a more nuanced view on whether greenness is strictly beneficial by examining the political environment.

  8. See an article from Nareit on September 25, 2020, titled “REITs continue focus on ESG during COVID-19 crisis”, at the following website: https://www.reit.com/news/reit-magazine/september-october-2020/reits-continue-focus-esg-during-covid-19-crisis.

  9. The full real estate assessment can be found at the following website: https://documents.gresb.com/generated_files/real_estate/2020/real_estate/assessment/complete.html#performance-reporting-characteristics.

  10. Cespa and Cestone (2007) also draw from agency theory but instead argue that CEOs invest in ESG to gain favor with non-shareholder stakeholders and entrench themselves.

  11. See a report from BlackRock, titled “Troubled waters”, at the following website: https://www.blackrock.com/institutions/en-gb/insights/blackrock-investment-institute/troubled-waters.

  12. The global real estate transparency index (GRETI) by JLL also provide some information about ESG in the ESG and environmental sustainability practices for the global real estate markets (Newell & Marzuki, 2022). Also see: https://www.us.jll.com/en/trends-and-insights/research/global-real-estate-transparency-index.

  13. See a report from Janus Henderson Investors, titled “ESG in COVID times: doing the REIT thing”, at the following website: https://www.janushenderson.com/en-it/advisor/article/esg-in-covid-times-doing-the-reit-thing/.

  14. See an article from NAREIT on February 01, 2021, titled “How the REIT industry is building diversity”, at the following website:: https://www.reit.com/news/reit-magazine/january-february-2021/how-reits-are-building-diversity.

  15. See Robinson and McIntosh (2022) for a literature review on ESG in commercial real estate.

  16. See Leskinen et al. (2020) for a literature review of green building certification in commercial properties.

  17. See a report from U.S. Securities and Exchange Commission, titled “Scarlet letters: remarks before the American Enterprise Institute”, at the following website: https://www.sec.gov/news/speech/speech-peirce-061819.

  18. See an article from NAREIT, titled “Leader in the Light Awards”, at the following website: https://www.reit.com/nareit/industry-awards/leader-light-award.

  19. A more segmented analysis, which evaluates the subcategories within GRESB scores, would shed light on specific drivers behind our results. Regrettably, we’re constrained by the data access we have from S&P Global, which only furnishes the aggregate score.

  20. Hijjawi et al. (2021) document a steady increase in the ESG combined score for Australian REITs from 2004 to 2019.

  21. Property type refers to REIT’s type of real estate property, which is determined by the tenant’s uses of the property. [S&P Global KeyField: 113,553]. Property types are regrouped into seven categories: office, industrial, retail, hotel, multifamily, health care, diversified and others.

  22. For robustness purpose, we also measure a firm’s total value as the ratio of the market value of a firm divided by total assets (Lamont & Polk, 2002; Beracha et al., 2019b). The untabulated results continue to hold and are available upon request.

  23. For robustness purpose, we also measure a firm’s cash flow as funds from operations scaled by total assets (FFO/TA). FFO is a widely accepted cash flow metrics for North American REITs. while North American REITs normally report their FFO, REITs around the world generally do not report FFO. For REITs do not have a reported FFO in our sample, FFO is calculated as net income + depreciation – Gains on sale + interest. The results are qualitatively similar.

  24. We follow finance (e.g., Cheng et al., 2015) and real estate (e.g., Beracha et al., 2019a; Feng et al., 2022) literature, to compute the annual stock return volatility, firms with less than 60 days of return are excluded in the final sample.

  25. When country-year interacted fixed effects are used, these variables have no variation and are subsumed by the fixed effect.

  26. Results are consistent if we use the ESG performance score without taking the natural logarithm.

  27. Funds from operations (FFO) are not widely reported by Europe and Asia Pacific REITs.

  28. We thank an anonymous reviewer for this comment.

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Acknowledgements

We are grateful for the helpful comments from David Harrison (discussant), participants at the 2022 American Real Estate Society (ARES) Annual Meeting, and the 2022 UF/FSU/UCF Current Issues in Real Estate Conference. The paper was the manuscript prize winner in Sustainable Real Estate at the 2022 ARES Annual Meeting.

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  1. University of Colorado, Colorado Springs, 1420 Austin Bluffs Pkwy, Colorado Springs, CO, 80918, USA

    Ryan G. Chacon

  2. The University of Texas at El Paso, 500 W. University Ave., El Paso, TX, 79968, USA

    Zifeng Feng

  3. Florida International University, 1101 Brickell Ave., Miami, FL, 33131, USA

    Zhonghua Wu

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  1. Ryan G. Chacon
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Correspondence to Zifeng Feng.

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Chacon, R.G., Feng, Z. & Wu, Z. Does Investing in ESG Pay Off? Evidence from REITs. J Real Estate Finan Econ (2024). https://doi.org/10.1007/s11146-024-09979-y

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