‘ESG doesn’t matter,’…says the person who lost the $50,000,000 acquisition

When Cushman & Wakefield says investors are bullish on commercial real estate (CRE) properties with ESG (environmental, social, governance) considerations, it’s time to listen. Buildings with strong evidence of ESG friendly assets price higher than non-ESG assets. And with the steep imbalance between supply and demand, every LOI counts now more than ever. For acquisitions managers, that means they must rethink their approach to gain the upper hand and reap the rewards of a closed deal. 

Profitable ESG is directly linked to increased building NOI. At Carbon Lighthouse, the NOI opportunities we uncover are underwritable because of both accuracy and high yield on cost. These new underwritable NOI opportunities give acquisitions managers a fast competitive edge that’s critical to beating out today’s fierce competitive bids. 

Carbon Lighthouse’s patented AI and ML tech uncovers hidden value in assets through the lens of uncovering building initiatives that generate strong returns. There is hidden value in every building. We leverage our billions of data points to comb through every ESG opportunity in a building to uncover what is underwritable and what matters to generate required returns. 

As an investor, dismissing ESG as investor activism is at best ignoring the cash potential readily available in ESG. At worst (and in this market, most likely), it means getting outbid in building acquisitions and losing major deals to competitors who used ESG to their advantage. Given the fiercely competitive market, acquisitions managers need to quickly find underwriteable value through ESG that their competitors can’t see.

At Carbon Lighthouse, we are dedicated to making decarbonization profitable, underwritable, easy and fast. We’ve worked with firms holding $1+ trillion in AUM to decarbonize their assets. We know the common pitfalls companies make when they think about ESG as anything but opportunities to win acquisitions and build exemplary building portfolios.

The five steps most commercial real estate firms go through in this process are: Denial, Talking, Baselining, Piloting, and Scaling — each associated with money lost or gained. As we walk through each step, we’ll show how acquisition managers can quickly pass through the phases that lose money and time, to the phases with profitable NOI generating ESG investments.

DENIAL

Denial doesn’t mean denying the existence of climate change, but rather denying that your real estate firm needs to do something about climate change.

Denial was a popular stage a decade ago, but it’s since become extremely costly for CRE firms and is the costliest of the ESG phases. Simply put, many limited partners (LPs) will not invest in companies in the denial phase, meaning firms in the Denial stage are losing access to capital and, importantly, to the cheapest capital. That means every stage of the CRE lifecycle is subsequently impacted by ESG, and most importantly acquisitions: without access to the most competitive capital, winning deals becomes materially harder.

Acquisitions managers can’t afford to stall in the Denial phase in today’s heated market. We know today that decarbonization IS profitable and creates a unique competitive edge for those who know how to leverage ESG’s potential. As such, the world of institutional CRE has quickly moved out of the Denial stage and into the Talk stage. Acquisitions managers simply can’t afford to remain in Denial or run the risk of missing out on returns in the short and long term. 

TALK

The next step is “Talk,” which means goals for reducing a firm’s carbon footprint are in the works. Of all the phases, Talk is the cheapest, which explains why the majority of the market has entered this stage. “Cheap” does not mean “Profitable”, however, which is also why the majority of the commercial real estate market will not tell you that they’re making money hand-over-fist from ESG.

During the Talk stage, firms might be hiring a sustainability director or investing some time and resources in the process of developing solutions to become carbon neutral, often by a target date like 2050. They may be highlighting buildings in their portfolio that are already certified in LEED, Energy Star or touting their GRESB (Global Real Estate Sustainability Benchmark) score. Until recently, ESG’s value to acquisitions managers hasn’t been clear. At best, they relied on these certifications to check a box — but ESG was unlikely to be a specific, underwritable edge with which to help outbid the competition.

Many firms stall in the Talk phase simply because they haven’t seen how ESG can be profitable. Excitingly, bleeding-edge technologies are putting ESG profitability within the grasp of firms and acquisitions managers alike and with it, the competitive advantage needed to drive and win competitive bids.

CLUES AI is Carbon Lighthouse’s solution that offers acquisitions managers data-backed and underwritable insights — before an LOI is signed — into the specific NOI a building can achieve through specific and high-yield ESG investments. Insights that competitors won’t have. And when acquisitions managers can clearly see and underwrite the profit potential, they can quickly move to the Baselining phase.

BASELINING 

Baselining is where firms start taking action and start spending more money, still typically without material returns. They likely have a sustainability director who needs vendors and tools to track bills and reporting and certifications and filing and measure current performance and calculate associated goals. 

On the upside, firms are able to show investors that they are indeed progressing toward the commitments made during the Talk phase. The downside is even after investing in this phase, nothing has materially changed and the firm still isn’t yielding any returns. At best, firms have identified the problems and set goals but it still might not be clear how firms are addressing those problems to achieve the set goals, much less doing so profitably and in an inspectable way. At worst firms are spending money on sustainability staff and vendors and achieving… nothing. Yet if firms could see that investments in ESG were actually a concrete and specific revenue driver, instead of a nebulous savings term absent in short-term value, they could use ESG solutions to secure increases in NOI for assets they’re selling, yielding more and higher best offers. 

The Baseline phase can give acquisitions managers a way to better scope out the competition during bidding. Has a competitor moved past the baseline phase and already capitalized on ESG wins? Or are they stuck not recognizing how ESG can be profitable? If they are stuck in the Talk or Baseline phases, it could be a sign of missed ESG opportunities to drive NOI, giving competing acquisitions managers the edge when bidding for buildings against them. 

PILOT

As much as the Baselining stage isn’t dripping with profit, Piloting is worse. This is typically the most expensive and time-consuming step, which is likely why only a few CRE firms have reached this stage of the process and why even less advance to Scale. Firms are spending even more at this phase, hiring more vendors and tools to implement projects, test, and correct mistakes. What’s worse — even though projects may be executed, it is likely that tenants, not the CRE firms, will be the ones seeing returns given various lease structures like NNN and modified gross leases with base stops. That is great for tenants but doesn’t move the needle for the firm since tenants still aren’t making leasing decisions based on energy costs. And if the firm isn’t seeing returns on a pilot, they won’t advance to scaling. 

The NOI Acquisitions EPIPHANY from Carbon Lighthouse’s SmartAI: 

Carbon Lighthouse has found that piloting often fails because firms aren’t evaluating pilots properly before scaling. Many firms at Pilot stage are asking, “Do I see energy savings in my utility bill?” instead of asking, “Do I see an impact in my NOI?” — similar to how other CRE investments like a lobby retrofit or other portfolio-wide rollouts are evaluated. 

CRE firms will only scale a pilot if they see it in returns. So while it may be tempting to weigh an ESG pilot’s success in energy savings in utility bills, those are not always apparent, and even when they are, the savings go to the tenant leaving the firm with no business case to scale. Most importantly, they don’t matter: real estate investors eat, drink, sleep, and breathe NOI. Utility bills are not the core business. If you’re reading this, you almost certainly know this already. For a large initiative and investment to become a priority, it must result in NOI. 

If you see direct results in the NOI, much the same as you might a lobby retrofit or another tenant improvement tied to leasing, then you can scale up. And indeed you can often scale up faster with ESG: the returns on ESG projects — if done right — are often far higher than other investments available. This is exactly how Carbon Lighthouse clients are achieving successful pilots. We pay rent directly to clients with NNN leases during ESG pilots (and portfolio rollouts), creating top-line income and giving firms clear evidence of NOI and a business case to scale across the portfolio. This offer for rent can be made during Acquisitions, with an underwritable range provided before an LOI is even signed. With this additional rent, typically ranging from $0.20 – $1 per square foot, Acquisitions professionals can get a powerful edge on their competition. 

SCALE 

Scale is where ESG starts to increase portfolio values by tens to hundreds of millions of dollars. Few firms make it to scale and in the US currently, only market leaders are at scale. Firms at Scale have piloted vendors, found a way to profit from sustainable solutions in a trackable, underwriteable way, and have rolled those solutions out across their portfolios. 

But all portfolio-wide rollouts aren’t the same. ESG rollouts can’t simply be reporting or measuring tools. Those simply prevent further loss and still aren’t generating returns. Only if NOI impacts are specifically evaluated during the pilot phase, and found to be underwriteable, will firms be willing to scale.  The firms that do figure out how to make NOI from ESG underwriteable and repeatable, achieve significant financial returns. Carbon Lighthouse, for example, has increased our clients’ portfolio values by $250M.

For acquisitions managers where ESG pilots have advanced to scale across the portfolio, ESG provides continued long-term opportunities to yield returns as assets are bought, sold and managed. Buildings live, breathe and evolve. CLUES AI incorporates patented technologies that constantly analyze building performance so that owners can ensure their building (and building portfolios) are operating at peak potential. ESG does not begin at acquisition and end at disposition. Carbon Lighthouse’s approach to ESG is a continuous process that ensures peak portfolio performance. 

 

CLUES AI: How to Make Money at Scale from Profitable ESG

Carbon Lighthouse’s CLUES AI platform can help acquisitions managers quickly navigate the 5 phases of ESG issues with an eye on outbidding the competition for profit and NOI.

CLUES AI can identify the potential for available NOI increase before bidding. For example, CLUES AI tells you there’s an extra $100K-$250K in additional NOI in the building. If the current cap rate is 5%, it means there’s $2M-$5M in additional value unseen by the rest of the market, thereby allowing you to increase your bid by $2M with the potential for $3M in upside profit from ESG. 

Over the past decade, CLUES AI has paved a clear, underwritable and profitable ESG path for CRE. Our clients are now well prepared to capitalize on acquisitions, are you?

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