Why commercial lenders and originators should be learning ESG

by David Kitai30 Mar 2021

Commercial mortgage pros are going to have to start learning the intricacies of ESG. Those three letters, representing the environmental, social, and corporate governance aspects of an investment, a company, a business, or a project, were once a niche concept reserved for sustainability-minded retail investors. Now BlackRock, the world’s single-largest asset manager, has declared it intends to make environmental sustainability a key goal in all its investment decisions.

As market leaders have shifted monstrous amounts of capital into ESG investments, regulators have begun assessing, defining, and incentivizing ESG investments. This means that the institutional capital and regulatory frameworks so crucial in every commercial real estate deal are factoring in ESG. One analyst believes it’s time for individual mortgage professionals to do the same.

Omar Eltorai (pictured) is a lead market analyst at Reonomy. In a recently published report on how ESG will impact commercial real estate, he noted the trends mentioned above and highlighted the fact that we’re still in the early stages of widespread ESG adoption. Eltorai spoke with MPA about what role ESG will now play in commercial deals, how mortgage professionals can get ahead of the ESG curve, and why they should see the rise of ESG as an opportunity, rather than another regulatory burden.

“ESG has really been a niche focus until the past year, because key market participants weren’t supporting it in a meaningful way,” Eltorai said. “But now we’re seeing how frequently it’s being mentioned as a factor. We’ve seen calls from the head of the SEC asking for commentary around whether ESG should be included in mandatory disclosures. BlackRock has also gotten behind the idea and while BlackRock isn’t the whole market, it is the world’s largest asset manager, so its voice is a bit louder.”

Eltorai explained that of the three pillars of ESG, we’re likely to see environmental factors play out most prominently in the commercia real estate space. Carbon footprints and carbon-neutralization strategies are quantifiable, measurable, and are already attracting significant capital inflows on the residential and commercial sides. The tactile nature of environmental improvements is especially important for the calculation of an ESG ‘score,’ a mechanism by which the overall sustainability of an investment can be quickly communicated.

Even as environmental factors are currently leading the ESG charge in the commercial space, the social impacts of commercial developments are being increasingly considered as an ESG factor. Eltorai gave the example of affordable housing, which is being considered a net positive for a deal’s ESG score due to its positive social impacts. While corporate governance is somewhat more amorphous, it’s also likely to play an outsized role for CRE companies and investors that are publicly listed and more immediately subject to the whims of investors.

Eltorai believes that all three aspects of ESG will become increasingly important given the country’s current political climate. President Biden has made fighting climate change and improving access to affordable housing key goals for his administration, while improving the overall diversity of access to opportunity in America underpins many of the Democratic Party’s policies. This could mean that regulators will place an even greater emphasis on ESG factors in the future.

Burdensome as new regulations sound, commercial mortgage professionals shouldn’t be greeting the rise of ESG with a groan, Eltorai said. Rather, it’s his opinion that understanding ESG could open up a world of opportunity for mortgage pros and for lending institutions. Lenders, he noted, will see more and more incentives to fund ESG-friendly projects. Capital, too, is likely to flow into ESG-friendly lending institutions to help them meet lofty sustainability goals.

For individual originators, Eltorai believes that learning and incorporating ESG lending procedures will lead to new opportunities. The clear appetite for ESG-friendly projects in the commercial space makes an economic case for understanding ESG factors, and as regulators and GSEs introduce ESG into their frameworks, getting ahead of the curve will open up new and growing liens of business.

“We’re very much in the early innings,” Eltorai said. “But there are aspects that are linked to existing financial concepts like environmental risk that are already being incorporated into financial frameworks by lenders and insurers…If you are able to originate loans that fit these ESG criteria, understanding ESG absolutely makes economic sense.”