ESG in Hotel Real Estate: Understanding ESG & the hotel asset lifecycle

Profit, People, Planet – the triple bottom line ‘Holy Grail’ that many companies preach – but how many practice it?

Over the last decades, governments and corporations alike have been pledging their commitment to fighting climate change and building a more inclusive society. On the environmental front, the landmark 2015 Paris Agreement vowed to create a global coalition zeroed in on achieving carbon neutrality by 2050 – a promising demonstration of the world’s growing commitment to the planet.

But the reality is that, since then, global banks have continued to – and have been allowed to – invest over USD 2.7 trillion into fossil fuel companies in the four succeeding years alone (2016-2019).

And the hospitality industry is not guilt-free either. According to UK data, while energy consumption per unit of economic output in the overall UK economy fell by 53% over the last three decades, the accommodation sector saw the opposite trend: a 10% increase in energy usage. Yet in the long term, travel and tourism is expected to continue to boom, which means that our position in and responsibility to our global ecosystem will only grow bigger. So, the key question is: how can we make bigger strides for our People and Planet?

To many, the answer is a resounding ‘ESG’.

What is ESG?

In recent years, similar to how CSR was once the poster child of the corporate world, the term ESG has earned itself somewhat ‘Vogue’ status – the purported gold standard for striving towards a sustainable future. But to reach that final step of becoming ‘ESG-compliant’, we first need to understand what it means. In this regard, there are two crucial considerations in deciphering the word ‘ESG’ for hotels:

1. An imbalanced scale. The ‘E’ in ESG often hoards the limelight. While environmental needs are undeniably the most pressing (and efforts in this area are more measurable), however, social and governance factors too are important pieces to the ESG puzzle.
2. An extensive scope. ESG goes far beyond simply installing energy-efficient LED lights. Across the span of a hotel’s life cycle, from its development to the eventual sale of the hotel asset, ESG measures can play a different role at each stage, all of which warrant careful consideration.

Therefore, in this article, we explore the intricacies of ESG in the hotel sector, firstly by equally examining each of ESG’s three factors in a hospitality context; and secondly, by taking a stage-by-stage approach to understanding the role of ESG in a hotel’s life cycle.

Deconstructing ESG in hospitality

The WTTC estimates that in 2019, the travel and tourism sector directly and indirectly accounted for 10.3% of total global GDP, and 330 million – or 1 in 10 jobs worldwide. As a massive driver of the global economy, what are some of the key factors of ESG in hospitality?

ESG key example metrics. Source: Own illustration.

Environmental

• Spotlight – Carbon neutrality: The strive for carbon neutrality has been a particularly hot topic, with decarbonization targets being at the forefront of many hospitality companies’ ESG goals. This includes numerous hotel brands like Accor, Hilton and IHG, who aim to at least halve their carbon footprint over the next decade.
• Transient not imprudent: The transient nature of hospitality makes us especially prone to being wasteful. But in an industry of this global scale, it’s not ‘just one towel’, or ‘just one straw’. It is the responsibility of providers not only to make ‘choosing green’ convenient for consumers, but to make it the norm. Why do we constantly have to leave out ‘Do not disturb’ signs instead of an occasional ‘Please make up my room’ sign?
• Together for better: Environmental sustainability is a collective effort, which is particularly challenging in a fragmented industry like hospitality. The establishment of targeted alliances such as the Energy & Environment Alliance (EEA) and Sustainable Hospitality Alliance (SHA) has been a crucial step towards consolidating best practices and resources, and such players will be key in driving the joint push for a sustainable future.

Social

• Spotlight – D&I in a global industry: In the social aspect, most notably, heightened social awareness is increasingly bringing D&I initiatives to the fore, not only in terms of ‘observable’ characteristics such as gender and race, but also ‘invisible’ factors including intellectual capabilities and mental health concerns.
• Caring for our people: Traditionally, the hospitality sector has been notorious for fostering a ‘long-hours, low-wage’ work environment. While work environments and perceptions in hospitality are arguably changing, the sheer scale of our industry only further emphasizes how important it is that we care for the people who care for our customers.
• Healthy body, healthy mind: In this ‘people business’ of hospitality, human health and safety are of utmost importance. Achieving this can be as simple as consciously using natural rather than chemical-based materials and products, to ultimately benefit both guests and employees.
• Building a more equitable future: Low-skilled labour, which comprises a high proportion of this industry’s workforce, is especially vulnerable to lapses in human rights issues. Meanwhile, one-in-five youths are at risk of poverty or exploitation, due to a lack of access to education or employment. Therefore, human rights groups and youth employment programs such as those organized by SHA are ever-more important in creating a sustainable but also equitable future.

Governance

• Spotlight – Guiding ethics: Company ethics are perhaps the most fundamental aspect of governance, as it trickles down to the company’s approach to all other factors. At the same time, the rise of ethical consumerism has also brought the era of ‘voting with one’s wallet’, whereby consumers seek to purchase from brands whose values are aligned with theirs – which means that a company’s ability to demonstrate that it adheres to ethical practices is more important than ever before.
• Putting the local in glocal: As consumers continue their quest for authentic, ‘off-the-beaten-track’ adventures, hotel companies are increasingly expanding into more ‘local’ or exquisite destinations and trying to provide highly localized experiences. In this context, local knowledge and effective communication will be key in ensuring that such ventures find the right balance between adhering to the company’s global vision and brand standards, whilst respecting local customs, regulations and their communities.

The role of ESG throughout the life cycle of a hotel asset

The ‘ESG factor’ has often been associated with the notion of premiums – implementing ESG is typically perceived to require higher cost premiums, while investors usually expect to receive a premium pricing upon sale for ESG-compliant assets. But is this a reality, or simply a myth?

At the same time, what is less frequently discussed is how ESG plays a role throughout the asset life cycle of a hotel. After all, developers and operators are involved in different phases of a hotel’s lifespan, while investors may acquire an asset at varying junctures, whether from its early stages of development to when its operations are already mature.

This thus brings us to two topics for discussion: (1) To what extent is the ‘ESG premium’ a myth; and (2) How is this purported ‘premium’ and other ESG considerations observed at each stage of a hotel’s life cycle?

Breaking down the asset life cycle of a hotel. Source: Own illustration.

Development

Design: With implementing ESG initiatives, unsurprisingly, the mantra is, “the earlier the better”. Developers and investors should maximize their ESG efforts as early as possible in the development stage, to reap the optimum benefits in the long-term – and this starts from the building’s design. Some important ways in which ESG factors may be incorporated into the design phase include:

• Sustainable buildings: Sustainable buildings have been found to be at least 20% more resource-efficient – whilst still providing a unique guest experience. For example, the multi-award-winning PARKROYAL COLLECTION Pickering, Singapore boasts 15,000sqm of green and water features, natural light and ventilation and zero-energy sky gardens; while the QO Amsterdam, which was designed based on the principle of ‘circularity’, features its very own greenhouse, energy storage system, and responsive thermal panels – all with the sole aim of conserving energy and resources.
• Passive houses: Passive design is a design process that creates ultra-low energy buildings that require minimal heating and cooling systems, thus significantly reducing energy and water usage. Originating from the German residential market, the concept has since expanded to offices, schools, retail buildings – and hotels (see example: Bruck Passive House Hotel).
• Adaptive re-use: The principle of circularity also applies to real estate. Buildings should be designed with the mentality that it may one day be adapted for alternative uses (e.g. a hotel may be converted into an office building in the future). This would help to minimize the cost and use of resources to carry out such conversions.

PARKROYAL COLLECTION Pickering, Singapore: Source: Agoda

Construction: Following the design phase, sustainable construction is also an important aspect of ESG, especially as the hotel industry continues to expand its global footprint. In Europe alone, approximately 300,000 rooms are expected to enter the market in the next few years – but resources are still finite. In the construction phase, major considerations include:

• Sourcing sustainably: Sourcing sustainable construction materials is key in ensuring that we build safely and within our means. For example, the Forest Stewardship Council (FSC) in the U.S. provides certification for products that come from responsibly managed forests, while Green Seal-certified products such as paints and sealers have been verified to be safer for human health and the environment.
• Sourcing/building locally: Perched 2,000-meters above sea-level, the Alila Jabal Akhdar in Oman is a prime example of how a hotel can be integrated into the local environment. Using traditional Omani construction techniques and local stones, the hotel was intentionally built to blend into the destination’s natural landscape, whilst offering an exquisite guest experience.
• The ‘Green Premium’ myth: Contrary to popular belief, developing a LEED-certified, ‘green’ hotel may not be as costly as one may think. In fact, the United States Green Building Council (USGBC) reported that the cost of constructing a green hotel is at best one to two percent higher than building a conventional hotel.

Alila Jabal Akhdar, Oman. Source: Remote Lands

(Re)Financing: Whether owners or investors are looking to finance new developments or refinance existing loans, they have one sole aim: to secure sufficient leverage on the most favorable terms. To that end, the rise of green and ESG-linked loans (nearly doubling to USD 180 billion in 2019) and the increasing push towards sustainable investing indicates that there is a growing shift in available capital towards ESG-oriented investments. This trend may lead to one of two scenarios:

• A larger pool of capital: The EUR 1 trillion European Green Deal Investment Plan (EGDIP) is just one example of how sustainability-focused investors will be able to capitalize on more opportunities to finance their ESG-compliant projects. Meanwhile, banks too are seeing the benefit of having strong ESG portfolios, as they present a significantly lower cost of risk.
• Restricted access to financing: On the other side of the coin, this growing trend towards ESG investing, supported by the widening network of the United Nations Principles for Responsible Investment (UNPRI), is a telling sign that investors who do not jump onto the ESG bandwagon may soon find themselves penalized with a smaller pool of capital and less financing opportunities.

Operations

Daily operations: The bulk of a hotel’s life cycle, both in terms of duration and resource usage, lies in this domain. Therefore, it is crucial for hotel operators (and owners) to be prudent in ensuring that their operations comply with ESG standards. Here, the main factors for consideration include:

• Tracking and management systems: It is often said that “what gets measured gets managed”. Hotel brands have been building proprietary systems to track and measure their environmental performance, in order to better manage their progress. Examples include IHG’s Green Engage and Hilton’s LightStay. In fact, Hilton reported that “Since [LightStay’s] debut in 2009, Hilton properties have reduced carbon emissions equivalent to removing 390,350 cars from the road and have contributed 6,273,934 volunteer hours in their local communities, while saving over $1 billion in utility costs.”
• Sourcing sustainably/locally: Each year, billions of dollars are spent in purchasing hotel furniture, fixtures and equipment (FF&E) alone. Sustainable procurement and purchasing of FF&E, operating supplies and equipment (OS&E) and F&B products are thus crucial in this aspect. Giving preferences to local suppliers will not only help reduce transportation costs and its related carbon emissions, but also support the local community.
• Towards a circular economy: In addition to sustainable sourcing, materials and products should be used in a circular rather than linear economy, whereby products are created such that they can be disassembled and broken down by nature (biological material) or reused (technical material). This way, these materials can belong to a continuous cycle of being reused and repurposed, following the cradle-to-cradle (C2C) principle, rather than the traditional ‘take-make-dump’ lifecycle.

Linear versus Circular Economy. Source: EU Sustainability Guide

CapEx improvements:

• Big steps, big rewards: Planned CapEx cycles are an opportune time for owners to invest into significantly raising the ESG standards of their assets. Depending on the hotel’s needs, capital improvement plans can range anywhere from simply retrofitting occupancy sensors for thermostats in guestrooms, to installing a full suite of solar panels. In 2018, Courtyard by Marriott Lancaster became the first U.S. Marriott hotel to be 100% solar-powered, producing an excess of 1.2 million kWh of electrical power each year.
• The ‘High Investment, Long Payback’ myth: In 2015, the USGBC found that sustainable buildings recorded an average 19.2 percent improvement in ROI after implementing sustainable projects for existing buildings, while new buildings reported a 9.9 percent higher ROI. In emerging markets, the payoff is even more evident: the International Finance Corporation (IFC) reported that energy efficiency projects in such markets had payback periods as low as 0.3 to 1.1 years.
• Continuous benchmarking and improvement: It is certainly important to measure the outcomes of capital investments and identify in advance further areas for improvement. Tools like the BREEAM In-Use assessment method and industry-specific benchmarking tools (e.g. from EEA) are just some examples of how this can be achieved.

Disposal

Asset value: The value of a hotel asset is directly linked to its operational cash flows. ESG-compliant assets will not only generate higher cash flows for investors/owners during the holding period, but also create a higher exit value. This may be achieved through one or both ways:

• Healthier top line performance: According to Skift, 53% of travellers are willing to pay more for environmentally sustainable products. Add to that the growing number of consumers who value companies’ ethics and their commitment to environmental and social sustainability, it seems that the players who can live up to these expectations will be better at acquiring and retaining customers, and perhaps even command a price premium.
• Improved bottom line margins: Higher compliance to ESG standards means greater building efficiency and lower operational costs – or from a social perspective, happier employees, higher employee retention and hence lower rehiring and retraining costs. This translates to higher profit margins and consequently, increases the asset’s long-term value.

Buyer pool: Similar to the scenarios that investors may face with (re)financing, ESG-compliant assets may initially attract a larger buyer pool, leading to the desired ‘green premium’ for sellers. However, rising regulations and growing social awareness indicate that investors are increasingly interested in – or even have to – ‘buy green’. This means that investors who hold assets that do not fulfill ESG criteria may find themselves increasingly faced with narrower buyer pools and even pricing discounts – such that eventually, we may be speaking more of ‘brown discounts’ than green premiums for assets that do not meet ESG standards.

ESG in hotel real estate: A ‘need’, not a ‘want’

There is no question that along with the continued rapid growth of our industry comes a mounting responsibility to ensure that this growth is sustainable. Fortunately for us, however, it is evident that adhering to ESG goals and standards is not only socially responsible, but also financially viable – and before we may even realize – ‘financially necessary’.

The opinions expressed in this article are those of the author/s and may differ from the opinions of Invesco Real Estate and other Invesco investment professionals, or Cushman & Wakefield and other Cushman & Wakefield professionals respectively.