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NAREIM DIALOGUES SPRING 2017 13 I n real estate transactions, no good deal gets done without painstaking due diligence. A real estate acquisition team reviews every aspect of a potential transaction, looking for hidden risks and under- capitalized opportunities. Until recently, "sustainability 1 " was not a major component of this due diligence process. Acquisition teams looked at environmental regulatory and legal risks, but by and large this was a defensive strategy to avoid substantial cleanup and legal costs in a property acquisition. Increasingly, however, leading companies are using sustainability as a lens to identify hidden risks and under-capitalized value in the acquisition process. Sustainability in the transaction landscape – is the investment industry figuring it out? In their recent survey of Private Equity firms, PriceWaterhouse Coopers found that 83% had established a responsible investment policy and 60% of these firms always screen target companies for environmental, social, and governance (ESG) risks pre-acquisition. However, these same firms are still in the early stages of developing strategies to value ESG in acquisition – only 21% of these same firms were putting a specific valuation on environment, social, or governance initiatives of their acquisition targets 2 . In real estate investment, more and more companies are integrating sustainability/ESG into their acquisition due diligence process. While some of this activity is driven by the investment community, companies are finding that integrating specific, material sustainability metrics into the investment process can help them identify opportunities to negotiate a better deal, add value during their hold period, and leverage sustainability improvements to increase asset value before disposition. Avoiding unforeseen risk, and capitalizing on known risk Why are companies looking at sustainability in transactions? Ultimately for the same reasons as other material items in due diligence – they are hoping to uncover opportunities to unlock under-capitalized value in a target, and looking to avoid unforeseen downside risk. For many sustainability leaders, their first experience working with the acquisition team is to conduct due diligence on an acquisition target's sustainability certifications. According to Sara Neff, Senior Vice President of Sustainability at Kilroy Realty, this verification role is just as important as looking for hidden value in a new asset. "Confirming a building's "green" certification during acquisition is really important. Some buildings may be advertised as LEED or ENERGY STAR-certified, but may have let their certification lapse, or have not completed the certification process in the first place. Finding this out early will help the acquisition team accurately price these attributes, and get a discount over a building that has a valid, current LEED or ENERGY STAR certification." Sometimes this downside risk of an acquisition target (once known) can turn into an opportunity – for real estate leaders with experience in LEED and energy efficiency, paying less for a building that had let their LEED or ENERGY STAR certification lapse, then working to improve performance and certify it post-disposition can help make the building more competitive in major markets at a low price. For a developer adept at redeveloping brownfields, discovering soil and water contamination can be a good thing – once this cost is reflected in the deal, an efficient developer can get a property in a great location at a great price, and leverage their experience to efficiently remediate the site for redevelopment. Old tools, new lenses In tackling sustainability evaluation of potential acquisition targets, sustainability leaders are finding that the tried-and- true tools of the acquisition process can be leveraged for their sustainability due diligence. For companies working on due diligence across industries, they often find that what they need to begin a sustainability assessment has already been collected by the acquisition team. According to Dan Weed, VP and Leader of Transaction Services at TRC "We usually start by going into the data room and seeing what's there. Usually there will be enough information to identify the 4-5 most material environmental risks in a transaction. From there we will develop specific risk questions based on these potentially material issues." Anna Murray, Vice President, Sustainability at Bentall Kennedy has also found that looking for sustainability opportunities is already part of how their acquisition team is assessing buildings and the market. "Sustainability criteria is included as part of our acquisition due diligence process. This process considers green building certifications and ENERGY STAR scores. It also ranges from including sustainability-related key performance indicators in the initial building condition assessment to considering external factors such as walkability and transit scores." For Laura Craft, Head of Global Sustainability at Heitman, the property inspection and commissioning during an acquisition often uncover other sustainability opportunities. "Many sustainability opportunities are identified during due diligence by physically walking the property for outdated lighting and water fixtures and by talking with the property team about the completed and proposed efficiency improvement projects for the property." " Diligence is the mother of good luck" – Benjamin Franklin ©iStock.com/bonniecaton