31 October 20227 minute read

Future-proofing real estate businesses with ESG metrics and blockchain technology

ESG (environmental, social and governance) is a value driver that increasingly affects real estate markets and guides key aspects of due diligence, acquisition strategy, and asset management. Stakeholders in the real estate industry are coming to understand that, beyond public interest in ESG and the need to comply with government regulations regarding ESG, there’s also sound financial justification for them to set and achieve ESG and sustainability goals. As the importance of ESG metrics grows, so does demand for monitoring ESG performance, generating and tracking reliable data, and improving transparency, trust and data security.

As a key business objective, many companies are setting goals to reduce their carbon footprints by using eco-friendly building materials or optimizing energy consumption in buildings. Many jurisdictions impose mandatory sustainability disclosure requirements, such as the EU's Corporate Sustainability Reporting Directive. In the US, the Securities and Exchange Commission has indicated it will adopt rules for ESG disclosure that will feature guidelines for greenhouse gas emissions, building on existing standards such as the Task Force on Climate-Related Financial Disclosures and the Greenhouse Gas Protocol. Companies also participate in voluntary reporting programs, such as the Leadership in Energy and Environmental Design (LEED) rating system.

The challenging part is to demonstrate tangible progress, to develop a meaningful measurement program across portfolios, and to build connections among stakeholders to guarantee transparency and traceability. Managers are tasked with collecting and processing a large amount of data which, in turn, challenges their ability to make informed decisions in real time. Questions also arise about whether companies are actually operating in ways that are as environmentally friendly as they claim. Stakeholders are demanding a viable solution to monitor ESG implementation.

Blockchain: A single, standardized platform

To collect and track reliable and trusted data, generate ESG reports, and automate the management and measurement process, many companies are now turning to modern technologies such as blockchain, AI and the Internet of Things. Blockchain is a combination of technologies – including digital signatures, asymmetric key cryptography, distributed ledgers and peer-to-peer communication – which collectively support a network of information cryptographically stored on-chain. When used to measure aspects of ESG performance, blockchain provides a single, standardized platform for meaningful measurement. The technology can be used to generate reports that demonstrate ESG performance and compliance. It also ensures all the data is collected, transferred and recorded in a consistent, immutable and tamper-proof way and enabling data standardization to guarantee transparency and preserve data security and privacy. When it’s supported with other digital technologies, like the Internet of Things, this data collection process can be automated and optimized.

For example, blockchain platforms can be used to monitor energy generation, storage and consumption. Blockchain technology can also help track how building materials are produced, used and recycled. Managers can use blockchain-based data systems to monitor ESG issues throughout the life-cycle of a building and make informed decisions in real time to strengthen sustainable investments, control ecological footprint of the whole portfolio, and optimize team effectiveness.

Tracking the social component

The “social” component of ESG also plays an important role in real estate investment. Innovative green financing mechanisms have unlocked investment in sustainable real estate as investors look for projects that will have a positive social impact, such as affordable housing, green office spaces, and renewable energy. Many companies are implementing changes to improve workforce wellness, which may include increased ventilation and air circulation, optimized space, hygiene and light.

More often, real estate companies are relying on sensors and devices installed in their buildings to determine whether the amenities they provide represent the optimal use of building space. These devices give property managers real-time occupancy rates and historical usage data, which can be recorded on the blockchain. Blockchain tracking can also help property managers automate routine maintenance tasks, such as ordering new light bulbs, optimizing HVAC1 systems by instantly streamlining heating and cooling of a space, detecting malfunctions and defects, and measuring and adjusting energy consumption via AI-based machine learning.

Tracking the governance component

The “governance” component of ESG requires a self-regulation mechanism that reflects a business’s commitment to accountability and the wellbeing of communities. Strong governance is built on fairness, transparency and security. Blockchain-based smart contracts can make this process easier and more effective by enabling transparency and immutability in real estate transactions and corporate policies. Using blockchain technology, companies can gather information promoting sustainability objectives while protecting any personal information collected while managing tenants, selling real estate, and servicing investors, employees and contractors. Privacy issues can also be addressed on-chain by using permissions to prevent access where necessary or through zero-knowledge proof technology.

But there are limits

Of course, blockchain technology is not the answer to all ESG challenges, and it doesn’t exist in a vacuum. Any blockchain-based solution must comply with legal and regulatory obligations, and technological limitations, addressing these concerns as they are integrated into ESG policies.

For example, a blockchain-based smart contract is often used to automate and protect transactions and data flow, facilitating automation, certainty and efficiency. One key concern is the potential risk and liability resulting from unintended programming errors in the coding protocol, which can lead to financial or other losses by transaction counterparties and pose risks to a company's broader reputation, triggering disputes leading to costly litigation.

Smart contracts are designed to perform largely without intermediaries. But there is – at least for the foreseeable future – a need for human oversight, intervention and interpretation to conduct code audits at the front end, maintain industry-appropriate protective measures and best practices, and address legal disputes and risk allocation resulting from smart contract malfunction, compromise of a party’s access to the blockchain, or potential hacks.

All these issues would need to be addressed in separate traditional text-based contracts. A court would likely look at the text and code as a unified single agreement as it determines parties’ rights and obligations.

New rules are emerging

Given concerns that the collection and storage of digitized data on-chain may disclose sensitive and confidential data, new regulations and guidelines are emerging that focus on accountability and liability with respect to safeguarding and disposing of data, privacy policies, appropriate use of personal information, data breach notification, and other sensitive areas. While the blockchain is considered relatively secure from hacking, backdoor attacks through wallets or other means may exfiltrate data from the blockchain. Confidentiality, security and privacy assurances at different levels are needed to ensure that a business complies with regulatory bodies and with regulations such as HIPAA2 and the GDPR.3

This means that companies should each develop their own comprehensive implementation strategy to monitor data flow, enhance security measures, conduct periodic risk evaluations, minimize the collection and sharing of confidential data, and assess trustworthiness among participating parties. Prudent companies should consider adding customized blockchain-related data protection and privacy provisions to their commercial agreements and imposing obligations on counterparties to comply with such regulations and implement appropriate security measures.

There’s more to keep in mind. Due to technical concerns such as transaction processing time, data privacy, anti-money laundering, know your customer and other regulatory concerns, the blockchain requires a certain degree of permissioned functionality – ie restricting platform access only to certain known participants and limiting the rights of those participants on the platform. This is why consortium and hybrid blockchains tend to be commonly used. This, in turn, raises further issues regarding such concerns as blockchain governance, designing consensus mechanisms among participants, and determining how to document rights and obligations among parties.

Moving forward in this emerging landscape

In recent years, a company’s strong ESG performance has, in many instances, translated into greater access to capital and a higher-quality investor pool focused on measuring real estate portfolios against sustainability benchmarks. Regulation forwarding ESG is expected to increase, and real estate companies will likely be ever more affected by ESG-related legal and regulatory disclosures.

In this emerging landscape, real estate companies should be mindful of their ESG attributes and the concerns of investors, regulators, lenders and other stakeholders. Blockchain and other modern technologies can help, offering a verifiable, efficient, and transparent tool for navigating ESG implementation. But companies looking to use blockchain technology to enable and track their ESG journey need to be aware, up front, of the potential technical and legal issues.

1 Heating, ventilating, and air conditioning
Health Insurance Portability and Accountability Act
General data protection regulation