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When Scottsdale, Ariz.–based Meritage Homes became 100% Energy Star compliant with every home it built starting in 2010, the company was at the forefront of energy efficiency among production home builders. Eight years later, the company’s sustainable efforts have paid off in more ways than just lowering buyers’ utility bills. The firm’s stance on energy efficiency has positioned it to capitalize on a trend of explosive asset growth among its investors, as well.

With environmental, social, and governance (ESG) investing, investment firms screen publicly traded companies for predefined objectives in those three areas. A successor to socially responsible investing (SRI), which shuns investments in products such as firearms, liquor, and tobacco from a moral perspective, ESG takes the philosophy one step further to consider the policies and processes companies use to run their businesses, the impact their actions have on the environment and society, and whether there’s diversity among board members and corporate executives, as well as transparency and clear reporting in governance and operations.

Now having won its sixth consecutive Energy Star partner of the year award in April, Meritage is about to release a comprehensive sustainability and corporate social responsibility (CSR) report that will also emphasize the company’s ESG investment attributes.

“Our CEO Steve Hilton thought we should get some recognition for the way we build our homes and run our business from more than just the EPA,” says Brent Anderson, vice president of investor relations at Meritage. “He saw an article on CSR and ESG reporting, and thought, ‘We’re doing all these things anyway, let’s start reporting on them.’”

GROWTH POTENTIAL
Hilton couldn’t have had better timing.

According to a recent report from consultancy McKinsey & Co., assets connected to some sort of ESG screen now account for more than $22.89 trillion, or 26%, of assets under management globally. That’s up from 21.5% of assets in 2012, with ESG investing growing at more than 17% annually, according to the report.

And the trend, which was largely viewed as an international investment niche in years past, isn’t just happening overseas anymore. While European investors still lead the world with an ESG allocation of more than 52%, followed in the rankings by Australia, New Zealand, and Canada, 21.6% of U.S. assets are now allocated to sustainable investments, according to McKinsey.

ESG aspects of investing are becoming so prevalent that Larry Fink, CEO of BlackRock, the world’s largest asset manager with $6.28 trillion under management, issued what was viewed as a warning to CEOs in his annual letter in January.

“Society is demanding that companies, both public and private, serve a social purpose,” Fink wrote. “In the current environment, these stakeholders are demanding that companies exercise leadership on a broader range of issues.”

Fink called on companies to be part of the solution on a broad range of issues, including climate change. “Your company’s strategy must articulate a path to achieve financial performance,” Fink wrote. “To sustain that performance, however, you must also understand the societal impact of your business as well as the ways that broad, structural trends—from slow wage growth to rising automation to climate change—affect your potential for growth.”

To Anderson and Meritage, that message resounded with steps the company was already taking. In addition to its sustainable building practices, the firm is also focused on other ESG-minded attributes like its community outreach initiatives and commitment to female leadership, including CFO Hilla Sferruzza, chief marketing officer Tracy Tannenbaum, and board member Deb Henretta.

“Basically, what we started hearing is that if this isn’t important to you yet, it should be,” Anderson says. “We actually had a long-time Meritage investor come to us and suggest that we take a hard look at ESG reporting, because it opens the door to more funds being able to invest in our stock. Of course, that’s a great benefit, but that’s not why we pride ourselves on being environmentally and socially conscious. We simply feel we have a responsibility to be that way because it’s the right thing to do. And it’s also what our home buyers want. They want green space, they want trees, they want energy-efficient homes.”

To Sheldon Stone, a consultant at Scottsdale, Ariz.–based consultancy Environmental Foundations, those are the exactly the kinds of characteristics an ESG-oriented home builder should be designing into its communities.

“Adapting to changes in consumer demand for sustainable, energy conserving and socially conscience housing options will significantly impact home builders’ investment returns and success,” Stone says. “Those home builders that incorporate sustainable and energy-efficient systems into their building standards to reduce costs are more likely to see an increase in demand that results in positive ESG investment returns. Those that don’t, for the most part, will be left behind.”

THE DISCONNECT
Aside from Meritage, the home building industry isn’t standing out with ESG investors, despite focus from many of the public builders on building better, more energy-efficient homes for the better part of two decades. Ask Anderson how many times he’s been asked about ESG criteria at investing conferences over the past several years, and he has a one-syllable answer: “Twice.”

That sounds right to Tony McGill, head of investment banking at Zelman & Associates, a New York–based investment and research firm focused on housing. “Without being an absolutist, I would say it never comes up,” McGill says. “It doesn’t seem to be a topic that capital or strategic investors are focused on.”

Many home building executives seem to be mum on the subject as well. BUILDER was hard pressed to find large, public home builders willing to speak to the increasing importance of ESG criteria in their businesses today, even among companies that are held up as examples of innovation and green building within the industry, such as Lennar, TriPoint, Pulte and K. Hovananian. “Sorry,” one executive wrote in a representative response. “But we are not going to be able to help you out with this one.”

Toll Brothers, which issues an environmental report detailing the sustainable aspects of its homes, declined the opportunity to talk about why it decided to create the report, and why the issue is important to the company.

Even at KB Home, which is celebrating the release of its 11th annual sustainability report highlighting how many tons of greenhouse gases its energy-efficient homes offset, executives chose not to speak to the ESG investment trend.

Perhaps that’s because the disconnect runs both ways. Among the ESG rating firms that are currently duking it out to provide data and ESG ratings to the growing number of investors in this area, few, if any, are focused on home builders.

For example, New York–based Institutional Shareholder Services (ISS), which describes itself as the world’s leading provider of corporate governance and responsible investment solutions, is still developing its universe of real estate and home building-related ESG screens, and opted not to participate in this article, although a representative said new ratings on the sector would be issued this spring. When it takes that step, ESG investors are sure to take notice, given the dominance ISS has with institutional investors.

At Bloomberg, the news and financial data company that many investors point to as a source for a broad range of ESG investing information, representatives offered information on ESG investing in general, but not ESG practices specifically within the home building industry.

And at MSCI, another large data provider that maintains several ESG-oriented stock indices, a representative said it could provide information on REITs, but not single-family builders.

ROAD BLOCKS
If ESG really is one of the fastest-growing sectors of investing, and home builders seem uniquely positioned to meet a growing number of ESG criteria, what gives?

“I’m sure the home builders are absolutely spot on when they say their investors aren’t asking about ESG,” says Adams, the sustainable real estate fund CEO. “But that’s because the questions don’t come in the form of ESG. Instead, they’ll just look at board membership, which is public information anyway, and say, ‘Oh, you don’t have any women or minorities on your board? Next.’ So, they just look at your disclosures, and don’t tell you that they’re asking.”

Andy Hill, president of Naples, Fla.-based Andrew Hill Investment Advisors Inc., takes a similar approach. While he doesn’t currently hold any home builders in his portfolio, he says if he did, the first thing he would look at would be the public disclosures of litigation at the companies. Then, he would Google to see whether the companies were or have been involved in any contentious issues with environmental groups. The last step would be to look at what the companies actually say about themselves. “I don’t spend a lot of time on the sustainability reports,” Hill says. “I look at them, and they’re nice to have, but the first thing I look for is potential litigation, and then what I can find out on Google.”

And yet, while that overlap is plain to see, one of the barriers for single-family home builders comes in the form of the questions many of the ESG rating agencies use. For instance, at Meritage, Anderson says many of the ESG-oriented surveys he receives ask about Meritage’s corporate carbon footprint, but not the energy efficiency of the homes it builds. “Even though we’re building homes that use 50% less energy than required by code, we’re not getting credit for that,” Anderson says. “They’re more interested in whether we use certified sustainable lumber, which is also positive, but that doesn’t tell the whole story. I find that we often don’t fit in their boxes, which is another reason why we’ve decided to issue our own report around this topic.”

Viewed through that lens, then, home builders aren’t yet tuning in to the rise of ESG investing because ESG investors aren’t really aware of the ESG aspects of home building. That’s even true for a company like Meritage, Anderson says.

“If an investor was really interested, they can find 90% of what they need to be able to make an informed, ESG decision on whether to invest in our company from what’s on our website,” he says. “But frankly, that’s too much work. A lot of these investors just look at the ratings the agencies give. It’s much easier for them to go to the source and say, ‘OK, give me all the companies that score an A on your ESG evaluation.’ But if all that means is you get the 10% who responded, and the other 90% didn’t answer because the evaluator didn’t ask the right questions, that’s not very helpful.”

Thomas Hart, a zoning attorney and partner who represents home builders at Columbus, Ohio–based law firm Isaac Wiles, sees the disconnect between builders and ESG investors in his daily work, even though he knows the objectives of the two are often the same.

“If you are in the home building business today, you have to be focused on tight, energy-efficient construction. It’s the home builders and developers who are often promoting more compact development closer in, and green space in communities, which has a direct, positive impact on people’s quality of life when they have a shorter commute. But builders aren’t doing these things, frankly, because institutional investors are asking them to. They’re doing them because that’s what the customers today want.”

From that perspective, Hart says home builders need to do a better job of highlighting the ESG characteristics that are already a part of their business. “Builders and developers clearly have more impact on how people actually live, and their quality-of-life issues, than actually gets talked about within the investment community,” Hart says. “More than anything else, it’s a communications challenge to reach institutional investors and make them aware of the efforts we’re already putting into our communities from an environmental and social perspective, while giving our customers what they want.”