Can Proptech ESG Firms Thrive Amid Hybrid Work?
Office owners leaned into them when it looked like a fuller return to office was in order
It’s a double whammy for office landlords. Return to office is slower than expected in many markets, leaving high vacancy rates stubbornly in place. At the same time, state and municipal deadlines for cutting carbon emissions from buildings draw ever nearer.
Nevertheless, that daunting scenario should not lead even the most cost-conscious real estate office owners to curtail plans to retrofit their buildings with technologies such as exterior building cladding, smart windows, thermal heating, and enhanced air-filtration systems, say proptech entrepreneurs and venture capitalists servicing owners’ environmental, social and corporate governance (ESG) demands.
“The current environment is absolutely challenging, no question about it,” said Anas Al Kassas, founder, CEO and CTO of Inovues, a Houston-based facade and window replacement technology startup. “Rising interest rates to low occupancy rates is impacting everything.”
Despite these challenges, owners face a carrot-and-stick set of reasons to make ESG retrofits, said Al Kassas. One form of the stick comes from mandates like New York City’s Local Law 97, which will start penalizing noncompliant landlords in January 2024.
“We still have a lot of clients that are evaluating retrofits, like what’s the measure that is going to deliver the most bang for the buck, the most energy savings, the highest impact on carbon emissions, and things like that,” said Al Kassas. “So instead of looking at 10 measures, you’re looking at the top two or three with the fastest payback.”
That’s because even the carrots to incentivize retrofit measures, such as Con Edison and other utilities offering generous incentives of up to 30 percent of total project cost, won’t last forever. “You have a three-year tranche, and sometimes measures in the next tranche are not going to be covered, so this creates urgency for these kinds of retrofits,” Al Kassas said.
Similarly, the federal Inflation Reduction Act offers carbon-reduction tax incentives.That’s “creating a path for existing buildings to be more efficient and get up to $5 a square foot of building area, so this is also huge,” Al Kassas added.
Venture capitalists such as Heather Widman, partner at Building Ventures, an early-mid-stage real estate technology firm, agree that momentum for ESG improvements is not flagging.
“Certainly, the pressures on owners related to return to work are very real, but from what we’re seeing, we feel like the other pressures are greater: from capital markets, from attracting and retaining the tenants that are going to come back — the best, most attractive tenants — as well as from the regulatory vector …,” said Widman. “We don’t think owners are going to want to take that tax, as well as the hit they might be taking on renewing some leases. So the smartest will not pull back on retrofitting, and even those that don’t will pay a heftier price than they’re paying right now. And our deal flow and teams aren’t slowing down.”
Although Building Ventures is not currently raising a fund, it sees continued enthusiasm among LPs for its investments in ESG-related startups, said Widman.
“We were definitely lucky in our timing of raising our second fund [in September 2022], but over the course of that fundraise, I think we were uniquely attractive to many investors because of our focus on decarbonization and an ESG,” she said. “I think that was one of our attractive value propositions. While we have many investors from across the industry, many of them are leaders who are pulling our industry forward and adopting practices like this for their own organizations. So we do have some self-selection there.”
Finding quality ESG startups has not been an issue, she added.
“The best and brightest entrepreneurs want to solve these problems and they’re still drawn to, ‘How do we make buildings better for people on the planet?’ ” Widman said. “Increasingly, it’s become our focus and the main piece of our own investment thesis. Of course, a good percentage of our portfolio falls squarely into the environmental piece, whether it’s energy efficiency, electrification, green materials, and such. But I don’t see us making any investments that don’t have a volume or value proposition that ties back to ESG in some way.”
Building Ventures’ ESG focus began early on with Measurabl, a sustainability data platform, and Canoa, a design platform and marketplace for purchasing of low-carbonization furniture and fixtures, as two of the firm’s investments, she said.
Jennifer Place, principal on the climate technology investment team at proptech venture capital firm Fifth Wall, said some landlords have changed their perceptions of ESG retrofitting.
“Overall, we’ve seen the real estate sector think about sustainability as a green premium or having no value,” said Place. “As we think about retrofits of the office space, sustainability and ESG has to be a meaningful part of any office strategy in terms of unlocking value and potential incremental cost-savings for office owners that are now pressured obviously by this dynamic environment on the return to office.”
Real estate’s global environmental impact also weighs heavily in the cost-benefit equation for owners and tenants, she noted. “As we think about the magnitude of the problem, taking buildings to net zero by 2050, it’s roughly $18 trillion that needs to be invested to get there. And, as we look at it, the technology available to us today isn’t halfway where it needs to be.”
Fifth Wall has been investing in a range of ESG-related startups, said Place.
“Runwise is a wireless control sensor network that’s in over 4,500 buildings now,” Place said. “It allows building operators to operate their heating systems better and has a payback within a year.
“Another area that we think needs to be a part of a return to office strategy is electric vehicle charging,” she added “Nobody wants to receive a customer that’s driven over an hour in their Tesla to your office to meet with you and have them feel stranded or like they don’t have a place to charge their vehicle. So we’ve invested in a company called Loop, which services that need.”
Such considerations seem to be sustaining the investment and growth into the ESG-related proptech startup world.
“It is a tough environment to raise funding now, especially with the recent bank failures like Silicon Valley Bank and all that,” said Inovues’ Al Kassas. “So it’s going to be a challenge. We’ve been raising a million, just a quick bridge note, and we have more than 50 percent of that filled over the past month. So there are investors that are still especially into climate tech, but it’s going to be challenging for a lot of software companies and startups in general.
“But, in climate tech, what we’ve been seeing is that there’s very strong momentum that has been building up over the past year, and there are investors looking to put money in what they’re seeing as a great opportunity for them because they can [invest in] a lot of startups and get a really favorable valuation in terms.”
“Opportunities are massive,” said Schwab. “The thing is that companies are hesitant to take a step forward and invest. This is something where we need more convincing. There’s a lot of uncertainty. If we don’t do ESG-related retrofits, these buildings completely lose their reason to exist.
“I was just in Europe for 10 days, visiting many customers there, and you have these Tier 1, 2 and 3 funds which invest in buildings and corporate real estate. Most of it today is attracted to Tier 1 because in Tier 1 you have tenants which have a long lease and so you have certainty that you can invest. The problem exists today with Tier 2 and Tier 3. And if we don’t do anything there, buildings are absolutely — in quotation marks — nonexistent. They have no reason to exist anymore, unfortunately. So we need to do something.”
Schwab also emphasized that immediate cost-saving from ESG retrofitting for owners should not be the only goal. Far more important is the need for industry leadership, and society, to continue to push for ESG initiatives as the world confronts potential climate catastrophe.
“If we are serious about what we’ve been putting out in society recently, then this actually needs to happen,” said Schwab. “Otherwise, this whole thing doesn’t make sense. Overall what we really need is leadership to make a change here because a lot of times in the industry, when things get tough, a lot of these projects get postponed.
“So we stop investing because everybody goes back to the core processes,” he added. “Overall this is not good because the biggest challenge for society is still, in my opinion, fighting climate change and reducing our energy consumption overall. We need to work together and provide leadership so that we don’t start, if times get tough like they are now, canceling these longer-term projects that have an impact down the road. And this also needs to be reflected in the evaluation of these companies.”
Philip Russo can be reached at firstname.lastname@example.org.