Moral hazard: Landlords face new scrutiny about tenant mix

Socially conscious investors are scrutinizing tone-deaf tenants

Landlords who lease to ESG outcasts face new stigma
(iStock)

As the biggest landlord on the Las Vegas strip, Vici Properties guzzles up extraordinary amounts of electricity to power all those neon signs, slot machines and air conditioners in the middle of the desert 24 hours a day.

But while the company can point to energy reductions and carbon offsets at its casinos, it can’t erase its original sin: Vici’s tenant is vice. For some investors, that’s a problem.

Socially conscious investors are paying more attention to the kinds of companies to which real estate owners lease. A common way is to buy into funds that promise to make only socially responsible investments.

“More money is going into these kinds of funds, and there are strong mandates some have for screening for these kinds of issues,” said Rodolfo Araujo, a senior managing director at FTI Consulting who focuses on environmental, social and governance investing. ESG investors are increasingly requiring companies to show what they’re doing to make progress in areas of environmentalism and diversity.

Property owners that lease space to controversial businesses such as casinos, fossil fuel companies, gun makers and alcohol and tobacco companies, face increasing scrutiny from fund managers pressured by their investors to avoid businesses they consider immoral.

It’s not just Sin City landlords that can be viewed unfavorably. Property owners in places like Houston — home to the country’s fossil fuels industry — or areas of the country where defense contractors and weapons manufacturers congregate may soon find themselves having to defend the rectitude of their rent rolls.

The idea of screening out controversial companies isn’t new. Some pension plans and other investors sensitive to public pressures have excluded so-called “sin stocks” for decades, and the trend is becoming more established with institutional Wall Street investors. Now it’s moving onto real estate.

Standard & Poor’s, for example, put a new policy in place in October for ESG indices it launched in 2019. REITs earning a significant portion of their revenue from certain tenants are excluded from the index series.

“We started to get some feedback from market participants [whose] overall motivation was to bring the ESG REIT index more in line with ESG across the broader world of equities,” said S&P’s Michael Orzano, who helped design the index.

For now, at least, the new rule hasn’t had that big of an impact. The change affected just two out of the 256 companies in the indexes. But Orzano said that could change if stakeholders ask for more exclusions.

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Some property owners are setting prohibitions on themselves.

Amsterdam-based landlord Redevco, which focuses mainly on retail real estate in Europe, said last year that it will choose tenants responsibly when filling vacancies. The company said that it will avoid — whenever possible — leasing space to tenants or occupiers that are “inconsistent with the principles of human dignity.”

For landlords like Vici Properties, though, it can be impossible to get around the nature of its tenants’ business. The company got its start in 2017 when it was spun out from a subsidiary of the Caesars casino corporation to own the company’s real estate.

Vici expanded this year, announcing two deals to buy more than $20 billion worth of gaming real estate including 15 properties from MGM Resorts as well as the Venetian, Palazzo and Sands Expo & Convention Center.

A spokesperson for Vici declined to comment on the notion that some investors frown upon its tenants. She did point to Caesars’ latest ESG report, which makes more than 60 references to its responsible gaming platform without providing any specific details on what the program does.

MGM’s ESG report makes a passing mention to responsible gaming, mainly to note that it’s a low priority for stakeholders compared with issues such as climate change and workforce diversity.

In the end, certain companies trying to shine up their image for ESG investors may be like R.J. Reynolds positioning itself as a wellness enterprise.

FTI’s Araujo said he advises clients to own up to what they do and shift their focus to the ways they offset ESG risk, such as their environmental platforms. Trying to appease all the critics, he said, isn’t going to work out for the business itself.

“If you run a program based on an ESG score,” he said, “you’re going to end up failing.”