Historically, impact investing fund structures were often more akin to private equity funds. Whilst having strong impact credentials, these often struggled with liquidity, resulting in a high proportion of investors shying away from the investment opportunity.
With the impact fund sector now in excess of US$500bn according to the Global Impact Investing Network and a significant proportion of investors comfortable with the concept, double-digit growth is expected to continue.
Impact investing in real estate
Is there the same appetite for sustainable real estate investing as seen in other investment categories? The growth in membership of GRESB, the ESG benchmark for real estate, is one indication that sustainability is a mainstream consideration in this asset class – GRESB members now represent over US$22 trillion AUM, with fund coverage now exceeding 1,000 property companies. It’s fair to say that true impact-driven real estate investing is a newer concept than the consideration of sustainability within mainstream real estate, but the core fundamentals to drive demand and supply are all in place.
From an investment point of view, with low interest rates the real estate sector has been viewed as a way to diversify investment risk for life and pension fund portfolios. Longterm rental housing can act as a strong diversifier as it is less correlated to other more cyclical property asset classes. The various leasing models associated with affordable housing also offer inflation linking. The credit strength of the sector and inelastic demand, particularly through the global financial crisis, has helped reinforce the view of the sector as a credible source of diversification.
For investors who are seeking positive sustainability solutions alongside financial returns, real estate investment can have both important social and environmental benefits. On the social side, housing represents a key tool for cities looking to develop to cope with growing, transient and ageing populations that require employment and social infrastructure – housing, healthcare, education. And environmentally, the development and operation of housing presents the opportunity to drive longterm environmental change through forward-looking design that creates operationally efficient homes, reducing carbon footprints and enabling social benefits such as reduced fuel poverty. Credible impact investment in real estate demands that investors consider both these aspects.
Finally, the myth that for high-quality impact to be achieved, financial returns must either be a secondary factor or an additional consideration, have been shown to be false. Certainly, in terms of real estate, the provision of well governed, affordable housing solutions offers clear social benefits, along with the benefits that new housing stock offers in terms of operational efficiency for the owner and occupier, reducing costs and returning income back to the investor.
Why focus on affordable housing?
A lack of affordable housing is a global issue and not one exclusively seen in developing markets, with acute issues also common in property hotspots in Western Europe and North America. Whilst there is no single definition of affordable housing, generally the term captures a wide spectrum of housing options, varying from social rent, to intermediate rent, to first-time buyer schemes aimed at getting people on the property ladder. Affordable housing looks to support low to middle income households, such as vulnerable groups requiring housing subsidy, or key worker households that are ineligible for social housing, yet struggling to find an affordable solution in the mainstream private rental market.
The potential demand for this type of housing is huge. In the UK, the combination of a history of selling public housing to private owners, together with high population density, has led to chronic housing shortages, with affordable housing a key crunch point. There is a current estimated housing deficit of 380,000 new homes per year, with one study estimating that 133,500 of these should be either within social housing or intermediate rent schemes1. A second report found that around 25% of UK households are living in poverty and 56% of those households are in full time work2. Rent is generally the highest individual cost to tenants each month.
Affordable housing benefits not just those who live in these homes but also the community as a whole. A shortfall of affordable housing has a direct impact on the ability of employers to recruit. Key workers, for instance, are essential to a city’s prosperity – with the COVID-19 crisis a very present reminder of the importance of these workers for the functioning of society. However, this is a group that can quickly be priced out of all but the least desirable areas.
Why is institutional investment in affordable housing important?
In the UK market, legislative and tax changes have made private ‘buy-to-let’ schemes less attractive, leading to a professionalisation of the private rental market, with institutional investors stepping in to fill the gap.
This has some important advantages over the traditional UK model of individual private landlords, for both the tenants and for society:
- Having larger, commercial property management companies overseeing rental properties can offer a higher, more standardised level of service for tenants.
- Commercial property management companies are often able to offer longer tenancies, in contrast with private landlords where tenancies may be shorter, creating a lack of certainty for tenants. Longer tenancies allow individuals to integrate into the wider community and contribute more freely, with the knowledge that the area is their home and not just a stopgap building in which to reside.
- Efficiencies for the landlord will be reflected in the occupational costs to the tenants, meaning their rental payments are more affordable – which often leads to higher occupation rates, underpinning financial returns.
- Where new build is possible, there is an opportunity to design, build and operate new homes that will almost certainly have a better environmental profile than the majority of older housing stock. This not only improves the carbon intensity of the property stock, but can also support the development of modern construction technologies, stimulating new industry and the associated employment opportunities.
These benefits do not come automatically with the shift from private to institutional money – the right partnerships and management structures have to be in place to ensure that benefits to tenants, communities and the environment are realised.
Working in partnership
A further advantage that institutional investors have in entering this space is the existence of housing associations that can, if considered a good fit, partner with one or more institutions to assist in the allocation of capital and management of properties. There are several in the UK alone with long track records of successfully delivering affordable housing schemes. These organisations often have deep relationships with local authorities that can be leveraged in the development and sourcing stages.
For the investor, having the ability to partner with an association that offers a strong cultural fit is a huge benefit to achieving impact efficiently. These organisations are generally well governed and transparent. It is essential that strong governance structures are put in place to oversee the partnership and fund’s assets.
For the Housing Association, the partnership provides off balance sheet capital, enabling them to continue their social mission with less reliance on cross subsidy or grant funding models.
Being transparent, understanding the impact achieved by investment and being able to consistently measure it are core factors to ensure investors and wider stakeholders understand investments in this area. Accusations of ‘greenwashing’ can be extremely detrimental to the reputation of a fund and to the wider sector. It is therefore essential that thorough impact assessments are conducted and shared with investors. Impact in real estate cannot be reduced to a single metric. There are different aspects of impact which need to be recognised and measured, and any potential housing investment may be market-leading in some areas but only reaching minimum standards in others. For BMO’s UK Housing strategy, we use a scorecard to give us a rounded view, and act as a guide to assessing investment suitability – see Box.