Real estate has taken something of a back seat, relative to other asset classes, in the “impact” investing story to date. This is changing as an increasing number of real estate investment managers explicitly target social and environmental outcomes alongside financial ones. However, investing in this relatively immature sector isn’t without challenges.
The term impact investing is often used interchangeably with Environment, Social and Governance and Socially Responsible Investing, but the three terms each represent subtly distinct investment styles.
While ESG refers to the environmental, social and governance practices of an investment that may have a material impact on the performance of that investment, SRI goes one step further by actively eliminating or selecting investments according to specific ethical guidelines. In impact investing, positive outcomes are of utmost importance, meaning the investments need to have a positive impact in some way.
Globally, impact investing is still in its infancy as an investment trend, reminiscent of ESG ten years ago. Like ESG, it initially found traction in the equities sphere, where it might be viewed as a natural extension of “active ownership” or “engagement” strategies. In private markets, impact strategies are closely related to “thematic” investing, with segments such as renewable energy at the forefront. One can to a certain extent view the focus on impact investing as a reaction against “green washing” or “ESG-washing”: the application of an ESG label to a strategy lacking in ESG substance.
In real estate, the growth of impact strategies has lagged other asset classes such as private equity and private debt. This is despite the acute shortage of socially related real estate. A recent report by the European Commission and the European Association of Long Term Investors identified a social infrastructure spending gap of €140 billion (AU$221.13 billion) per year, of which 40 per cent was in social housing and 50 per cent in health care and long-term care.
Still, the asset class is growing, as illustrated by a recent bfinance search for an endowment that evaluated more than 20 dedicated real estate funds around the world that are focussing on opportunities in areas such as affordable housing, social housing, greening strategies (for example retrofitting) and urban regeneration. And there is increasing interest by investors with the 2019 INREV European real estate investor conference having dedicated sessions on “impact real estate”.
While most of the managers are relatively small, with less than US$500 million (AU$702.3 million) in assets under management, there are some larger funds focused on affordable housing in the US and parts of Europe. The fund universe is continuing to grow, with a significant number of real estate managers in the process of launching funds or separate accounts in this space, while others are actively considering doing so. There is also increasing interest in profiling overall real estate exposure in terms of its impact.
The trend has been spurred by the UN Sustainable Development Goals, which were formalised in 2015. Although not designed with investment in mind, the SDGs have gained traction among asset owners and managers. We now see impact-oriented real estate managers frequently measuring contribution to these goals.
Despite the new and expanding breadth of managers and strategies available to asset owners, this space carries a number of distinct challenges.
Many of these obstacles stem from immaturity. Most of the funds are still small in size, and/or run by relatively new managers (or even start-ups) without lengthy track records.
As such, investors should focus on the corporate context and assess the manager’s commitment to pursuing these strategies over the longer term. In addition, short track records make it important to examine the experience and personal track records of team members in generating both strong financial performance and impact.
Newer, smaller firms are also less likely to have jumped through the more conventional ESG hoops such as membership of the Principles for Responsible Investing (PRI): such tick-boxes should not be taken as indicators of a robust approach to ESG.
Given that the market is relatively immature, some investors find it more effective to implement separate managed accounts in order to access the desired strategy. Alternative routes include using a fund-of-funds or taking a direct approach, building the portfolio in-house.
More broadly, investors must grapple with the lack of agreement on how impact should be defined and what the appropriate measures of impact should be. This ambiguity can also produce cynicism over the potential for “impact-washing.”
It’s therefore crucial for investors, particularly boards and trustees, to agree on the types of impact that they should be seeking to achieve and how they intend to monitor and measure those outcomes. With many managers pursuing unique and somewhat esoteric strategies, the investor must bring clear objectives to cut through the noise.
Groups such as Global Impact Investing Network, Impacting Investing Project, Social Value Portal and Pensions for Purpose are providing valuable resources to educate investors on these issues.
There are additional challenges relating to political and reputational risks. While private investment in areas such as social care can evidently bring a social good, there are debates surrounding the extent to which financial investors – as opposed to governments or non-profits – should be involved.
Reputationally sensitive investors may fear incidents such as the Southern Cross Healthcare debacle in the UK, in which the care home group collapsed when it could no longer afford rents after a sale-and-leaseback program. Grants and tariffs may be vulnerable to the political climate.
For institutional investors exploring impact investing, sacrificing financial performance for the sake of non-financial benefit is not an option consistent with fiduciary responsibilities. The impact real estate sector, like other parts of the impact investing landscape, is dominated by players seeking risk-adjusted net returns that are equivalent to the non-impact segment.
At the same time, asset owner demand for these kinds of strategies will continue to be supported by fund members. This is well illustrated by the 2018 Pensions with Purpose study from ComRes, which showed 46 per cent of UK defined contribution pension holders believe their pensions should be invested in organisations that reflect their social and environmental views. Given the high level of support from millennials for impact investing, this is a trend that’s only likely to continue.
As asset managers respond to this movement, clear internal goals and stringent analysis of potential managers will be key to maximising returns and delivering on member expectations for meaningful impact.
Peter Hobbs is managing director, head of private markets, at bfinance.