Impact investing is the nexus between achieving competitive investment returns, and positive social and environmental outcomes; goals that in the past were often seen to be in opposition. Lisa Davis, PGIM Real Estate’s recently appointed executive director of impact investing, explains how that perception is changing as investors increasingly understand that achieving a positive impact can also drive returns.
PERE: We hear a lot more about impact investing these days. What is driving progress in this area?
Lisa Davis: Investor demand is a key factor. As a more diverse group of individuals, including women and the next generation, gain increasing input into investment decisions, they bring a greater desire to achieve a positive impact with their investments, not just their philanthropy. Investing reflects their values in many ways – shareholder activism, consumer choices and impact investing. This drives additional flows of capital, innovation and more accountability across the financial sector.
PERE: What real estate markets and assets present attractive opportunities for impact investing right now and why?
LD:Real estate has a profound impact on people’s lives and the environment. At this point in the cycle, we are paying close attention to investment strategies that are defensive and less correlated, and to opportunities that create value by investing outside core markets and the highest value locations. Multifamily affordable housing can be defensive and undervalued. It’s generally more resilient to economic shocks than other real estate sectors and its shortage means it has extremely low vacancy rates and sticky tenancy. Almost half of all renters in the US pay more than 50 percent of their income toward housing costs and rents are rising faster than incomes in most markets.
At the same time, institutional capital has a much lower penetration in the sector, particularly in the ‘naturally affordable’ Class B and C apartments. This indicates there may be some mispricing and an opportunity to improve net operating income through scale, capital investments and high-quality property management. Many investors feel margins are thin and costs are high, particularly in core locations in gateway markets.
Investing in non-core areas that have been out of favor with investors in the recent past is one way to create value. Select non-gateway markets are good value, particularly secondary markets experiencing growth and that are more affordable than coastal markets. This is where we can create a high impact by focusing on community needs, bringing essential community services and amenities, and enhancing the community experience in locations that have been lacking new investment.
These developments seek to transform both the property and the community, and to catalyze additional investment. We work with operators and partners aligned with this mission, that have deep local connections and a demonstrable track record in sourcing public finance to create value and find opportunities that may be otherwise missed.
PERE: How do you create investment performance through impact investing?
LD:It starts from the same fundamentals that lead to profitability in other real estate investments: experience and judgment in selecting investment opportunities; management of execution, market and operational risk; a solid research foundation and insights into market fundamentals. Impact investing can also drive alpha through investing in property types and locations that are undervalued, using impact programing to enhance performance through improved tenant satisfaction and catalyzing additional investment in a neighborhood by thoughtfully addressing community needs.
“As a more diverse group of individuals, including women and the next generation, gain increasing input in investment decisions, they bring a greater desire to achieve a positive impact with their investments, not just their philanthropy”
Perhaps the most important aspect that sets apart strong impact investment managers in the real estate sector is effectiveness of execution. Research shows that diverse teams are more effective. When impact managers, properties and contractors have diverse organizations they can access and retain the best talent, reflect the communities they serve and be better positioned to capture the innovation that comes from diversity of thought. This leads to the best execution of impact strategies.
PERE: How do you measure and report performance from impact investing?
LD: Impact measurement is rapidly evolving and the range of measurement systems can be confusing, but it’s becoming increasingly standardized. Environmental impact standards at the asset level vary by region and property type, but there are sufficiently consistent frameworks that owners and investors can use as benchmarks, such as LEED and BREEM.
At the fund level, GRESB is an excellent tool for gathering and reporting performance. However, there is more variability in measuring social priorities. The Global Impact Investing Network’s IRIS metrics provide a comprehensive classification for measuring social outcomes at the asset level. UNPRI also asks helpful questions for setting and reporting fund-level policies and practices to achieve social outcomes. Although translating the UN Sustainable Development Goals into specific real estate practices is challenging, the industry is starting to adopt ways to connect investment decisions and management to SDG outcomes through frameworks such as the UN Environment Program’s Positive Impact Property Working Group.
Our impact measurement and management framework analyzes the social aspects of a property’s location to help inform the business plan for the asset. For example, we consider neighborhood school quality in the context of a regional average which, combined with data about the number of school-aged children in a property, can guide community managers in programming for children and youth, connections to transportation to alternative schools and resident turnover for families with children who are dissatisfied with nearby schools.
PERE: Is impact investing risky and, if so, how do you mitigate that?
LD: It can be inherently less risky. For example, affordable housing has a lower default rate and has experienced less cap-rate compression than other sectors, making it more resilient across market cycles. Transformative development also seeks to use public financing to serve in a top-loss capacity and to create momentum in development scenarios to protect it from credit tightening. Fundamentally, when you are providing for basic human needs such as stable housing and essential services, these investments may be less cyclical in the level of demand.
Many elements that create positive social and environmental impact also mitigate investment risk. For example, investing near new transit locations creates stronger returns than car-dependent locations. In the last downturn, walkable locations lost much less value than other locations.
Making a difference
Three best practice tips to track and measure impact investment performance
1. Set measurable or observable impact targets and consistently track and report against them.
2. Recognize that all impacts should be observable, but they may not always be measurable. The quality of community and social connections at a residential property may be hard to quantify, but are essential to quality of life, feelings of safety and tenant retention.
3. The real opportunity for enhancing returns – financial, social and environmental – lies in the analysis of key data to manage performance through constant learning and improvement.
PERE: What is the role of public policy and regulation in impact investing?
LD: Markets that provide impact investment opportunities generally require government and philanthropic support to build infrastructure and scale. Regulations, tax incentives, credit liquidity and subsidies help align investments with desired public goods. As markets mature, the nature of support may move from subsidy and regulatory requirements to incentives and consistent regulatory guidance.
State and local governments, along with the private sector, have come to see the affordable housing crisis as a threat to economic expansion and quality of life, and have stepped up to address it. This is evidenced by inclusionary zoning programs, which require private developers to dedicate a percentage of units for tenants below a certain income. Another example is the recently passed ‘Opportunity Zone’ program, which provides tax incentives for investing in areas requiring revitalization.
PERE: What is the ultimate goal in impact investing?
LD:The goal is that investors can invest for positive social and environmental impact across their portfolio, and that impact considerations factor into all their investment decisions. As the number of impact strategies grow and investors become more aware of their impact requirements, the real estate industry will increasingly understand its full impact on people and the environment and embrace the significant opportunities for positive change.
This article was sponsored by PGIM. It appeared in the Sustainable Investing special supplement that accompanied the October 2018 issue of PERE magazine.