Institutional investors the world over are increasingly demanding more than just financial returns from real estate investments, due in part to changing governmental policies.
The growing focus on socially responsible investments, or ethical investing, has prompted several mainstream investment managers to set up real estate impact investment funds. The latest example is Los Angeles-headquartered CBRE Global Investors, which earlier this month announced a £250 million ($324 million; €319 million) first close on its CBRE UK Affordable Housing Fund – an open-ended real estate vehicle focused on providing affordable housing in the UK. The fund targets a 6 percent total return, according to CBRE GI’s head of UK funds Hannah Marshall.
This trend has fast been gaining ground. The UK has seen a rise in the number of pensions looking to invest in such strategies over the last two to three years, according to Karen Shackleton, director at Pensions for Purpose, an industry organization seeking to raise awareness about impact investments for pension funds.
In the US, meanwhile, sustainable, responsible and impact investing (SRI) assets grew by as much as 38 percent from 2016 to 2018. This is according to the Washington, DC-based membership association US SIF Foundation’s 2018 report, which found that SRI assets now account for $12 trillion of the $46.6 trillion in assets under professional management in the US.
The drive toward impact
The New York State Common Retirement Fund recently committed $50 million to Irvine-based Avanath Capital Management’s third affordable housing fund, Avanath Affordable Housing III, which closed on $338 million in January 2018, according to PERE data. Affordable housing is also one of the initial focus areas for the Ford Foundation’s $1 billion mission-related investment (MRI) portfolio. To date, the New York-based organization has committed $70 million to five managers in order to further its goals in affordable housing.
“As a social justice philanthropy seeking to reduce inequality, we need to leverage the power of all of our assets, including our endowment,” a spokesman from the Ford Foundation told PERE.
Policy changes, like the 2015 Paris Climate Accord, have been a key driver behind the push towards more socially responsible investments. Impact investment vehicles build on ESG principles, which encourage the consideration of environmental, social and governance factors when screening potential deals. However, impact investing differentiates itself by going one step further and establishing goals directly linked to the fund’s investment strategy. These can include aiming for measurable reductions in carbon emissions, creating jobs in the community or providing affordable housing units for lower-income groups.
When the US ultimately pulled out of the Paris Climate Accord in 2017, some institutional investors in the US took it upon themselves to uphold a promise to protect the environment, according to Lisa Woods, managing director at KPMG’s tax practice and member of KPMG’s Global Impact Investment Institute.
The California Public Employees’ Retirement System, for instance, announced in a press release that it will continue to support the Paris Agreement “because it makes financial sense.” The pension fund also joined the Global Climate 100 initiative, which looks to meet the Paris Accord’s target of reducing emissions by 80 percent by 2050.
Bumps in the road
Given that impact investing is still at a relatively nascent stage, there are still several barriers facing institutional investors. These include lack of knowledge on the subject, lack of data related to the risk-reward profile of impact investments versus traditional strategies, concerns about scalability and reputation risk, Shackleton explained.
The financial benefits of impact investing are not clear cut yet either. Like conventional funds, the key to success in impact investing boils down to fund selection because the distribution of individual fund returns varies widely, according to a 2017 report by the Global Impact Investing Network and Boston-based portfolio manager Cambridge Associates. The study, which analyzed the financial performance of 20 real estate impact investing funds and 616 conventional real estate funds with vintage years ranging from 2004 to 2014, found that real estate impact investing vehicles provided better downside protection but limited upside compared to conventional funds.
Real estate impact funds reported a pooled net internal rate of return of 0.8 percent, compared to the 4.9 percent net IRR reported by conventional funds. But as the study noted, IRRs for impact funds were dragged down by the poor performance of a few large vehicles. On the other hand, impact investment funds with less than $50 million in assets under management returned a 10.2 percent pooled IRR, compared to 6.3 percent for conventional funds of the same size.
Then there is also the issue of determining the appropriate percentage of an investor’s overall portfolio to be allocated to impact investments and the department overseeing these commitments. Around half of Pensions for Purpose members, for instance, invest using capital set aside for the purpose of pure impact investments. The other half commit to impact investment funds using capital dedicated to a specific asset class like real estate, according to Shackleton. In the case of the Ford Foundation, its endowment has spoken of plans to commit up to $1 billion specifically to impact investing over the next 10 years.
Los Angeles-based real estate developer and owner Rising Realty Partners targets zero-net-energy assets, and it partners with local charities to drive tenant demand. Founder and president Christopher Rising says the firm has found that some pension funds separate their impact investment and real estate investment teams. As such, meeting solely with impact investment teams that may not always understand the ins-and-outs of real estate can be a challenge for the investment manager, he said.
As investors continue to seek more ways to combine philanthropy and finance, the onus is on investment managers to create a more institutionally accessible and financially rewarding impact investing market.