Philip Nell, head of UK real return assets at LaSalle Investment Management, writes about impact investing in real estate. Part two of Why every real estate investor will become an impact investor.
As in other countries, affordable and social housing is the largest and most liquid impact sector in the UK. It also faces a chronic supply-demand mismatch that dates back to the introduction of Right to Buy, the government policy that permitted social housing tenants to buy their homes from the state at discounted prices, in the 1980s.
In December 2020, over 1.1 million households were on the waiting list for social housing in England alone, with many of those living in unsanitary or overcrowded conditions or listed as homeless.
Even the most radical solutions, such as exponential growth in construction activity or an overhaul of regulation and taxation, would take many years to reverse the inherent imbalances in the sector. A years-long period where demand for both social and affordable housing will continue to far outstrip supply is a window of opportunity for core real estate investors to provide the private funding required to build affordable homes, backstopped by an effective certainty of demand.
Another significant opportunity exists within the overlapping area between housing and healthcare, in providing assisted living and care home facilities. Clearly the sector has been negatively impacted by the pandemic. However, new-build facilities and those not fixated solely on short-term profit margins have performed significantly better in terms of residents’ health and wellbeing.
More fundamentally, the inevitable logic of demographic change demands a huge increase in specialised real estate that can accommodate an ageing population, more active lifestyles and disparities in couples’ needs, such as ‘extra care’ schemes that offer independent living with centralised care. The supply of employees, historically a major challenge for retirement facilities, may also improve post-pandemic, due to increased appreciation of and government support for caring professions.
The healthcare sector offers other options for impact investors, such as primary (eg. GP clinics, medical offices) and secondary (hospital) facilities. These assets are extremely creditworthy and traditionally have long lease terms, though this is somewhat offset by their limited alternative use options and reliance on public sector spending that can fluctuate according to economic conditions. Nonetheless, it remains another compelling opportunity set, particularly alongside or in conjunction with centres of excellence in life sciences, which combine exposure to healthcare and education – the third key sector of the impact market.
Something which unites all three sectors is not just the strength of demand, but the sheer volumes of publicly available data to demonstrate and corroborate it, especially compared to traditional commercial real estate. Rather than having to assess the economic value of a unit to a retailer, which is currently almost impossible, you can look at the social housing waiting list, or levels of local authority expenditure on adult social care, or the number of working adults in need of retraining. Being able to more accurately quantify the level of demand for an asset only serves to further derisk the investment.
The political realities of a post-Covid world suggest that an inflow of private capital and intensifying competition between impact investors need not necessarily inflate asset prices, weaken investment terms and degrade the attractive risk-return proposition currently on offer across these sectors. The fiscal strain of governments’ emergency pandemic responses raises the prospect of an impending retrenchment in public funding. Such a future shortfall in housing, health and education spending would imbue impact capital with the kind of scarcity value that can be a necessary condition for a successful financial investment.
Minimising downside risk
There are some risk factors to manage. Impact’s defining features of intentionality and additionality – i.e. actively creating a positive impact beyond what would otherwise have occurred – often requires investors to commit to higher levels of development. New-builds are typically better suited to addressing supply imbalances and securing social benefits and, from an environmental perspective, development can deliver best-in-class assets with significantly lower operational carbon.
This can be regarded as a riskier form of property investment. But there are possible mitigants, such as undertaking forward funding on developments with committed tenants and working alongside experienced development partners. Investing in and retrofitting existing assets does also retain a role within impact – one which will become increasingly important, once the real estate industry has picked the lower-hanging fruit on its journey towards net-zero carbon.
Similarly, on the tenant side of the equation, the nature of impact investing means some leases may fall below investment-grade from a credit perspective. However, this can be insured against at a portfolio level, by letting assets to government or quasi-governmental tenants. And these investments will be concentrated in historically stable sectors: performance data from the MSCI UK universe marks out the Healthcare and Residential Non-Market Lets indices as generating significantly less volatile returns than the wider market.
Real estate impacting investing is at an important juncture. Recessionary environments typically drive a flight to safety, rather than prompting investors to diversify into new strategies that carry inherent operational risks. But the combination of a shift in attitudes in response to a once-in-a-century pandemic, compelling fundamentals and an imminent tipping point in cost of capital, as a critical mass of institutions make the shift, is set to usher in a new consensus around impact.
Most real estate investors have had exposure to impact investments in the past and will continue to devote more and more resources to, at the very least, minimising the negative impact of their portfolio.
The difference post-Covid is that every real estate manager will encounter powerful incentives to evolve into a fully-fledged impact investor, especially in the fields of in homes, health and learning. The combination of strong financial returns and positive societal outcomes on offer from this kind of diversified, flexible approach, which reduces sector risk and operator concentration, is simply too attractive to turn down.
Read part one here: Why every real estate investor will become an impact investor
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