Private Wealth, By Leila Boulton
September 9, 2015
In 2009, OpenPath Investments, a social impact real estate company based in San Rafael, Calif., took a unique approach to improving one of its portfolio properties, a 60-unit apartment complex in Provo, Utah. The firm launched a pilot program aimed at strengthening the social safety net for the low- and middle-income residents while incorporating sustainable practices into their lives. The “UrbanVillage” program, as it is now known, encourages residents to network and take an active role in their communities.
Despite being warned by another large-scale property manager that allowing residents a voice in how their communities were run would create “headaches for management,” OpenPath forged ahead. “To our shock and surprise, the residents came up with community gardens, movie nights, potluck dinners, hobby nights, reading clubs, workout groups and job-networking groups. It was fairly fantastic,” says Peter Slaugh, founder of OpenPath.
The experiment also benefited the firm and its investors. When the property was sold a few years later, the internal rate of return on the deal registered 20% compounded annually. “We had a buyer that loved what we were doing, embraced the UrbanVillage program and actually hired us as a third-party vendor to facilitate the program,” says Slaugh.
For affluent impact investors, socially and environmentally responsible real estate can be both personally rewarding and lucrative. Many private funds in this small but growing space are returning 15% or more annually.
“These funds have pretty compellingly attractive returns,” says Dave Hood,senior real assets strategist at Sonen Capital, a San Francisco-based firm that has over $350 million in assets dedicated to impact investing.
Impact investing in real estate is defined as “purchasing physical properties with the intention of earning a financial return through rental income and property value appreciation and/or, for social investors, achieving other social/environmental or socio-economic objectives,” according to “An Overview of Impact Investing” by Phillips Hager & North Investment Management, a division of RBC Global Asset Management. Funds in this space typically buy underperforming properties, then physically improve and manage them in ways that enhance their financial, environmental and social returns.
Not many publicly traded funds provide pure exposure to social and environmental impact real estate. “There’s a much more pervasive universe of choices on the private side,” says Hood, who previously oversaw a $9 billion portfolio of real estate, private equity and natural resources investments for the Stanford University Endowment Fund.
After the 2008 financial crisis, interest in real assets increased as a way to strengthen portfolios through diversification and downside protection. Generating income, a traditional hallmark of real estate investing, is also particularly attractive in today’s near-zero-interest-rate environment. In addition, real estate can act as a hedge against inflation. Since 2008, the contribution to global wealth from real assets has increased almost 5% per year; it is expected to continue to increase at about this rate annually, according to Sonen Capital’s 2014 report, “Real Assets Primer: Research and Thought Leadership on Impact Investing,” which cites research from Credit Suisse.
Just 3% of global impact assets under management are currently invested in real assets, including real estate, according to J.P. Morgan’s May report, “Eyes on the Horizon: The Impact Investor Survey.”
But impact-oriented real estate appears poised to take off, according to the 2014 report, “Impact Investing in Real Estate” by Ananda Ventures, a social impact asset manager with a European focus, and Impact in Motion, a think tank based in Germany. The report identifies six potential sectors for impact investments in real estate: environment and energy; agriculture and forestry; affordable housing; underserved communities; senior citizen housing; and a mix of other sectors, including education.
So far, only a small number of impact funds have entered the real estate market. Yet the report anticipates significant growth—driven by several factors:
- Impact funds seeking larger-scale, lower-risk investments and the chance to attract new types of investors, such as institutional clients.
- Investors pursuing diversification into vehicles that offer market-rate returns while producing social or environmental benefits.
- The availability of profitable niche investment opportunities, especially in underserved communities and affordable housing.
Hood says most of the affordable housing sector has been wholly or partially subsidized by governments for many years. Now, private, for-profit funds are entering the picture.
“There is a wealth of opportunity in affordable housing. We have also seen interesting investments in charter schools and in medical and assisted living facilities. But the best place for us to find that marriage of financial return and impact, both environmental and social, is in affordable housing,” says Hood.
Demand for housing by U.S. low- and middle-income renters is solid. Rising apartment rents and stagnant wages have created a serious need for renovating existing, less expensive complexes, as most new construction is aimed at high-income renters. “The supply of affordable housing is constrained. This makes the investment opportunity that much more compelling,” says Hood.
U.S.-based impact real estate players that invest in housing include the JP Morgan Urban Renaissance Property Fund, which promotes the development of affordable housing using “green” specifications, including solar heating and recycled building materials. The Goldman Sachs Urban Investment Group invests in companies owned by ethnic minorities and in developers of urban communities.
Other domestic funds include Parkmont Impact Investments Partnership, which invests in residential and commercial real estate in urban neighborhoods and town redevelopment centers in New York, New Jersey and Connecticut. The firm targets a 15% IRR while helping to build food markets, health-care facilities and fitness centers.
New York-based Jonathan Rose Companies recently partnered with TIAA-CREF to launch a fund that invests in greening affordable and mixed-income multifamily housing in the Washington, D.C.-to-Boston corridor, as well as in Chicago; Denver; Los Angeles; San Francisco; Portland, Ore.; and Seattle.Turner Impact Capital, launched last year and based in Santa Monica, Calif., invests in charter schools, worker housing and health-care facilities.
At least one REIT, Washington, D.C.-based Housing Partnership Equity Trust, operates in the U.S. The REIT is managed by the Housing Partnership Network, a collaboration of housing and community development nonprofits. Several investment banks and foundations have collectively provided $100 million to invest in modest-income multifamily properties across the country.
There are also opportunities abroad. London-based Bridges Ventures finances elder care homes, environmentally sustainable properties and affordable housing. Brussels-based KOIS INVEST has a fund that invests in affordable housing in Belgium, while Monterrey-based venture capital firm IGNIA finances affordable housing and health-care services in Mexico.
While social impact real estate is gaining in popularity with investors, so is eco-friendly real estate. Investment opportunities in the green segment of the real estate market are largely driven by global trends in demographics, urbanization and redevelopment, increasingly rigorous energy efficiency mandates for commercial and residential buildings and tenant demand for sustainable offices and homes.
“The free market is now concerned about green and socially responsible policies. Landlords have to serve their tenants,” says Paul Adornato, a research analyst at BMO Capital Markets.
While there are almost no pure-play green real estate funds, many real estate companies do report sustainability measures and energy-efficiency improvements. “Most of the REITs have some sort of green policy. It’s a normal way of doing business today. Their investors care and it’s a good way to save money,” says Adornato.
Last summer, two publicly traded commercial REITs raised $700 million to invest in green real estate development and retrofit projects. Regency Centers (NYSE: REG) and Vornado Realty Trust (NYSE:VNO) launched bond placements of $250 million and $450 million, respectively.
Impact investors concerned about mitigating carbon emissions and resultant climate change are investing in modifying buildings to decrease their energy use. Buildings account for about one-third of the world’s energy consumption and greenhouse gas emissions, according to a 2014 report from the United Nations Environment Programme Finance Initiative (UNEP FI) Property Working Group, “Unlocking the Energy Efficiency Retrofit Investment Opportunity.”
The estimated investment opportunity in energy-efficiency-commercial-building retrofits ranges from $231 billion to $300 billion per year globally by 2020, says the report. Investing in a 30% improvement in commercial building efficiency would result in an IRR of 28.6% over 10 years, according to UNEP FI.
Academic studies and UNEP FI data demonstrate that both commercial and residential eco-certified buildings provide investors with considerable advantages over comparable non-certified properties. “On average, statistical studies have found office rental price premiums for LEED or Energy Star certification of 3% to 6%, occupancy premiums of approximately 10%, and sales price premiums of 10% to 13%,” says an April report by the Rocky Mountain Institute, “How To Calculate And Present Deep Retrofit Value: A Guide For Investors.”
The long-term payback from lower energy and water bills can also be significant. Sustainable buildings generally cost 5% to 10% less to maintain than non-green buildings, notes a Rocky Mountain Institute report.
There are also a number of financial, insurance and tax breaks for going green. DSIRE, the Database of State Incentives for Renewables & Efficiency (dsireusa.org), provides a wealth of information on federal, state and local incentives for installing renewable energy systems and improving energy efficiency.
Fannie Mae’s Multifamily Green Initiative rewards multifamily properties that have a third-party green certification, such as by LEED or Energy Star, with a lower interest rate on loans. Fannie Mae multifamily lenders can grant building owners a 10-basis-point reduction in the interest rate of a refinancing or acquisition.
“Lower cost financing accrues to better returns at the tail end,” says Hood.
With impact investments, social and environmental factors often operate synergistically. And some real estate funds are actively working to increase these effects.
OpenPath, for example, buys “Class B” and “Class C” workforce housing apartment complexes in supply-constrained metropolitan areas that are underperforming in terms of occupancy and rent levels, then upgrades the individual units to improve their energy efficiency, enhances the common areas and establishes the UrbanVillage program. The firm invests in the Western states, including Oregon, Utah, Arizona, Texas and Colorado.
The UrbanVillage program and the firm’s foray into impact investing sprang from the financial crisis. “We stumbled into this space fairly accidentally back in ’08, ’09, when the market was really soft because jobs were super scarce. Tenants were suffering and barely making ends meet,” says Slaugh.
“I asked myself, ‘What can we do to improve our properties and make them a little bit happier places and a little bit more supportive to our residents?’ knowing that, if our residents are struggling, it’s going to flow all the way through to investors. We’re all inextricably connected in that regard,” he says.
One of the major socio-economic barriers for residents at low- and middle-income apartment complexes is isolation. “Everybody closes their door and disappears. We created a social program that focuses on getting residents to know one another, open those doors and start collaborating on projects,” says Slaugh.
Although he says the motivation for the first UrbanVillage program was simply to help residents weather hard economic times, after about nine months he noticed that the property’s cash flow was increasing—in a market where rents were flat to declining. “You could not raise rents, but with the more connected community, our turnover costs were way down. Our resident referrals were up. Residents were actually inviting their friends to come live at this place because things were happening and they were part of something,” he says.
OpenPath targets a total IRR of 14% to 16% for its investors, but has historically returned 18% to 20% or more. Distributions to investors come in the form of an 8% annual preferred return, plus 70% of the capital gain. The investment minimum is typically $50,000. Investors include high-net-worth individuals, family offices and institutions.
Slaugh says that asset classes serving millions of people, such as real estate, can be great vehicles for impact investing. There’s also room for social and environmental innovation. “We are looking at adding beehives, and perhaps chickens, to our properties to create a backyard-farming atmosphere,” he says.
“This is the fun stuff. We get to be as goofy as we want to and it translates to residents that are fully engaged, really inspired and excited to be at our properties.”
It Takes A Village
OpenPath Investments’ “UrbanVillage” program allows residents at each property to choose the particular activities they want to engage in. “This isn’t a policy mandate from the top down. A complex in Phoenix may have different needs than a complex in Portland (Ore.). We fund the ideas that the residents come up with,” says Gino Borges, director of impact at OpenPath.
Participation in the program is voluntary, but “residents are very much inclined to participate, if you just set the stage and provide some guiding principles,” says Peter Slaugh, founder of OpenPath.
Borges says the UrbanVillage concept unlocks the aggregate value of a community for the individual. “The upper class likes to talk about the power of networking. But there’s a lot of social capital in our communities. We have nearly 2,200 units and anticipate going to 4,000 units over the next two to three years,” says Borges.
Examples of the value of social interaction abound. At one of the firm’s properties in Phoenix, an unemployed electrician was told about a potential job opening by another resident while both were attending an UrbanVillage event. “That opportunity doesn’t happen if people are just sharing apartment walls but not connecting,” says Borges.
A resident at another property in Arizona, a single mother on financial aid with a young son, was employed to help market the complex. The woman’s other son died two years ago and she’s been understandably depressed. “Here’s a woman who’s been struggling for a long time. All we did was give her some responsibility and she’s completely risen to the occasion,” says Slaugh.
At the firm’s newest property in Colorado Springs, Colo., the engineer responsible for renovations suggested using the giant flat-screen TV in the clubhouse to connect the residents, via Skype, with their relatives deployed overseas. About 40% of the units are occupied by military families because of the complex’s proximity to the U.S. Air Force Academy and the North American Aerospace Defense Command (NORAD). “We do a once-a-month check-in with the guys and gals that are serving abroad. That’s an example of how we mold to the complexion of our resident base and address their needs,” says Slaugh.
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