The bigger picture

Considering ESG issues can address social issues and generate healthy returns, says Jun Sakumoto of Avanath Capital Management

Impact investing, considered by some as the ‘evolution of philanthropy’, is quickly gaining momentum among institutional investors.

According to the Global Impact Investing Network 2016 Global Impact Investing Trends Survey, assets under management in the impact investment market increased by 18 percent between 2013 and 2015, and survey respondents reported an increase from $25.4 billion to $35.5 billion in impact investment allocations during this period.

There are several reasons that impact investing is emerging as an attractive niche opportunity for institutional investors. Firstly, there is a growing consensus that many societal issues, such as housing, healthcare and education, can be best addressed through private equity.

Impact investing serves as a market-based solution to fill the gap left behind by government-funded programmes and philanthropic organisations.

There is also an increasing acknowledgment that impact investments offer comparable risk-adjusted returns to traditional ventures.

In fact, more than half of respondents in the aforementioned survey reported that they are investing to achieve risk-adjusted returns, and are finding that impact investments consistently meet, and even exceed, financial expectations.

As a result, major institutions, including pension funds, endowments and foundations, are increasing their allocations to impact investment funds based on the understanding that positive social change need not be at the expense of financial returns. Rather, impact investing serves as a sustainable model for generating profit.

As investment strategies evolve to respond to market needs, investors are deploying more capital to underserved sectors.

One primary example of these allocations lies in affordable and workforce housing. Market fundamentals point to a prevailing need for quality affordable housing in the US.

On a national scale, more than a third of US households pay more than 30 percent of their income toward rents, and of this third, 16.5 percent of households are severely cost-burdened, meaning they are spending more than 50 percent of their income on rent.

The growing imbalance between supply and demand of affordable housing is placing enormous pressure on low-income families and communities. Spending as much as half of one’s income on rent is untenable in the long term, and detracts from other areas such as health, access to food, and education.

This gap in the market presents an opportunity for investors to capitalise on unmet demand by preserving and enhancing quality affordable housing in rent-burdened markets across the nation. While there is a definite need for new affordable product, there is an even deeper need to preserve the existing supply of affordable assets.

For example, according to a report, The State of the Nation’s Housing, from the Joint Center for Housing Studies at Harvard University, an estimated two million rent-controlled units will expire over the next decade, 64 percent of which are supported through the Low-Income Housing Tax Credit programme.

These units are at risk for redevelopment into expensive market-rate apartments.

Institutional investors recognise the shortage of affordable housing as a societal issue that can be addressed through private capital. By acquiring and repositioning existing affordable assets, investors can preserve the diminishing stock of affordable product for low-income families, while also achieving strong, consistent risk-adjusted returns.

Measuring social and financial impact

One of the primary challenges with impact investing is measuring and justifying impact. How does one measure social impact relative to financial return on investment?

The 2016 Institutional Real Estate Allocations Monitor report by Cornell University’s Baker Program and Hodes Weill & Associations found that the percentage of institutions that consider environmental, social and governance (ESG) principles in their investment decisions increased to 29 percent in 2016, up from 16 percent in 2015.

The actual implementation of ESG principles in portfolio and asset management is a critical factor that institutions are increasingly evaluating in their impact investments.

In the affordable housing sector, there are two primary areas of focus that deliver ESG impact while also positively impacting the bottom line.

The first is social programming. Through social services such as after-school programmes and financial literacy courses, multifamily owners can increase resident satisfaction and retention, which in turn minimises turnover.

Multifamily investors often underestimate the expenses associated with turnover, which undermines asset performance.

At Avanath, our affordable housing portfolio has an average resident turnover rate of 15 to 20 percent, while comparable market-rate properties generally have a much higher turnover of 50 to 70 percent.

From a financial perspective, a lower turnover rate improves operational efficiency and creates higher overall occupancy, thereby generating stable cash flow and attractive returns.

With regards to social impact, providing quality living environments that are also affordable contributes to the overall stability of a neighbourhood, and could have positive implications for society at large. Ancillary social benefits can include a reduction in crime, improved health, and higher quality of life for residents.

The second area of focus is sustainability. Social and financial impacts can also be measured in terms of sustainability initiatives that optimise water and energy efficiency.

By adhering to environmental principles, investors can reduce operating expenses associated with water and energy usage, boosting overall net operating income.

For example, at one of our affordable housing communities in Sacramento, California, we replaced 12,600 square feet of turf with drought-tolerant landscaping to achieve a 30 percent reduction in water usage. These water conservation efforts resulted in nearly $10,000 in annual savings, a significant long-term financial gain.

By integrating resident support services and sustainable practices, owners can yield significant, lasting environmental and social benefits.

In doing so, investors can enrich the quality of life for underserved communities while simultaneously generating strong risk-adjusted returns for themselves.

The bottom line

There is a growing understanding that there is both a profit and social impact to be made by preserving access to quality affordable housing for low-income families.

In 2017 and beyond, impact investing will continue to rise in prominence, primarily because the case is being proven that solving society’s biggest issues does deliver competitive returns.

The limited supply and virtually unlimited demand for affordable housing in the US creates a unique investment opportunity to respond to what the market needs, and to do so in a way that is both sustainable and profitable for institutional investors.

This growing demand means that quality affordable assets will always be nearly full, which translates to stable cash flow.

Across our national portfolio of 60 affordable and workforce properties totalling 7,000 units, our average occupancy rate is over 98 percent—an indication that property level renovations and social services can positively affect the performance of affordable assets.

Beyond the provision of deeply needed affordable housing, investors can restore and transform communities that have historically been underserved by institutional capital. Financial returns are simply an added reward to helping these communities thrive.
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