Publications

- August 1, 2017: Vol. 4, Number 8

Big Impact: Why impact investing is gaining traction among global investors

by Jun Sakumoto

Impact investing — the choice to make investments with a positive social impact — is gaining momentum among institutional investors. According to a 2016 Global Impact Investment Survey, assets under management in this sector increased from $25.4 billion in 2013 to $35.5 billion in 2015, indicating substantial growth and strong investor appetite for social impact investments.

Although the potential for making a social impact was a considerable driving factor in this increase, more than half of the investors surveyed noted they are investing for risk-adjusted, market-rate returns and are finding impact investments consistently meet, and even exceed, their financial expectations.

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

One societal challenge that has emerged as a key area of focus for many institutional investors is the need for affordable housing. Below are three reasons impact investing is gaining traction among institutional investors, and how these shifts are affecting the affordable-housing investment market.

ALIGNING PROFIT WITH SOCIAL IMPACT

Consensus is growing that some of the issues facing our society can be addressed and solved by the investment community. Impact investing serves as a market-based solution to fill in the gap left by government-funded programs and philanthropic organizations. This is especially true in the affordable-housing sector.

The State of the Nation’s Housing 2016 report by the Joint Center for Housing Studies of Harvard University found more than one-third of all U.S. households face cost burdens, meaning they are spending more than 30 percent of their income on rent. Of these households, 16.5 percent are severely cost-burdened and are allocating as much as half of their income to rent. In many coastal markets, where the cost of living is significantly higher than in other parts of the nation, more than half of all renter households are considered cost-burdened.

The growing imbalance between supply and demand of affordable housing continues to place enormous pressure on low-income families. Spending as much as half of one’s income on rent is unsustainable over the long term, and detracts from other areas such as healthcare, quality education and retirement savings.

While some corporations are investing in tax credits to assist in the development of new low-income housing tax credit (LIHTC) properties, there is an even greater need to preserve the existing supply of affordable product. As rent restrictions expire, the number of affordable units coming out of affordability is a growing concern and an area of opportunity for institutional investors.

The Joint Center for Housing Studies estimates 2 million rent-controlled units will expire over the next decade, 64 percent of which are supported through the LIHTC program. These units are at risk for redevelopment into market-rate apartments.

Institutional investors are beginning to recognize 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 access to affordable housing for low-income families, while also generating strong, stable cash flows and risk-adjusted returns. The opportunity to generate both profit and social returns, especially in the affordable-housing space, is driving increased investor appetite for impact investments.

NUMERICAL VALIDATION

One of the most prominent challenges impact investors once faced was measuring and justifying social impact. Today, more metrics are available, and greater transparency exists in the measuring of social impact relative to financial return on investment.

As the correlation between social impact and financial returns becomes more quantifiable, more investors are making the leap into this sector. A report by Cornell University found 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.

In the affordable-housing space, investments can be quantified in two key ways:

  1. High occupancies and low turnover: Social impact can be measured in terms of high occupancies and low turnover, both of which have a direct influence on the financial performance of an affordable-housing investment. Multifamily investors often underestimate the costs associated with turnover, which undermines asset performance. The average market-rate multifamily community has a turnover rate of 50 percent to 70 percent, resulting in greater vacancies and reduced cash flow. By contrast, many affordable portfolios maintain occupancy rates of 98 percent or higher, with minimal turnover. These factors improve operational efficiencies and generate more stable cash flows and risk-adjusted returns.
  2. Cost savings through sustainability initiatives: Social impact also can be measured in terms of sustainability initiatives that optimize water and energy efficiency. Implementing sustainable practices, such as water conservation measures, can reduce operating expenses, thereby improving overall net operating income. At an affordable-housing community in Sacramento, for example, more than 12,600 square feet of turf were replaced 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 return on investment.

By keeping turnover low and implementing sustainable measures, investors can yield tremendous environmental and social benefits while helping underserved communities. Impact investments provide a viable solution through which investors can simultaneously generate risk-adjusted returns and address some of society’s most prominent challenges.

DIVERSIFICATION AND MITIGATED RISK

Impact investing is one way institutional investors can diversify their portfolios with yield-generating assets that also are resilient with regard to economic pressures. This is especially true in the affordable-housing investment market. While market-rate housing is subject to fluctuations in the market, affordable and workforce housing provide consistent revenue, even during adverse economic conditions, making them relatively insulated from external factors, especially in rent-burdened markets. In fact, when the economy falters, occupancies and the need for affordable housing actually increase, making affordable-housing investments well-positioned to withstand economic downturns.

From a core real estate investment standpoint, impact investments offer a more stabilized source of revenue, as many of these underserved sectors face virtually unlimited demand, which translates to steady income and attractive yields to investors. Although affordable housing historically has been undeserved by private capital, there has been a renewed interest as market fundamentals point to a strong investment opportunity in this asset class. Demand for affordable housing continues to outpace supply, and demographic trends support future demand and growth in this sector.

THE BOTTOM LINE

Acknowledgment is growing that returns need not be sacrificed to advance social objectives. In addition to addressing societal issues such as housing, healthcare and education, impact investing is being proven to generate risk-adjusted returns comparable to traditional ventures. Looking ahead, the impact-investment market will continue to grow in prominence, as institutional investors continue to achieve positive bottom-line results from their impact investments.

 

Jun Sakumoto is COO of Avanath Capital Management.

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