ESG is high on the agenda. What opportunities and challenges does it create for property investors?
Dana Gibson: Looking at real estate generally, there are strong tailwinds for the sector which is leading to more and more capital coming into it. For example, 60 per cent of the global population is expected to be urbanised by about 2030, the middle class is expanding globally, and data creation is estimated to grow five times over the next five to seven years. These tailwinds underpin our growth strategies, but that growth poses challenges to the industry and its participants. Thirty-five per cent of all global energy use comes from the built environment. Construction is carbon and resource intensive. The creation of greenhouse gases is parabolic and economic losses, both insured and uninsured, as a result of climate change are worrying. So, as an industry, we have some real questions to answer about how we responsibly house a global population and provide work environments in a responsible way. One of the opportunities in the broader focus on ESG as a general topic, aside from creating the right outcomes, is that it involves all the industry’s stakeholders. Investors and managers will have to engage with other stakeholders – the market (tenants and residents), communities and governments – to address these climate challenges and ensure assets are contributing positively to their communities. The most important goals are reducing carbon, both operational carbon and embodied carbon, and providing positive community engagement and social outcomes. Aside from this, there are also financial goals – more resilient buildings will be more operationally cost efficient, they will have longer life cycles reducing capital expenditure and they will be built for a longer occupancy for tenants/residents.
How are investors and managers integrating ESG into their strategies?
Erin Ledger-Beaupre: ESG is becoming a much greater focus for all real estate investors. When we did our original investment in the affordable housing space five years ago, it was part of the equation, but it wasn’t the biggest part of the equation. It was: “This investment makes sense from a risk-adjusted return basis with some ESG benefits as well, but more in the background.” That has changed now. ESG must be the first item on the checklist – or very high on the checklist – from an investment consideration perspective. There’s a greater focus on not just driving financial outcomes but driving them in a way that takes into account how we provide services to residents. So, for example, our affordable housing platform has a discussion every single time they look at rent reviews related to affordability levels for the residents. What is a reasonable increase that should be passed through? While rents might be 20 or 30 per cent below market and, in theory could be increased significantly, it is sought to be done in a way that takes into account what the tenants are going to be able to afford over the longer term. That affordability analysis is given deep consideration and factored into decision-making.
Dana Gibson: When it comes to ESG outcomes, it starts with data collection. Everyone has to know from where they are starting, and through the data collection process, measurable milestones and goals can be established. For example, at Macquarie Asset Management, we have committed to invest and manage our portfolio in line with global net zero emissions by 2040, ahead of Paris Agreement targets, so we’ve set that goal in our portfolios.
Affordable housing has a strong social element. What’s driving interest there?
Erin Ledger-Beaupre: This sector has a strong ‘social’ component as the need for residential, affordable housing is an increasing issue across the globe. We’re seeing interest from the institutional investor universe in this asset class, with demand growing even further during down market cycles, because people need to downsize or reduce their monthly payment. Based on a 2020 report by the National Low Income Housing Coalition, there is an absolute shortage of more than four million affordable rental homes in the US, driving tenant demand.
Dana Gibson: The great thing about the residential sector, from high mid-market to affordable, has been a relative lack of volatility compared to other sectors and its returns are highly correlated to inflation.
Do you think ESG goals are driving more investment into affordable housing?
Erin Ledger-Beaupre: There is a much greater focus by investors on ensuring affordable housing becomes a feature in their portfolio. They are not just looking for exposure to high-end luxury residential, where development has been historically. They are really providing residential products that span the demographic spectrum of the residents and the communities they serve.
Dana Gibson: We see many pension funds expanding their investing locally. They rightly see themselves as having responsibility to the communities in which their clients live and work.
How are investors addressing the affordable housing crisis across the globe?
Dana Gibson: I think it’s just through investing in the right assets that address the requirements investors have. As Erin said, a lot of the development has come into the luxury sector, but it obviously doesn’t address affordability and housing shortages in certain areas. You can produce similar potential outcomes in affordable housing as you can in the luxury segment. It comes down to capital allocation.
Erin Ledger-Beaupre: One of the things that we see as a challenge in the US is that the affordable housing stock declines over time, because it’s harder to develop new products. When class A apartments are 20 years old, they are class B apartments, so they become a more affordable product. But investors will tend to value-add the investment back to a class A product, instead of looking at it as a product with a price point for which there’s a true need in the residential marketplace. Investors can create value in the asset by improving the overall profile of the project, in a way that doesn’t replace the existing tenant base with new tenants, for example, by maintaining the project as an affordable housing product instead of trying to move it up to a luxury product.