Real estate investment is being reshaped by environmental and social concerns, finds new whitepaper

Real estate seafront

Real estate fund managers and investors are squaring up to tackle twin threats of climate change and an affordability crisis in housing, which they say could create sea change in the real estate investment world, according to a new whitepaper by SEI.

Fund managers see climate change as a major potential threat, with investors having traditionally focused much of their attention on coastal areas that are vulnerable to rising sea levels. 

“You better start thinking about that ‘thousand-year flood’ happening twice in 10 years. Natural disasters that might have been historically rare are becoming regular due to climate conditions. We think about that every time we evaluate a portfolio or single investment,” says Pat Jackson of Sabal Capital.

Joe Lubeck, CEO of American Landmark agrees, saying that his firm is “very cautious about coastal investments and we don’t do waterfront investments at all, mostly due to insurance”.

Overall, 42 per cent of real estate investors see climate change as a “net opportunity” rather than a threat, compared with only 21 per cent of fund managers. Investors’ optimism centred around enhancing properties with environmentally friendly materials and technologies. 

New ventures include “passive houses”, such as the one Sound Mark Partners has recently financed in Hoboken, which are ultra-efficient buildings with very low requirements for heating or cooling. This brings down the carbon footprint but also improves the value proposition for owners and renters. 

“Climate change and housing affordability are not disconnected. You can mitigate both issues through greater density of housing in less vulnerable areas,” says Oscar Vasquez, COO of Encore Capital Management.

Tech hubs like San Francisco are now commanding prices of USD1,000 for one square foot of living space, and in London, a 60 square metre apartment costs the equivalent of 14 years’ salary. A demographic shift is adding a strain, as the ageing baby boomer generation chooses increasingly to retire ‘in place’ as opposed to selling up and moving into assisted living.

Approximately half of all investors in North America and Europe see significant potential in real estate projects that address the need for more affordable housing. Ventures to address this problem include projects to build homes out of shipping containers, as well as more promising 3D printed homes.

“We see a huge affordability crisis in America, which really can only be solved by creating more housing,” continues Vasquez. “In the US, we’re at approximately a 64 per cent homeownership rate. We can talk about policies, tax credits, opportunity zones, but at the end of the day, more housing needs to be built. We produce pretty much the same level of housing that we did back when the US had about 80 million fewer people.” 

Fund managers are ramping up efforts to tackle social and environmental problems in housing, with 56 per cent saying they have turned away otherwise attractive investments on ESG grounds. That figure rises to 69 per cent of managers based in Europe, compared to only 51 per cent of North American firms. 

But Lubeck says affordable housing is not always easy: “Our concern continues to be with being able to make a reasonable profit at every turn of our investment while at the same time delivering affordable and high-quality products to our residents. There’s a lot of new construction in the apartment world, but it’s almost all high end.” 

Construction and development costs are going up, meaning that landlords are charging higher rents. Moreover, wage stagnation means the average worker’s ability to pay those rents is limited.

“The result is investors end up sinking money into Class A projects like luxury condos because there’s more slack in that demographic’s budget and an investor can charge enough to make their money back,” notes Lubeck.

Governments in states such as California have attempted to impose rent controls, but this has inadvertently worsened the problem as landlords hike rents in anticipation of new regulations. Restrictions on housing density further prevent developers from building enough to satisfy demand.

The future for real-estate investors is shifting away from the big cities, and towards secondary cities and suburbs, as many grow wary of high rents in city-centres. Sound Mark Partners finances Class A projects in secondary markets, with CEO Jenna Gerstenlauer explaining that they have found “investors favour these sorts of projects over luxury condos priced at the top of the market that might not be able to command the same rents in a downturn”.

Vasquez chooses instead to invest “in places near job centres but not too near to be unaffordable”. “We invest in the suburbs and exurbs. The people living there are working in the hospitals, the schools, the businesses and governments in the surrounding suburbs. The wealth gap and affordability crisis has forced us farther outside central business districts, but not driven us to entirely new markets or geographies.”

SEI interviewed 117 fund managers and 60 institutional investors in the fourth quarter of 2019 and the first quarter of 2020, for a new whitepaper, 'The future of real estate investing'. Download the paper here.