Sophie van Oosterom, Wojciech Herchel and Mark Callender consider how ‘impact investing’ in social housing could help to reduce inequality
The UK has relatively high levels of economic and social inequality compared with neighbouring countries in Europe. Although this is not new, the COVID-19 pandemic further exposed and increased income, health and education inequalities. People on lower incomes were more likely to be in jobs for which it was impractical to work from home, they were more frequently on zero-hour contracts or furloughed, and their children were less able to access online education. While successive governments have aimed to reduce inequality through different initiatives, these are unlikely to succeed unless institutions invest alongside them.
When it comes to social impact investing, what do real estate investors need to consider and do in order to deliver a positive impact? Is social impact investing consistent with insurance companies’ strategies? And is there a trade-off between social impact investing and financial returns?
What is impact investing?
The term ‘impact investments’ is defined by the Global Impact Investing Network as “investments made with the intention to generate a positive, measurable social and environmental impact alongside a financial return”. A couple of points are worth emphasising. First, impact investing is not meant as charity, and it also does not inevitably mean that investors must accept a below-market return. Second, it is important that the environmental and/or social objectives are defined at the beginning of the investment (‘intent’) and that stakeholders are regularly updated on progress. The environmental and social objectives should not be an optional extra, bolted on once an asset has met its financial targets.
At Schroders Real Estate we have added two further tests to our impact investments. The first is ‘additionality’, by which we mean investing in assets that investors with purely financial targets would dismiss – for example creating new business space in a deprived area to support local start-ups and boost employment. If investors with purely financial targets are competing to buy the same building and will use it for the same purpose, then, in our view, the asset is not an impact investment.
Our second principle is ‘to do no (significant) harm’. That seems obvious, but is not as easy as it sounds. For example, an unintended consequence of some regeneration schemes could be that people with higher incomes move into the area and current residents are priced out. It is therefore important to adopt a place-based approach, engaging with local people and businesses, identifying their needs and making sure that they benefit from the investment. Regeneration should be done with local people, not to them.
Social impact investing, investment strategies and capital requirements
Impact investments are investments for which the return is driven by a combination of social impact and financial risk–returns optimisation. This might require a longer investment period for an investor to reap the full rewards. In addition, impact investment projects are likely to be more substantial than single-asset redevelopments, and could require larger-scale co-ordination among the investment to ensure optimal outcomes. Lastly, the risk profile of impact projects (volatility of outcomes) might be different compared to ‘normal’ investment projects.
We believe that these impact investment characteristics play to the advantage of insurance-led investors. The longer investment horizon provides a good match for liabilities, while the sustainable income and diversification of risk give insurers an opportunity to build more resilient portfolios.
Indeed, investments in sectors such as social and affordable housing, town-centre regeneration and build-to-rent have seen a strong flow of capital from insurers in recent years. For example, several large UK insurers, in a bid to contribute to the Build Britain Back Better programme, are providing long-term financing to housing associations. These associations use the funds to provide more affordable housing or to advance their environmental, social and governance agenda – for example by upgrading existing stock to meet the minimum EPC rating of C for all residential tenancies by 2028.
“Impact investments are investments for which the return is driven by a combination of social impact and financial risk–returns optimisation”
The effect on financial returns
Finally, we consider whether there is a trade-off between social impact investing and financial returns. The answer does not seem clear cut at first. Many projects, in hindsight, have yielded very strong financial returns while delivering a positive social impact; the regeneration of the Kings Cross area in London comes to mind. A quarter of a century ago, this was a deprived area with multiple social problems, but now, thanks to public and private investment, it is a thriving community. Early investors in the area have enjoyed strong returns, with prime office capital values in Kings Cross having risen by 200% since 2000, compared with a central London average of 125%.
While the build costs of social versus normal housing are roughly the same, rents on social and affordable housing are around 50% and 80% respectively of local market rents. New social and affordable housing may benefit from government grants, or from planning policies that reduce the cost of land, but these subsidies are unlikely to fully match the 15%–20% profit margin that developers typically earn from building new homes for sale. As such, social housing development is unlikely to yield similar financial returns to development of housing for market rent or sale.
However, a different picture emerges if we consider investing in existing social housing, rather than development. Figure 1 and Table 1 compare the capital growth on the MSCI UK Annual Index with data from Jones Lang LaSalle (JLL) on the capital growth of general needs social housing. While the series are not strictly comparable*, we can draw three broad conclusions.
First, taking the period since 2011, existing general-needs social housing has seen faster capital growth (3.4% per annum) than the average for existing UK investment real estate (2.6% per annum). Although JLL does not calculate income returns, net yields for general-needs social housing are around 4%, so it seems likely that annualised total returns during the past decade have been similar to the all-property average (7.6% per annum).
A second, more important point to make in today’s market is that general-needs social housing capital values have been more stable than those of other types of real estate. While it could be argued that this means general-needs social housing is less risky, we think volatility is a poor measure of risk, and that a fairer assessment is that it carries different risks. On one hand, the government’s commitment to pay the rent if residents cannot afford it means that social housing is more insulated from the economic cycle than other types of real estate.
On the other hand, the highly regulated nature of the sector means investors are more exposed to government policy changes.
Third, it follows from the above that general-needs social housing is less correlated with other types of real estate. As a result, adding this strategy to a real estate portfolio should lower the total risk and improve risk-adjusted returns for the total portfolio, due to the diversification benefits.
Lastly, the ongoing Solvency II reform in the UK is a chance to rewrite the capital rules and recognise that the aforementioned risk characteristics of the social infrastructure and real estate, particularly when income is government-backed, could qualify for lower capital requirement.
Investors should not automatically assume that assets aiming to deliver positive social impact will deliver a lower financial return than those which do not. While this may be true in some instances, the data on existing general-needs social housing suggest that it has performed in line with the UK real estate market during the past decade, and that adding it to a balanced portfolio would improve risk-adjusted returns. Looking ahead, we anticipate that, as impact investing grows and more data becomes available, we will find further assets that not only have a positive social impact, but also deliver superior financial returns.
*JLL’s data on social housing covers England and the national average is based on regional data that has been weighted to reflect the stock of social housing in each region. The MSCI data is for the UK and is unstructured by region, with a higher exposure to London. JLL’s capital values include provisions for future capital expenditure (for example better energy efficiency and remediation of unsafe cladding), whereas the MSCI capital growth series are adjusted for capital expenditure that has been incurred.
Sophie van Oosterom is global head of real estate at Schroders
Wojciech Herchel is head of insurance advisory EMEA at Schroders
Mark Callender is head of property research at Schroders
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