While socially responsible investing (SRI) has become popular in the general investment community, it continues to be a relatively overlooked sector of the commercial mortgage market.
According to the Social Investment Forum, a Washington D.C.-based nonprofit organization, there is currently an estimated $2.3 trillion in investments in the U.S. that are deemed socially responsible, but almost none of that sum is going to real estate.
That contrasts sharply with the typical portfolio asset allocation, which would designate approximately 10% to real estate. This difference indicates the enormous potential for the socially responsible real estate sector: $230 billion.
Up to now, part of the challenge for many investors, like insurance companies and pension funds, has been the need to put a meaningful amount of money to work in a targeted area with an understanding of exactly what they are going to get.
Options meeting these needs have been limited, but things are beginning to change – with the advent of an increasing number of commercial real estate firms and funds dedicated to community development and SRI, as well as a growing awareness that social responsibility as it relates to commercial real estate investing does not mean sacrificing returns or quality.
There has long been one segment of the commercial real estate markets considered a socially responsible sector in which to invest, namely low-income housing tax credits (LIHTCs), which are usually funded with private debt and equity and generate a stream of tax benefits that investors use to offset their tax liabilities.
However, LIHTC investment vehicles are generally illiquid, have a holding period of 15 years, include cumbersome accounting practices and produce negative pre-tax impact.
Now, socially responsible commercial real estate is facing a huge fork in the road. Yes, affordable housing tax credits remain a bastion of the SRI industry, but now there are major debt and equity funds being raised to invest in community development, urban retail, green building and more.
These funds represent a new era for socially responsible real estate investing and what's more important, collectively, they offer much greater liquidity and diversification for socially responsible commercial real estate investors than options previously available.
Why, at long last, the growing acceptance of SRI in commercial real estate? Perhaps it is partly connected to the overall green movement in the U.S., which has seen people become increasingly concerned with the state of the environment and the plight of their fellow citizens.
CRE investment vehicles
What makes a community development investment? It could be something as simple as a loan guarantee for a small business in a lower-income area, but the horizon has widened greatly as real estate funds, banks and other real estate intermediaries have become more creative.
Examples of the various types of commercial real estate investments that might qualify as SRI include loans within enterprise zones, investment in military housing bonds, equity for redevelopment of inner-city retail and bridge loans on affordable housing.
And the list goes on, with a wide variety of property types and virtually any part of the capital structure potentially qualifying as socially responsible – from investments in first mortgages, mezzanine, bridge loans and commercial mortgage-backed securities (CMBS) to preferred equity, entity-level loans for real estate operating companies and pure equity.
In addition to allowing direct investments in the aforementioned assets, the commercial real estate industry has progressed to the point that there is now a variety of types of investment vehicles through which investors can partake in the various SRI investments.
For quite some time, LIHTC investment funds have been one option, some with assets state-specific and some diversified nationally. The funds are usually closed-end, meaning additional investment in the fund is closed off once a certain dollar benchmark is reached. In addition, these investment funds tend to be 15 years in length with fixed-rate returns, therefore subjecting investors to interest-rate risk on their investments.
A number of closed-end, private equity funds have also been developed. These funds often feature shorter time frames, around eight to 10 years. About half of that time frame encompasses the draw-down period of funds as investments are made and the remaining time representing the period till an exit strategy – such as the sale or refinancing of an asset – is achieved.
Some of the funds are focusing on new development or rehabilitation of various property types. Those equity funds tend to offer a first layer of return after the initial draw-down, with additional returns dependent on the performance of the assets.
Introduced to the market much more recently are open-ended, diversified investment funds that continually accept new funds, drawing down those funds almost immediately and deploying the capital across a national base, in a wide variety of property types and across the spectrum within the capital stack. These vehicles offer perhaps the most widely diversified SRI opportunities for commercial real estate yet, with a typical five-year time frame and floating rate returns.
The increasing number of investment vehicles available is an important factor in the growing interest in socially responsible real estate investing. Diversification across the parameters of geography, property type and asset type allows the SRI investor a highly noncorrelated fund with a broad base for social impact.
In summary, investing in socially responsible commercial real estate is an emerging market, but one whose time has come. As investors across the country look to broaden the diversification within their SRI portfolios, we can be sure that community investment and revitalization will play increasing roles in a variety of forms – and that firms and funds focused on socially responsible commercial real estate investments will multiply.
And with further exposure to the topic, we may get closer to the $230 billion that should rightly be focused on socially responsible investment opportunities right in our own backyards.
Neil Bo is a managing director at Pembrook Capital Management, a New York-based real estate investment management company that has created investments for community development, providing capital to underserved geographic locations and underserved property sectors. Bo can be reached at nbo@pembrookgroup.com or (646) 388-5906.
