Socially responsible investing is hot.
A report from global management consultant firm McKinsey & Co. finds that investment funds connected to some sort of environmental, social, or governance (ESG) screen now account for more than $22.89 trillion, or 26%, of assets under management globally. That’s up from 21.5% of assets in 2012, with ESG investing growing at more than 17% annually, according to the report.
ESG investing considers the policies and processes that publicly traded companies use to run their businesses, the impact their actions have on the environment and society, and whether there’s diversity among board members and corporate executives. The trend—largely viewed as an international investment niche in years past—isn’t just happening overseas anymore. While European investors still lead the world with an ESG allocation of more than 52%, 21.6% of U.S. assets are now allocated to sustainable investments, according to McKinsey.
ESG aspects of investing are becoming so prevalent that Larry Fink, CEO of BlackRock, the world’s largest asset manager with $6.28 trillion under management, issued what was viewed as a warning to CEOs in his annual letter earlier this year.
“Society is demanding that companies, both public and private, serve a social purpose,” Fink wrote. He called on companies to be part of the solution on a broad range of issues, including climate change.
“Your company’s strategy must articulate a path to achieve financial performance,” he wrote. “To sustain that performance, however, you must also understand the societal impact of your business as well as the ways that broad, structural trends—from slow wage growth to rising automation to climate change—affect your potential for growth.”
Institutional fund managers are bullish on ESG-friendly companies, and multifamily builders and developers are heeding the call, says Sam Adams, CEO and cofounder of Vert Asset Management, home of the Vert Global Sustainable Real Estate fund.
Adams holds recognizable multifamily stalwarts such as AvalonBay Communities and Equity Residential, as well as commercial standouts Boston Properties and Simon Property Group, in his top 10 holdings.
“Companies like AvalonBay and Equity Residential, when they do new projects, really focus on putting them in urban locations that are close to public transportation, services, and jobs. That helps with density, but it also helps with rents,” Adams says. “But on the other hand, for AvalonBay, we really took notice when they bid on a project in San Francisco and put in more affordable units than the required minimum. So what we’re trying to do with this fund is find the guys like AvalonBay and Equity Residential who are on the front foot with sustainability, not just because it looks good, but because it’s also good business.”
One multifamily operator and builder whose business is particularly good when viewed through the ESG investing lens is New York–based Jonathan Rose Cos., which works with cities and nonprofits to build green, affordable, and mixed-income housing, and owns more than 15,000 affordable units nationwide.
While the firm is a big mover in the “impact investing” space—which goes a step beyond ESG to focus on companies that are proactively pursuing positive change—its business is anything but touchy-feely. The company garnered attention last year when it bought Forest City Realty Trust’s affordable housing business for $500 million. That move seems particularly prescient now as the luxury apartment market’s star wanes and demand for affordable housing is on the rise, with nearly 19 million U.S. households paying more than 50% of their income for housing, according to the firm.
With those tailwinds at its back, Jonathan Rose Cos. recently closed a $233 million affordable housing preservation fund, the fourth of its kind at the firm, near the top end of its $150 million to $250 million range. It was able to attract around 125 institutions, including Deutsche Bank, the Ford Foundation, and an affiliate of Nuveen, according to The Wall Street Journal.
“We were really targeting institutional investors, investment advisers, leading impact investment managers, family offices, and high net–worth individuals who have both an impact lens and are focused on financial returns as well,” says Kristin Koch, director of investor relations at Jonathan Rose Cos. “They want to see both. They believe, as we do, that impact doesn't have to come at a cost to financial performance.”
Or, as Mike Arman, the firm’s CFO puts it, “There’s just a bigger bucket of capital than there was five years ago when it comes to impact investing. Certain investors who weren’t in the space five years ago have an entire department dedicated to impact investing today.”
Risk and Reward
Fund managers are increasingly tying their investment screens to ESG criteria, or using them to fine tune their investments to limit risk, as studies have shown companies that rate favorably on ESG screens are less prone to volatility. That’s because ESG, which is inherently focused on the processes companies use in their business, promotes best practices within firms themselves that often help them run more efficiently, or with a focus on their internal risk factors that they can then try to limit.
“It might not be a buy-the-stock, don’t-buy-the-stock decision, but ESG screening gives you a better risk analysis,” says Adams. “Think about companies that have a big carbon footprint. If there were to be a carbon tax down the road, that would impact the stock, and the company had better have a plan in place if that happens. So these big institutional fund managers are trying to use the data to limit volatility. One of my investors likes to say, ‘Instead of using a map to figure out our stock picks, now we’re using GPS.’ ”
Investors point to BP’s lagging safety record before the Deepwater Horizon catastrophe in 2010, and the more recent Volkswagen emissions scandal as events that ESG investors saw coming. ESG investor advocacy campaigns have also intersected with corporate policy changes, including Dunkin’ Donuts and McDonald’s responding to investor pressure to phase out Styrofoam cups starting this year, and the widespread focus on sustainably sourcing palm oil by large consumer products companies such as Colgate-Palmolive.
Companies that want to woo ESG and impact investors should be ready to listen to their views, even on specific elements of projects. For instance, at a recent meeting about an upcoming multifamily project designed by architect Carrier Johnson + CULTURE, an investor asked about unit depths in a particular building.
“The financial backer wanted to make sure the unit plans weren’t too deep, which would result in decreased sunlight to the units,” says Kyle Peterson, director of the firm’s L.A. office. “Socially conscious investors are affecting how developers approach projects from all aspects and scales, not just publicly traded companies. This includes the analysis of projects from a variety of spectra such as human well-being, sustainability, and general creature comforts.”
And while investors used to sacrifice returns in order to invest their conscience, that’s no longer necessarily the case.
“Interestingly enough, studies show that ESG investing, done right, actually helps the financial bottom line, too,” says Shel Horowitz, president of Hadley, Mass.–based consultancy Going Beyond Sustainability. “In home building, that makes particular sense, because a good ESG profile will lower costs for energy, materials, and transportation while increasing buyer loyalty and decreasing price sensitivity.”
It also gives investors a methodology to judge home builders on that they may have overlooked in the past.
“From an investment perspective, a lot of the ESG discipline keeps you out of trouble,” says Andy Hill, president of Naples, Fla.–based Andrew Hill Investment Advisors, a dedicated ESG investment firm. “So, it’s a risk reduction strategy, but by limiting those losses, it’s also a way to put yourself in a position to enjoy superior gains.”