Are ethical property funds a good investment?

by Jonathan Adams
ethical property funds

At the end of August, The Times newspaper reported on two real estate funds, Home Reit and Responsible Housing Reit, were seeking to raise £250 million each from City investment managers. The placings from both REITs to raise new capital to invest in expanding their property portfolios will probably be successful despite the fact Reits have recently struggled.

The two Reits in question aren’t, however, raising funds to invest in commercial or retail property assets, which is where the sector has recently suffered. Both Reits are marketed as ESG (environmental, social and governance standards) funds and invest in social housing. They rent accommodation, usually paid for by the state, to vulnerable people.

Home Reit floated on the London Stock Exchange last October and has since returned investors a solid 15.9%.

home reit plc

The fund renovates homes and small blocks of flats that are then rented by local authorities and charities to house local homeless people. It currently has a portfolio of 3800 beds rented out and aims to double that number with the new investment it is raising. Home Reit has already spent the £240 million last year’s IPO brought in plus another £80 million of debt.

It expects the new properties it has identified for renovation and rental, worth a combined £400 million, to generate a yield of around 6%.

Responsible Housing Reit doesn’t yet own any real estate assets but plans to build a portfolio of homes for the disabled and elderly it will both buy and renovate and build from scratch. To that end, an IPO the Reit hopes will raise £250 million in investment capital is planned for the end of this month.

The Reit is being run by Canadian Asset Manager BMO, which has appointed Guy Glover as its manager. He and his team will build and renovate properties to the specification of what care providers say they need most, which sounds like a new generation of sheltered housing properties.

He comments of the IPO and Reit’s intended activities:

“It’s really exciting to be able to appeal to more sustainable and ethical investors. But actually this is a product that appeals to mainstream investors as well. It’s about giving people independent living. Giving them their own front door is a really important part of what we want to achieve.”

What are ESG funds?

Both Reits are businesses and their reason to exist is, ultimately, to make money for their investors. But ESG funds have committed to making that money in an environmentally and socially sustainable and responsible way. The business model must take into consideration the needs of all stakeholders from investors, to customers and end users of a product or service. As well as meeting environmental sustainability criteria.

There is, however, no fixed definition of what funds marketing themselves as ESG must meet. This sometimes comes as a surprise to investors in ESG funds who haven’t read the fine print and discover their holdings include oil and gas companies and mining companies.

These sectors are not ruled out by all ESG funds. Some take the position that investing in such companies is within the scope of their investment strategy if they are committed to reducing their carbon footprint. Both Shell and BP, for example, are committed to becoming net zero emissions energy companies by 2050.

Some ESG funds have the investment philosophy that the most practically effective approach to meeting environmental goals is by investing in big energy companies that are publically committed to transforming themselves, and the energy economy, onto a carbon-neutral footing. The argument is that, practically, we need energy. And big energy companies need time and fossil fuel revenues to do so or it won’t happen.

ESG funds are also often referred to as ethical funds. However, ethics are personal and each individual investor must come to their own conclusions on which investments meet their ethical framework. Before investing in an ESG fund it is important to look at the companies it is invested in and understand the investment strategy which will inform future changes to holdings.

Not every ESG fund will necessarily be a match with your personal ethical framework. But many will so as long as you research funds you are considering there should be plenty of options, including ethical property funds.

Are ESG and ethical property funds higher risk or offer lower returns than industry averages?

Once upon a time, fund managers and private investors sometimes considered ESG and ethical investing as higher risk. However, that is no longer the case and many professional investors argue it is now higher risk to invest in funds and companies that do not have strong environmental, sustainability and governance standards.

With plenty of choice on the market now, there is no issue diversifying risk between a portfolio of ESG investments, including ethical property funds.

With the ESG funds sector now so broad it is difficult to make meaningful statements about returns, which vary significantly from one fund to another. However, there is now a growing body of evidence that investing in ESG funds does not in any way compromise potential investment returns. In fact, it may help them.

A recent S&P Global Market Intelligence report highlights that ESG funds outperformed the S&P 500 over the first year of the ongoing pandemic:

“In the first 12 months of the COVID-19 pandemic, many large investment funds with environmental, social and governance criteria outperformed the broader market. One fund went from being among the poorest performers to the top of the list following tweaks to its portfolio.”

“S&P Global Market Intelligence analyzed 26 ESG exchange-traded funds and mutual funds with more than $250 million in assets under management. We found that from March 5, 2020 — the month that the World Health Organization officially declared COVID-19 a pandemic — to March 5, 2021, 19 of those funds performed better than the S&P 500. Those outperformers rose between 27.3% and 55% over that period. In comparison, the S&P 500 increased 27.1%.”

Some analysts, however, see a risk on the horizon for ESG funds. Namely that the growth in number of ESG funds will see more capital chasing the same stocks with high ESG ratings, potentially inflating values to a point that impacts upon returns. Even if that scenario does unfold, which is by no means a certainty, it will not affect every ESG fund in the same way or mean they don’t still represent an acceptable or even strong return on investment.

Greg Davies, head of behavioural science at Oxford Risk adds another caveat:

“In practical terms, because ESG funds offer exposure to existing well-documented factors — for example they are known to favour high-quality stocks — they may reasonably be expected to outperform the market over long periods”.

How to invest in ethical ESG property funds

The growing number of ESG-marketed Reits and other formats of property fund means investors now have a good choice and the ability to diversify risk. Many of the major fund managers, like Schroders and Aberdeen Standard, now offer ESG property funds.

The mainstream fund managers usually offer property funds that are relatively similar to standard property funds in terms of their holdings. There is simply more stringent criteria around which property assets can be held by them.

Another option is one of the growing number of property funds, like Home Reit and Responsible Housing Reit, investing in social housing. Other examples include:

  • CBRE UK Affordable Housing Fund
  • The Social Housing Infrastructure Fund
  • Civitas Social Housing

As part of a balanced investment portfolio, property funds can offer a good source of income and are generally considered low risk. However, most major open-ended commercial property funds have been suspended for much of the past couple of years after the Covid-19 pandemic hit the offices and retail property markets badly.

Office and retail-focused property funds are likely to be cheap over the next couple of years but also represent a significant risk due to the economic uncertainty surrounding both real estate categories. Residential and logistics properties such as warehouses look much safer categories over the near to mid-term.

Investors may also want to steer clear of open-ended property funds to avoid the risk of the investment being locked in if the fund is suspended due to a shock resulting in a rush of investors wishing to redeem their holdings. Exchange-traded property investment vehicles like Reits and closed-ended investment trusts offer liquidity and ESG options.

This article is for information purposes only.
Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.
There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.

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