Opportunities for sustainability in the built environment

Long-term infra­struc­ture invest­ments lie at the heart of Westminster’s lat­est plan to boost the nation’s econ­o­my. In the fore­word to the government’s Build Back Bet­ter pol­i­cy doc­u­ment, Boris John­son writes: “We will redress Britain’s his­toric under­in­vest­ment in infra­struc­ture, with £600bn of gross pub­lic-sec­tor invest­ment over the next five years, so our Unit­ed King­dom becomes a tru­ly con­nect­ed king­dom.”

Infra­struc­ture projects aren’t sim­ply about build­ing roads, bridges, ports and air­ports. They also deliv­er pub­lic insti­tu­tions such as schools and hos­pi­tals. Social hous­ing is also being tar­get­ed for invest­ment. This is one of the main rea­sons why the gov­ern­ment has been engag­ing with oth­er big investors, such as pen­sion funds, insur­ance com­pa­nies and local author­i­ties.

Invest­ment is all about risk and reward. The big­ger the risk you take, the more you should expect to receive in return. Infra­struc­ture invest­ments tend to tie up cap­i­tal for longer peri­ods. The so-called illiq­uid­i­ty pre­mi­um they pay to com­pen­sate for this is what makes them attrac­tive to investors. 

Pen­sion man­agers, insur­ers and sov­er­eign wealth funds – for instance, the Sau­di Ara­bi­an Pub­lic Invest­ment Fund that recent­ly bought New­cas­tle Unit­ed Foot­ball Club – all take a long view when it comes to invest­ment. Bonds – usu­al­ly gov­ern­ment-issued gilts – are a key com­po­nent of their high­ly diver­si­fied port­fo­lios, as these pro­vide a rel­a­tive­ly reli­able income over the medi­um to long term with lit­tle risk. But the exceed­ing­ly low inter­est rates since the glob­al finan­cial cri­sis of 2007-08 have depressed bond yields, prompt­ing investors to seek com­pa­ra­ble returns else­where. This in turn is lead­ing to increased allo­ca­tions to asset class­es offer­ing a com­pa­ra­ble bal­ance of risk and return. 

Many insti­tu­tion­al investors have his­tor­i­cal­ly con­sid­ered infra­struc­ture projects too risky for the effort these tend to require. Their argu­ment has been that you need spe­cial­ist advice and the abil­i­ty to nego­ti­ate the right price on the way in, or you’ll nev­er achieve the returns you’re seek­ing. By con­trast, they have seen real estate as a stal­wart option for decades. Yet nei­ther of those char­ac­ter­i­sa­tions is accu­rate. The two sec­tors have expe­ri­enced very dif­fer­ent for­tunes in recent years. 

The finan­cial cri­sis exposed some struc­tur­al prob­lems with prop­er­ty that have only become clear­er since then. In com­mer­cial real estate, demand for high-street retail space has fall­en as we do more of our shop­ping online. Any­thing but pre­mi­um office space in the big city cen­tres has been on the slide for years. There sim­ply isn’t the demand for sec­ondary (on back streets) and ter­tiary (on ring roads) space that there once was. Some of these prop­er­ties have been con­vert­ed into hous­ing in recent years. If they are near good trans­port links, they’re like­ly to become prime devel­op­ment sites for local author­i­ties with afford­able-hous­ing quo­tas to fill.

This shows that, how­ev­er much we might think real estate is as safe as hous­es, cer­tain parts of the mar­ket aren’t nec­es­sar­i­ly a sound long-term punt. What’s more, there are new­er risks to con­sid­er. For instance, achiev­ing the UK’s goal of car­bon neu­tral­i­ty by 2050 has fast become the main envi­ron­men­tal, social and gov­er­nance (ESG) com­mit­ment of busi­ness­es and their investors. 

A recent report by Car­bon Intel­li­gence iden­ti­fies the risk posed by the real-estate sec­tor to investors’ net-zero aspi­ra­tions. While any prop­er­ty under con­struc­tion today should meet envi­ron­men­tal spec­i­fi­ca­tions, about three-quar­ters of the build­ings that are like­ly to be in use in 2050 have already been built. 

“When investors start lift­ing the lid on their port­fo­lios, they’re prob­a­bly going to see that they’re reliant on out­dat­ed tech­nol­o­gy and ways of oper­at­ing build­ings,” says Chris Par­rott, an inde­pen­dent pen­sion trustee and for­mer head of pen­sions and ben­e­fits at Heathrow Air­port. That leaves this ‘safe’ asset class with con­sid­er­able expo­sure to cli­mate-change risk, cre­at­ing a lot of work to align the sec­tor with ESG tar­gets. The costs involved will reduce investors’ returns. 

Infra­struc­ture, so long asso­ci­at­ed with cru­cial – but not nec­es­sar­i­ly ESG-friend­ly – objec­tives, has had some­thing of a rebirth as more and more nations chase net-zero tar­gets. As a sec­tor, it’s respon­si­ble for the many renew­able-ener­gy projects that are pro­lif­er­at­ing around the world. Nonethe­less, these all still car­ry ESG risks. For instance, any invest­ment in bat­tery stor­age would rely on cobalt min­ing. Most of the world’s cobalt is pro­duced in the Demo­c­ra­t­ic Repub­lic of the Con­go, a nation with one of the most con­sis­tent­ly poor records for human rights abus­es. 

Such infra­struc­ture projects are unlike­ly to inter­est pen­sion fund man­agers. Giv­en that they have fidu­cia­ry duties to their mem­bers and must also meet the expec­ta­tions of reg­u­la­tors and soci­ety at large to invest respon­si­bly, they are cau­tious by nature. 

Sal­ly Bridge­land is chair of the Local Pen­sions Part­ner­ship Invest­ment, which man­ages the invest­ments of some of the largest coun­cil pen­sion schemes. She says that “the impor­tant thing is to look at things that oth­er peo­ple are not invest­ed in, in both prop­er­ty and infra­struc­ture. The risks asso­ci­at­ed with infra­struc­ture dif­fer from those involved in real estate. You need to under­stand these risks and, ide­al­ly, have the skills to man­age them inter­nal­ly.”

One growth mar­ket that strad­dles real estate and infra­struc­ture is the devel­op­ment of sus­tain­able cities that include social and afford­able hous­ing. These are termed ‘impact invest­ments’, as they can be seen to have pos­i­tive ben­e­fits on local com­mu­ni­ties.

The num­ber of social hous­ing units in the UK has plum­met­ed from its peak of 6.6 mil­lion in the late 1970s to about 2 mil­lion. Par­rott thinks that the effort to rebuild the nation’s social hous­ing stock could be a “game-chang­er” for coun­cil pen­sion funds. 

These funds can’t sim­ply finance house-build­ing for the local author­i­ties they’re asso­ci­at­ed with, as that would breach their fidu­cia­ry duties. But there are ways in which they can invest in asset class­es that match their prin­ci­ples, accord­ing to Karen Shack­le­ton, an inde­pen­dent invest­ment advis­er to pub­lic-sec­tor pen­sion funds. 

“While cli­mate change has been a pri­ma­ry focus for many investors, local gov­ern­ment funds have iden­ti­fied sus­tain­able cities as some­thing they’re inter­est­ed in. This is because they sat­is­fy both the envi­ron­men­tal and social aspects of their ESG cri­te­ria,” she says. “Social and afford­able hous­ing projects are very much an impact strat­e­gy, because these can achieve coun­cils’ goals in help­ing the home­less and oth­er vul­ner­a­ble peo­ple.”