Q&A with Garth Davis, CEO of New Market Funds by Rod Lohin

Should institutional investors consider impact investments in real assets? We have spent a fair bit of time speaking with — and frankly, educating — institutional investors on investing in affordable housing, specifically because it should be one of the easy ways for them to have an impact and to continue to earn market rate riskadjusted returns.

With regards to the pension funds, you could also make the case that investing in affordable housing has a positive impact on the underlying beneficiaries (teachers, firefighters, police, etc.), whereas continuing to push the market higher on multi-family rental and condo development projects actually raises housing costs and erodes the real income of the underlying beneficiaries and their communities and clients.

What makes real assets attractive as an impact investment? What are the challenges? The two main things that make this subsector attractive are low risk and cash-flow producing assets. The impact part of this subsec- tor, in order to maintain affordability, requires a cap on returns, but in exchange, investors usually have a larger equity buffer and units renting an average of 25%+ below market rents, so there is much lower vacancy risk. Institutional investors looking to avoid market risk in hot markets like Vancouver or Toronto can use this as way to invest with downside protection despite challenging valuations. Key challenges of moving into this space include the following:

• Lack of a track record— although there is a long successful track record in the U.S. under the Low-income Housing Tax Credit (LIHTC) market, and most institutional investors have successful track records investing in market rate multi-family housing.

• Capped returns— particularly in the development phase, as developer risk premiums are not applicable when the takeout is below market rental units, and many of the large institutional investors will only hold low yielding, low risk, stabilized multi-family properties that they themselves develop (and capture the developer premium), even though

the target returns are in line with most pension target returns in real estate (~CPI +4%).

• Complexity. These deals typically involve multiple levels of government and non-profit or co-op operators. Institutional investors are somewhat familiar with the former, but not at all with the latter.

• Deal size. There aren’t that many single size projects that would meet the size threshold of institutional investors, and then very quickly you start to bump up against concentration issues.

• Fund size. Institutional investors often access niche alternative markets via third party fund managers, but have minimum fund commitments of $50-100 million and constraints that restrict them from representing over 10 per cent of any given fund. This puts the minimum fund size in the neighbourhood of $500 million-$1 billion, which comes back to the track record issue.

• Diversification requirements. Most institutional investors have subsector and market diversification restrictions. For example if they are willing to put 10 per cent of their total assets in real estate, they might be willing to put

25 per cent of that allocation into multi-family real estate, but they also would have restrictions on, say, total BC real estate being 15 per cent. When you line it all up, their diversification requirements may not line up with the key demand areas for affordable housing.

What is needed to engage institutional investors?

A few things need to happen. First, groups like New Market

Funds need to develop a proven track record of doing these deals. Secondly, early movers from the institutional investor side need to spend the time to understand these deals and the track record as it develops. And third, leadership in the institutional space will need to come from CEOS who recognize the growing opportunities to invest responsibly in real estate and improve conditions for average citizens.