In the business world, there’s a stigma about investing based on an ESG model: environmental, social and governance. Some call the companies in that group too soft. Others say it’s a losing proposition because it lacks dividends.
However, more and more are thinking it makes solid business sense—for real estate.
One is Jonathan Needell, President and Chief Investment Officer, Kairos Investment Management Company (KIMC), a Southern California-based real estate investment company that specializes in workforce and affordable multifamily housing and making a positive environmental and social impact.
Building a 51-property portfolio by using criteria that steps well outside the high-end, Class A luxury model, KIMC currently controls about 10,000 apartment homes from coast to coast with most properties in Texas (17), Utah (seven) and California (six).
Needell defines ESG’s stigma as such: “When you consider ESG stock funds, for example, a portfolio manager would usually filter out industries such as oil, gas, tobacco. But those are the high-yield dividend stocks. So, investors might see that and say the returns could be impacted.”
He doesn’t look at it that way. He avoids trendy, high-end Class A properties in go-go coastal markets that could fetch the highest rents. KIMC instead focuses on environmental consciousness, managing risk by avoiding markets that have been involved in the recent flood of natural disasters or located in extreme climates. Needell describes it as an inclusion-based screening method that is created after excluding risky markets.
Climate Trends
“We look at areas that have been and could continue to be susceptible to natural disasters,” Needell says. “We won’t go to Miami because, after all, it’s going to be underwater by 2040, right? If we’re going into Florida, we start at Naples and go north. New Orleans is another area we wouldn’t buy into. Yes, there’s a wall built to protect the city, but there’s still too much risk.”
“We look at earthquake risk. Ten years ago, in Oklahoma, there were no earthquakes that measured above 2 on the Richter Scale. You read about them now. People today immediately point at fracking as the reason. So, Oklahoma is not a long-term hold.”
“We fully take global warming into consideration. Ten years ago, the claims you heard about man-made climate change were mostly anecdotal. But not anymore, the scientists will tell you.”
“We avoid the hottest climates. We avoid Las Vegas and Phoenix. Last year, Phoenix had more than 100 days where the temperature exceeded 100 degrees and Vegas had 70 such days. There was a period when Phoenix had to close its airport because planes could not get enough lift. Those conditions can make day-to-day operations dysfunctional. It might not be as bad as a major snowstorm, but it’s at least as bad as rain and ice. Being that hot for that long hurts the logistics of a functioning city. Just driving around in that environment is uncomfortable. It’ll get pretty hot in your car.”
According to a report released in April by Climate Central, Las Vegas has warmed 5.8 degrees Fahrenheit since 1970. That’s more than any other city in the United States. Rounding out the top five fastest-warming cities were El Paso (4.7 degrees), Tucson (4.5 degrees), Phoenix (4.3 degrees) and Burlington, Vt. (4.1 degrees).
Flood and rainfall are other considerations. “The kind of event for Hurricane Harvey—the storm stalled over the area and made landfall four different times, bringing over 50 inches of rain—was a once-in-500-years event they will tell you,” Needell says. “That’s unheard of. So, the insurance industry will tell you that it was probably the worst storm in terms of damage ever -- based on the number of claims -- but that number is inflated because it was such a densely populated area.”
Needell says that given the spike in extreme weather events, FEMA should consider redrawing its maps based on a 20-year forecast to better reflect the risk of flood.
Needell tracks demographics in the 75 MSAs and 217 submarkets. While it seems like we are crossing off a lot of markets -- and therefore, deals -- in many places, we will still listen for deals in those places. We have to maintain an open and entrepreneurial mindset. Many of the leading brokers know this about our strategy.”
Conscientious Fix
Needell also seeks to own and manage communities in which he can make environmental and social improvements.
“We buy old things we can fix,” he says. “We like LIHTC properties that can be purchased after their tax credit compliance period. Meaning the tax credits are no longer at risk, but the apartment units rents are still regulated. We might own it for a decade. We add to it, we refine it. We’re not looking to buy, fix and flip.”
Needell says he creates social programs for his residents where he will invest in things such as flu shots. He invites a health services firm and pays them $25 per shot.
“We also serve a free lunch that day to encourage participation,” he says. “Our residents like free. When you look at our resident profile, these are mostly people who are living paycheck to paycheck. They need to work. If they get sick, there’s no paycheck and no rent. The chance for an eviction goes up. We don’t want that. If the flu shots prevent just one eviction (and the costs that go with it), that pays for itself and the entire flu shot program pays for itself. We pay for the lunch to host the program from our marketing tenant relations budget.”
As for upgrades and amenities, it depends on the property’s situation, Needell says.
“Water-saving devices such as aerators, low-flow toilets and leak monitors help a lot,” he says. “In Seattle, for example, they help pay for the low-flow toilets to be installed in older properties. In other properties, they might already have low-flow toilets, but they need aerators.”
“At one of our apartment communities in Oklahoma City, we saved $80,000 in annual expenses on a $10 million asset just because of the attention we paid to our water maintenance. In another, we only saved $65,000 annually in expenses but there we didn’t have to pay for new toilets.”