The Renaissance of Sustainable Real Estate (with Patient Capital)

The real estate market is no longer a static element of the global economy, thanks to the combination of new factors linked to supply and demand, including interest rates, inflation, private real estate, and urban regeneration. In this article, we will shed light on some of the most important factors of the real estate market as tools for social attractiveness, as well as its intangible assets and its role as an agent for culture and social inclusion, concluding with a comment on the sustainability of real estate as an element that attracts patient capital.

Unconventional monetary policy and interest rates

Fifteen years of unconventional monetary policies have left their mark. The nominal interest rates on public bonds (and others) are zero or negative. According to the Bloomberg Barclays Global Aggregate Negative Yielding Debt Market Value index, at the end of September 2021, the amount of debt in the world that produces a negative return is equal to 15 trillion dollars. Investors thus have a choice: either they must reduce expectations of returns, which is difficult to do for those who have taken on liabilities to honor, or they must modify the investment structure to include new assets.

Inflation

The reawakening of inflation is in the middle of the radar for investors in both the United States and Europe. A few years ago, not many would have foreseen such a rapid exit from the scenario of price stability that has characterized the global economy for some time now, and today there is great uncertainty relating to the scenarios of how long inflation will last. Some believe it is just a flare-up that will last only a few quarters, caused by procurement problems in global supply chains induced by the pandemic, while others think that it can be a long-term phenomenon, favored by the unconventional monetary policy adopted over a decade ago by the central banks. In any scenario, investors cannot ignore the risk of erosion of their purchasing power due to inflationary shocks.

Real estate

It is investors who increasingly believe that allocation to real estate should be higher than it has been traditionally, due to some benefits, such as:

• the possibility to obtain the yield given by the differential between the rent and operating costs, able to face those liquidity needs traditionally satisfied by investment in fixed-income securities;
• investment in an asset whose cash flow is linked to inflation, even if there is a certain time lag necessary to recalculate rents, that is particularly useful in the scenario previously recalled.

Private real estate

Acquire assets listed on the market, or not? This is a dilemma for which there is not yet a clear answer, even though investors are increasingly attracted by private investments (not only in real estate) that allow for (sometimes apparent) stability of assessment and a consequent reduction of volatility. There is also the possibility to acquire an illiquidity premium (even though the size of that premium has until now been set in a manner that is more intuitive than scientific) and to isolate the investment from the shocks to the preferences of investors, who can enter and exit liquidity assets at their pleasure, sometimes with short-sighted behavior that ends up reducing the balancing value of the assets themselves. In his report on "The Future of Alternatives 2025," Preqin finds that investments in private real estate will grow at a compounded annual rate of 3.4 percent between 2020 and 2025, to reach 1.238 billion dollars.[1]

"Urban regeneration" as a tool for attractiveness and geopolitical competition

"Urban regeneration" represents a great element of discontinuity in the life of cities, increasingly characterized by new centralities. A movement born in Europe for the need to remodel the containers of our lives in phases of transformation, it takes on different modes in different geographical contexts, depending on needs. Geopolitical competition, that is increasingly evident between cities given the forecast that 75 percent of the population will live in urban centers in 2050, the growth of 30-50 percent of the number of metropolises with 10 million inhabitants, with the polarization between large winning cities and the rest of the world, are elements that characterize the centrality of regeneration at the global level. In Italy, Milan is one of the cities that has the greatest dynamism and has been able to renew itself thanks to operations such as Porta Nuova, Citylife, Arexpo, Santa Giulia, and Sei Milano.

Risks and DNA of innovative and sustainable urban regeneration

The realization of urban transformation projects, in particular of brownfields, have various criticalities, especially due to the long amount of time that passes between the idea and completion. Times are generally long in Italy, and the work of developers is made harder by the macroeconomic shocks that affect conditions of growth and funding. A successful urban regeneration project must be innovative and sustainable: innovative, first of all, in terms of its construction technique, concept, and exploitation of private spaces for public use as generators of value acting as positive externalities, adapting and enhancing local needs with an international vision  (examples are piazza Gae Aulenti and the City Life gardens in Milan); sustainable, since the economic sustainability of the project derives from a strict coherence between the project vision and execution, through residential solutions and experiential locations linked to commercial real estate in respect for the environment (for example, planting trees on the large terraces of modern residences represents a synthesis of innovation through vertical development, enhancing green areas, and responding to housing needs linked to the wellbeing of the place).

The intangible assets of urban regeneration…

The green dimension and private spaces for public use in general (such as gardens, squares, and fountains) have taken on a vital role in urban generation projects, going from "necessary evils" (i.e. costs to sustain akin to urban planning fees) to "intangible assets" that increase the value of the other functions (in particular of living). The public space creates "social value" for the wellbeing of the end user, responding to criteria of respect for valuing green areas and families, in addition to being a natural infrastructure connecting different assets and turning various real estate interventions into a single ecosystem. A virtuous example is the BAM (the Library of Trees in Milano Porta Nuova), an innovative initiative to the benefit of "territorial centrality" with high value added for the City of Milan. 

… and the role as agent of culture and social inclusion

Those spaces favor social inclusion, the sense of belonging to a neighborhood – aspects that increasingly seem to be lacking in many cities – engaging the citizens. In the past twenty years, Milan has been the subject of a contemporary renaissance with important urban regeneration projects whose minimum common denominator is respect for criteria of sustainability. Due to that aspect, real estate has acted to anticipate trends occurring across all sectors, on respect for ESG criteria in the approach to investments and in business management. The pillar of sustainability in urban regeneration is certainly the ability to create places able to act as anchors of attraction for specific targets, with evident positive impacts on the ecosystem in which it is located. In this way, a work of art placed in a square or a sophisticated tree planting operation that enhances the biodiversity in a public park take on a role of cultural agents in which to explore and learn with different experiential activities. A square can become a tool of social inclusion in which each single element responds to a significant need (for example: a dog area, bocce park, play area, etc.) functional to various targets (families, elderly, etc.) increasing the versatility of temporal use (the needs manifest themselves at different times and days). The success of those anchors is highlighted by the frequency flows motivated by the interest of local residents, and of citizens who go to the new experiential districts intentionally for their free time. The potential of that body can be maximized by maintaining over time a pro-active management of the place and adapting the different initiatives/events consistent with the vision of the project and the relevant targets, that in addition to creating value for direct users, have positive repercussions for the city and ancillary activities.  

In search of the eternal beauty of sustainability

In Italy, we have numerous examples of cultural projects and initiatives that have always promoted the value of art and nature. Covid-19 has accelerated a trend underway that recalls the need for focusing on the circular economy, especially in certain core sectors for Italy such as food and beverage and textile/clothing (merely by way of example). The strict constraints imposed by the pandemic have forced all companies to adapt their value chains, processes, the layout of physical spaces, and have forced all stakeholders to change their behavior. Apart from the tragic impact at the health level, this phenomenon has led to a change in behavior, stimulating what we can hope will be a virtuous circle in which the creation of economic value derives also from environmental and social sustainability. The new paradigm of centrality of sustainability as a must-have in which profitability is guaranteed if and only in the case of harmony with the relevant environmental and social contexts, is the best example of culture for our country, that has always been known for the great beauty of its natural, architectural and artistic works.

Risk management and ESG investing in real estate for the attractiveness of private capital

The potential risk of a process of urban regeneration is the gentrification of a city neighborhood. Embodying sustainability in the design vision with goals of social inclusion and fair access to the opportunities offered by the city allows for creating value for the collectivity – place-making value – and not falling into the process of gentrification. To a growing extent, large urban regeneration projects must renovate and create entire neighborhoods with the goal of forming residential and working conditions that:

• are consistent with the spending capacity of families and businesses;
• ensure long-term sustainability from an energy standpoint and in terms of minimization of environmental impact;
• are pleasant and attractive.

The challenge is to give life to depressed urban areas, transforming them into a new territorial centrality for our cities. Sustainable urban regeneration projects can represent highly attractive investment opportunities not only due to the potential yields anticipated, but also because of their characteristic of respecting the ESG dimensions of long-term investments. The empirical evidence shows that there is a positive relationship between respect for long-term ESG parameters and economic sustainability. The perseverance in following the paradigm of long-term sustainability, in urban regeneration projects, is the best formula for success that makes initiatives of that type attractive for national and international investors.