Making Sustainable Cities Investable
In this short essay, I offer a broad overview of some key issues that come up when thinking about the role of private investment in (re)developing sustainable cities. I concentrate on understanding why investors might look to sustainable cities as an important investment arena.
But I would like to do this within a frame of thinking about how sustainable cities themselves become investable for private capital. This means integrating the project level -- what sorts of buildings, infrastructure, retrofitting, or energy production projects are sustainable -- with a larger vision of cities (broadly understood not merely as political jurisdictions, but as metropolitan regions) as vibrant organisms that need to be thought of holistically for sustainable investment to achieve its potential. Private investors cannot do this alone -- for sustainable cities to become investable, close cross-sector coordination among regional, national, and international governments, the private sector, and civil society groups will be necessary.
I take investment in sustainable cities to be a subset of responsible investment -- that is, investment that integrates environmental and social factors into investment decision-making, and support long-term sustainable economic activity that serves the interests of society as a whole.1 As I hope to make clear, I believe that sustainable cities are a promising new focus for responsible investment, and a theme that sheds like on the role that finance can play in serving the interest of society as a whole.
Cities have been for some time a vital focus of efforts to address anthropogenic global warming through sustainable investment. For instance, a recent report by the United Nations Finance Initiative Environment Programme (UNEP FI) on "Cities" offers a convenient highlighting of the key reasons that advocates cite for focusing on urban areas.2 Cities account for outsized resource consumption -- they are home to 50% of the world's population but account for 75% of the world's carbon emissions and 60-80% of the world's energy consumption.
Rapid urbanization in the world's developing economies is a leading social and environmental macrotrend which raises the importance of developing sustainable urban forms amid substantial disparities in wealth and access to opportunity. Already, urban environments across the world both direct and constrain our capacity to respond to issues of resource consumption, carbon emissions, and, more expansively, sustainable human and economic development.
At the same time, cities offer enormous opportunity. The concentration of economic, social, and intellectual activity in close quarters makes cities sources of innovation and diffusion of sustainable practices.3 There are positive externalities associated with urban economic activity. Well-designed, dense, compact, and connected urban form is tied to more sustainable living patterns. And by virtue of their concentration of people and activity, cities offer scale, the ability to support sustainable investments of the magnitude to make a difference in the face of the immense challenge posed by climate change.
So what are sustainable cities? For the purposes of this note I will focus primarily on carbon mitigation, the topic that has received the most attention to date in terms of investment, though there are other resource issues around water or ecosystem preservation, for instance, or resiliency and adaptation issues related to likely changes in climate, that are equally as important.
A variety of approaches to the problem take into account both the need to find new ways to build new cities that serve growing urban populations, and the imperative of revitzing existing cities of all sizes by making buildings more energy efficient, energy sources clean and renewable, and urban design more friendly to carbon mitigating lifestyles and work patterns. Though there is no clear working definition of a "sustainable city" as of yet, we can set as a rough benchmark something like an urban area that mitigates climate-related emissions significantly enough to meet consensus estimates for what is needed to mitigate climate change. In other words, sustainable cities must meet their share of responsibility in global targets for emission reduction set out by organizations such as the Intergovernmental Panel on Climate Change.4
An impressive and growing literature on sustainable cities has focused on the need for new commitments to sustainable urban planning, investment, civic engagement, and national and international coordination in support of sustainable cities. International groups like the C40 Climate Leaders Group -- supported by the Clinton Climate Initiative, or ICLEI -- Local Governments for Sustainability, bring together municipal leaders with public, private, and non-profit organizations to highlight and share best practices and toolkits. Climate change networks that engage the private sector -- groups like Ceres and its Investor Network on Climate Risk; or the Climate Group -- have similarly worked on specifically urban issues in relation their broad goals of guiding private sector activity towards more sustainable practices.
The role of private investment in sustainable cities has received specific attention, with advocates from all sectors searching for ways to mobilize private capital towards more efficient, resilient, and productive cities5. Discussions often center on how to engage private investors, what products they might use to invest in sustainable cities, and what public policies will most successfully catalyze private investment.
Sustainable Cities are an Opportunity for Private Investors
Investing in sustainable cities is more a topic of discussion than an investment discipline as of yet. Investors might look for sustainable projects such as wind energy production, or green building development, or transit lines and smart growth real estate – but these are not necessarily linked to cities themselves.
But there are a number of reasons to think that investors might take up sustainable cities themselves as a topic. I will focus here on the growth of two types of investors who may come to play an important part in this movement – to simplify, I'll call them Responsible Investors and Impact Investors, though in reality there is substantial overlap in who they are.
The archetypal Responsible Investor is a large institutional investor – say a pension or sovereign wealth fund – with theoretically long term time horizons and a class of beneficiaries (pensioners, or citizens) who would reap gains from increases in the public good as well as financial returns to the fund.6 Sustainability has become an important theme for these investors, on the belief that over the long term investments with superior environmental (and social) benefits will potentially outperform, by reducing risks from political, cultural, and economic change, and capturing the benefits of forward-looking economic devleopment.7 They may have signed onto the UN Principles of Responsible Investment, whose preamble notes that "these Principles may better align investors with broader objectives of society." Many need to invest very large sums of money.8
Responsible Investors face the challenge of balancing their portfolios in the face of environmental and social macrotrends, from the growth of emerging markets, to global resource depletion, to rising disparities in wealth, to global trends towards urbanization. The issue that has received perhaps the most attention in recent years is climate change, with, for instance, a recent report from Mercer Investment Consulting arguing that investors must significantly shift their portfolios and asset allocation strategies to take into account the risks and opportunities associated with climate change mitigation and adaptation.9
From this perspective, investment sustainable cities offer a number of advantages:
- Scale: Cities offer the potential for large scale investments in sustainable infrastructure and real estate, creating opportunities for market development.
- Long term time horizons: These investments can mature over long periods, supporting the time horizon of the funds themselves.
- Positive externalities: Funds, and their beneficiaries, can benefit from sustainable investment strategies that support economic development and encourage market development for the transition to a low-carbon economy.
- Risk mitigation: Sustainable cities may help funds protect themselves against the downside risks of climate change disrupting economic activity.
Each of these factors, at the level of the city, enhance the benefits of any particular sustainable project in which a fund might be invested. Cities with comprehensive sustainability strategies ought, in this view, be more compelling investment opportunities.10
Impact Investors focus on investments that make financial sense, and have intended, specified, tangible social and/or environmental benefits. They are often associated with innovative investments meant to catalyze other private and public sector capital, or with taking risks and accepting reduced returns in exchange with outsized social impact--for instance by creating investment vehicles that serve low income areas or that support innovative energy efficiency investments. They may join organizations such as the Global Impact Investing Network, which focus on regions and sectors of interest to multiple investors.11
The archetypal Impact Investor is a foundation or high-net worth individual focused on creating social impact through market tools. For these investors, sustainable cities offer:
- Innovation: The innovation associated with dense urban living, and the ability to grow to scale relatively quickly, allows Impact Investors to support catalytic opportunities.
- Leverage: Sustainable Cities offer potentially scalable models that can be applied elsewhere, creating leverage for the social benefits of impact investments.
- High impact targets: Impact Investors have the potential to provide below market capital to low-income areas, or to support mixed-income development, that ensures that sustainable cities serve whole populations, and do not merely externalize environmental costs onto underserved areas. In addition, investors particularly concerned about specific localities have the opportunity to address a variety of issues all connected to the sustainability of a particular place of high interest to them.
- Sustainable investment ecosystems: Impact investment can involve complex deals and risk taking on innovation that require the support of public, private and civil society ecosystem in order to succeed. Sustainable cities, understood holistically, would be laboratories for developing investment ecosystems that deploy private capital more effectively to public purpose.
As for Responsible Investors, the idea of a sustainable city – a metropolitan region whose design and culture favor sustainable energy use and living patterns – increases the benefits for Impact Investors of each of these factors, by capturing the benefits of individual investments and creating mutually beneficial and reinforcing deployments of capital.
Vehicles for Investment
Responsible Investment and Impact Investment have both received substantial attention and growth in recent years, catalyzing products for all sorts of investors that have carbon mitigation, urban resiliency, or sustainable land management built into their business rationale.
For instance, the World Bank, the IFC, the European Investment Bank, and others have developed a class of "green bonds" meant to appeal to institutional and retail investors who look for relatively straightforward investment products that serve these sustainability goals. These bonds help finance, among other things, urban infrastructure projects tied to carbon mitigation efforts. The Climate Bonds group is working on standards to ensure that green bonds fulfill their environmental promise, and in the process provide readily accessible products for investors and bond issuers alike. 12
Other examples include real estate funds that target transit-oriented development or energy efficient buildings. Efforts have been made by large real estate fund managers to green their existing building portfolios. Green building guidelines such as the LEED program of the US Green Building Council, the BREEAM ratings in Britain, or Green Star in Australia have all helped set standards for energy efficient buildings. Specialized funds have developed to help green affordable and workforce housing units, or to revitalize brownfield sites in cities and reduce sprawl, or to build or refurbish mixed-use, mixed-income buildings in proximity to transit.
Finally, venture capital and fixed income funds have supported innovative small business development around environmentally sustainable goods and services.
These various products are designed to appeal to different sorts of investors. Responsible Investors are looking for products which fit into their portfolios, and can be benchmarked for financial return against peer groups with less social impact. These investors face the challenge of finding investable products that aggregate enough deals to absorb institutional scale capital. They often depend on third parties -- public or civil society -- to work with them on designing investable deals, either through community engagement or financial support of one sort or another. Successful products have typically come in the form of conventional investment products, with support from collateral organizations ensuring the delivery of public benefit. For Impact Investors, the need is for a robust infrastructure that can source deals in hard to work places, or provide capital to mitigate risk or enter new spaces for investment. Across the range of investments, urban areas and sustainability have been a focus.
But the products themselves rarely are designed to support sustainable cities, understood holistically. Instead, they focus on projects, deal aggregation, and fund development that contribute to sustainable goals within an urban setting. How can we take this interest in sustainable investment products, and turn it into support for sustainable cities themselves?
Making Sustainable Cities Investable
For private investment to fully participate in making cities sustainable, investment products, public policies, and civic support need to be created around efforts that combine an interest in sustainability, the importance of cities, and the multiple potential sources of capital. This will be most effective where the models of urban places and metropolitan regions are developed that link investment to broader sustainability goals. Otherwise, the benefits of sustainable projects -- one-off sustainable investments -- cannot capitalize on the long-term benefits and innovative potential of truly sustainable communities.
To make a city investable, then, it requires the coordination of projects, funds, investors, policy makers, and civil society organizations, around a common goal against which specific types of investments can be measured. Investors differ in their needs and capacity, and so multiple forms of private capital will be necessary to support sustainable cities. Just as importantly, a framework that coordinates these sources of capital, helps build pipeline opportunities, and creates mechanisms to hold investors accountable for superior social and environmental performance, is fundamental to creating a sustainable investment platform. In other words, some set of stakeholders must create a vision for a sustainable city that both encourages and holds investment to account.
Examples of sustainable city policies abound, but examples of sustainable city policies designed to catalyze private investment are harder to come by. Four examples can help illustrate what might be necessary to make sustainable cities investable. First, the JESSICA program, a program of the European Investment Bank, encourages the creation of metropolitan-based investment funds that catalyze private investment by creating investment policies that use public money to catalyze longer term time horizons, and coordinate multiple sources of investment from public and private sources. In theory, the JESSICA program will help make investment in sustainable urban areas more attractive, and the place-based nature of the fund offers the potential for coordinating investment against a broader vision for a sustainable city.13
In the United States, Living Cities, a consortium of the country's largest charitable foundations, has begun efforts to integrate public policy and private investment towards share goals for urban regeneration. In a difficult investment climate generally, and in places in need of investments like Detroit, Cleveland, or Baltimore, Living Cities is working to integrate urban regeneration strategies so that multiple stakeholders have a share goal against which the value of specific deals can be measured. Not every deal needs to deliver the same social and environmental benefits, but together the deals are meant to create capacity, in cities as a whole, to receive sustainable investment.14
And in Rio de Janeiro, the Brazilian Ministry of the Environment, the municipality and state of Rio de Janeiro, and the US Environmental Protection Agency have begun work on a bilateral project that seeks to coordinate public and private investment opportunities in Rio, in anticipation of accelerated private infrastructure and other investment due to the World Cup in 2014 and the Olympics in 2016. This project aims to support the directing of investment towards the development of a sustainable Rio. A sustainable Rio includes efforts to extend public transit systems and transit-oriented development, improve water and waste management, and revitalize Rio's bays, so that access to economic and social opportunities for people of all classes is tied to investment and development criteria.15
Finally, Sitra's own low2no project in the Jatkasaari district of Helsinki has focused on ways to make the development of a city block -- through new urban design criteria, procurement strategies, and innovative use of sustainable materials -- both a model for and tool to create a market for sustainable development practices that can be extended throughout Helsinki, Finland, and beyond.16
Together these relatively new projects, even in their developing state, offer some suggestions as to how to make sustainable cities an investable opportunity for private markets. They suggest a series of considerations for making sustainable cities -- as cities, as places, as sources of mutually beneficial investment and positive externalities that generate both public goods and investment returns – investable.
Build a common table around the goal of a sustainable city: Coordinating public, private, and civil society actors around a common goal can lay the groundwork for sustainable investment from the private sector. At the level of the project, complicated deals requiring multiple sources of funding and multiple forms of approval from the public sector can benefit from linkage to clear sustainable development goals. At the level of the city, a coherent strategy for carbon mitigation can help match investment opportunities to investors who can achieve sustainability results. Perhaps most importantly, at the level of the city, a consensus set of goals can take the onus off any one particular investor, fund, or project to achieve everything themselves.
- Think systemically about market transformation: Private investment in sustainability, especially in the built environment, can sometimes focus on one-off investment opportunities or signature projects rather than the development of systemic sustainable change. If the development of a sustainable investment ecosystem is necessary to support such change, attention must be paid not just to high-profile projects, but to robust investment intermediaries, community engagement, forums for coordinating different kinds of investment, pipeline generation of deals that serve a common goal, and procurement strategies that help create robust sustainable supply chains of goods and services.
- Use land-use planning, regulations and incentives to guide the market: Even investors who focus on sustainability as an intended outcome are guided by regulations and incentives that promote public goals. A clear policy framework around land-use and green building regulations, incentives for energy efficiency and alternative energy production, or public private partnerships that match public and private money are all ways to help both catalyze private investment and to shape investment outcomes. The use of public policy must strike a balance between engaging investors and offering a reasonable rate of return on investments that make demonstrable contributions to urban sustainability.
- Sustainable cities should be inclusive communities: The idea of a resource efficient, low-carbon city will not answer the challenges of climate change and resource scarcity if it is inaccessible or unaffordable to all but the wealthy or powerful. Otherwise, the gains in sustainability are likely to exacerbate social inequity at the same time that they outsource environmental damage beyond a city's borders. An integrated approach to supporting sustainability with social equity is needed to create truly sustainable cities. This is true both for the challenges of retrofitting and regenerating existing cities, and meeting the demands of the growing urban populations and new (mega) cities found especially in emerging markets.
The advantages of making sustainable cities an object of private investment should rebound to society and investors alike. A holistic view of sustainable cities, with a coherent plan for engaging private investors across the range of asset classes, sectors, and risk/return profiles that cities need for private investment, should allow for self-reinforcing positive externalities. Cities can coordinate their public policies and investments with private investors to accelerate the transition to a low-carbon economy within a framework that ensure the creation of public goods. Investors, in return, should be able to reap the benefits of more dynamic and resilient economies that will, over the long term, mitigate the risks of climate change, and help define and create new investment opportunities.
This virtuous circle will only be achievable if we move beyond one-off investment in projects and funds, and find a way to make sustainable cities themselves investable.