The Dark Side of Impact Investment in Green Buildings

The buzzword among institutional investors all over the world is “impact”. They are no longer just thinking about the financial risk and return of their investments, but want to accomplish broader societal goals, such as energy efficiency, better labor standards, diversity and inclusion, reduction of poverty. The list goes on.

In principle, such lofty goals and the profit motive could be satisfied at the same time. For example, Aldi and Lidl are not usually regarded as social enterprises, but they both sell good quality food for very low prices, thereby providing great benefit to families on low budgets. However, that is not how institutional investors think about societal impact these days. In these circles, impact is associated with the concept of additionality: making investments that otherwise would not have been made. In financial terms, this additionality means that these investors would be willing to make investments with a negative net present value (NPV), instead of only making positive NPV investments, as they would do when purely motivated by the profit motive.

Let’s take a look at what this would mean for energy efficiency investments in real estate. The graph below depicts the theoretical relationship between the capital invested in a building refurbishment and the resulting energy use. Of course, this graphs goes downwards as more investment leads to better energy performance. But it does not do so in a linear way. It is quite cheap to increase a building’s energy performance for very inefficient buildings, but once a building reaches an energy label B or A, it is very expensive to get is all the way to energy neutral, for example.


Somewhere on that graph lies a point where the total present value of all the financial benefits from the improved energy efficiency equals the costs: the NPV zero point. According to standard financial theory, all investments on the curve lying to the left of that point should be made, as they create value. But investments lying to the right should be avoided, since they destroy financial value. This is important: making an investment of that nature destroys capital.

In a world with unlimited capital, that would not be a real problem. Unfortunately, we do not live in such a world, and the amount of capital needed to get our societies’ building stock in line with the Paris goals is enormous. So if society’s capital owners would make a lot of impact investments, making a few buildings absolutely outstanding in terms of energy performance, they may not have enough capital left in the long run to improve the energy efficiency of the rest of the building stock. That is the dark side of impact investment.

To benefit society as a whole, we need to employ our limited capital in the most efficient way possible, and focus on the investment opportunities lying to the left of the NPV zero point. It may be good to be even stricter and only focus on projects with a highly positive NPV, so all the way up in the north-west corner. That way, we will see capital grow faster, so creating the capital we need to finance the greening of all of the building stock. We need a long-term perspective here, not aiming to get to energy neutral right away, but looking at the refurbishment of each building a number of times until 2050. As technology improves and gets cheaper, the curve will shift down, improving the energy efficiency gain of a given investment, and thereby shifting the NPV zero point to the right, leading to more value-creating investments. For optimal impact, a growing capital stock is key. Impact investment in its