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Sustainability and energy efficiency are powerful trends in the residential real estate market. But can these concepts go beyond being mere “buzzwords” to enhance investor returns and deliver greater client satisfaction?
Lorenzo Sargenti, founder and managing partner at Shape Equity Partners, joins the show to discuss an entire real estate investment strategy that is wholly focused on sustainability.
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- The history of Shape Equity Partners.
- How the company identifies strong secondary markets that have high potential ROI for multifamily development.
- Why Shape Equity Partners has a strong focus on sustainability and efficiency in their real estate developments.
- How the company manages to build using quality, sustainable materials while still remaining price-competitive.
- Why Lorenzo believes that a focus on sustainability and efficiency can enhance investor returns in CRE.
Today’s Guest: Lorenzo Sargenti, Shape Equity Partners
About The Alternative Investment Podcast
The Alternative Investment Podcast is a leading voice in the alternatives industry, covering private equity, venture capital, and real estate. Host Andy Hagans interviews asset managers, family offices, and industry thought leaders, as they discuss the most effective strategies to grow generational wealth.
Andy: Welcome to the “Alternative Investment” podcast. I am your host, Andy Hagans. And today we’re talking about sustainability, obviously, a very powerful trend in the luxury home segment. But how does it affect investor returns? And how can investors participate in this trend? And joining me is Lorenzo Sargenti, who is founder and managing partner at Shape Equity Partners. Lorenzo, welcome to the show.
Lorenzo: Thank you, Andy. It’s a pleasure to be here.
Andy: And, you know, I think Shape Equity Partners is a pretty unique company. Obviously, a lot of developers use the word sustainability or eco-friendly. I hate to say buzzword, but almost like a buzzword. But, you know, looking into Shape Equity Partners, it really seems like you focus so much on these things, you know, more so than a typical developer. So, could you sort of take us back to the beginning? How did Shape Equity Partners begin?
Lorenzo: Well, Andy, it’s an interesting question. As you might know, I’m originally from Switzerland, where these topics are actually very topical. And then when I moved to the U.S. about 15 years ago, I was looking for a residence for my family. And I was actually pretty surprised with the quality of multifamily residential buildings, you know, the basics, to some extent, were, I would say, very average from a construction standpoint. Then, I started brainstorming a little bit about the opportunity. And I felt that construction could do much better in getting the basics rights.
So things like, for example, using better materials, installing materials more efficiently. I always like to use the example of windows, actually installing windows that are appropriate for the external climate, keeping the heat out in the summer and keeping the cold out in the winter, those basics were not there. And so, you know, at the time, I was doing something else. And I will say, in the back of my mind, until I founded Shape Equity and I really saw an opportunity to focus on these themes for multifamily residential. And, over time, also developed a belief that because of this theme, we can actually have a meaningful impact for all stakeholders, not just our investors, but ultimately as well, the community and the buyers of our assets.
Andy: So, does Shape Equity Partners, are you exclusively developing in multifamily? Or do you also develop single-family homes?
Lorenzo: We are focused on primarily on multifamily, we do a little bit of single-family homes as well. And we’re starting to explore commercial spaces as well. But our sweet spot has been primarily multifamily and single-family homes. Our journey started in the northeast of the U.S. and we then expanded across the U.S., and we’ll then move internationally. But we felt that there were significant opportunities in the northeast in the U.S. And that’s where we started our journey.
Andy: Understood. So, would you say that sustainability or energy efficiency, are these really like the top-level themes that you use, you know, in your marketing and then just your thesis to investors or to, you know, your clients and tenants?
Lorenzo: Well, look, there are three main themes around our investment strategy and our development strategy. The first one is basically focusing our investments and development projects outside of city centers. We’ve done a lot of analysis that actually ended up leading to an internal proprietary algorithm that we’ve developed to really identify real estate opportunities outside of city centers. My observation was that…and it started really in New York that there weren’t that many opportunities of accelerated asset appreciation outside of city centers. If you think about New York, Brooklyn was kind of an exception, unless you, of course, went further out of the city.
And I felt that that was very odd. In other parts of the world, if you think about cities like London or Paris, the first circle outside of the core city center, really often many opportunities for investments and development. So, we started looking at data and, over time, developed this algorithm that basically tries to leverage public and private data, as well as uncorrelated data, to identify investment opportunities to bring this to life and be very specific.
You know, for example, correlating income and demographics with uncorrelated data sets, like at what time of the day do people, specifically, women, run outside? And you actually notice that there was a direct correlation between running at night, and increases in asset values, correlated, of course, to income and demographics. So, we started leveraging this data…
Andy: I mean, right off the bat, that kind of makes sense to me, if women feel safe to run, you know, at night, then it’s obviously it’s perceived as a safe environment, safe neighborhood, right? A family-friendly neighborhood.
Lorenzo: Exactly, exactly. And so, we basically tried to leverage these data sets to have a quantitative approach in our due diligence process and identify these opportunities. So, that’s step number one. Step number two is innovating designs and architectures. So, we feel that, you know, to some extent, the basics of climate efficiency and climate awareness is building, I would say in designing in a way that optimizes your natural resources. So, things like optimizing natural lights, the interiors of the structure, making sure that it leverages natural energy. And there are many, I would say, concepts on this theme, that really create the first step in the efficiency process. And then, of course, the final pillar is leveraging materials, construction concepts that, at the end of the day, creates more efficiency for old stakeholders.
And our strategy so far has been not to take it too far. What climate awareness for us at the moment means in practice, it’s building better with better materials, and really focusing on leveraging capabilities that already exist in terms of efficiency. And then of course, we’ll innovate from there with additional technologies that can really push the envelope further. But if you don’t get the basics right, you know, things like solar energy, or heat pumps, or some of the themes that you hear now out there are, to some extent, superfluous if you don’t get the basics right from the beginning.
Andy: Understood, yeah. So, in other words, sustainability, eco-friendly, these are important aspects, but very few consumers are going to rent or purchase a home based just on those things. But that being said, you know, I think what a lot of people think about environmental issues, or energy efficiency, increasingly, it’s becoming a pocketbook issue, a financial issue. I mean, in Europe, you know, especially obviously, energy costs have skyrocketed, but even in the United States, energy costs are significantly higher than they were just a couple of years ago. So, have you noticed the theme? I guess, there’s the financial argument for energy efficiency, have you noticed that, you know, bubbling up in conversations more in the past 6 to 12 months?
Lorenzo: Hundred percent. I think that the increase in energy prices, the increase of gas prices as an example, has really increased the sensitivity on these topics. And we also see a significant push from the various institutional funds on concepts and themes of ESG where they’re now mandated to invest in ESG-compliant companies and investment funds. But the sensitivity is really accelerating with the end buyers and renters. And there is an economic reason for that. Some of our assets have demonstrated that you can start reducing your total cost and your total bill by simply building better. The example, again, that I always like to use, right, if you’re installing proper windows and you don’t need to blast the heat in the winter and the air conditioning in the summer, it will actually save you dollars on a monthly basis. And that is something really basic that every developer out there should pay attention to. And we feel that things will just start accelerating from there.
This is true on the residential side, on the commercial side, you’re still seeing a number of organizations. I like to mention Prologis as an example. Prologis is a company that owns and builds warehouses, and their focus has been really on resiliency and climate awareness. And you can see that their investors, their stock price is really positively impacted by this strategic focus on climate and resiliency.
Andy: Yeah, you know, it’s interesting in that institutional world you mentioned with the focus on ESG. It’s almost like it doesn’t matter. You know, some people have a positive association with ESG. Some investors have a negative association with ESG. But it almost doesn’t even matter in the sense that if institutional buyers are going to favor ESG, you know, if regulation is going to…it’d be like swimming against the current to fight these sorts of things. You know, one question I have, I mean, it seems like in states like California, or in certain more progressive, you know, localities, a lot of these things might even be legally required. So, how much of this sort of development is aligning with standards and localities versus I feel like if you’re in, let’s say, Houston, Texas and you’re developing, you know, more eco-friendly multifamily, that would be more of a differentiator versus in, you know, Bay Area, California. It’s probably what literally everyone is doing because they’re legally mandated to, right?
Lorenzo: Yeah, look, you’re raising an important point. My philosophy on this is, change happens for several reasons. One is a new regulation that accelerates the change. But at the end of the day, oftentimes, the real acceleration comes when it makes economic sense to accelerate that transformation, and you mentioned before ESG, I think the G of ESG is extremely important. Because if you govern this process and if you create transparency around themes of efficiency, around themes of sustainability, I think you create transparency on why building differently has a positive impact for all stakeholders. And that transparency is important. We’re investment individuals, right? We are number driven. And if we can demonstrate transparently, that building this way is actually better for everyone involved, including investors. I think there is a real acceleration in this transformation.
And look, construction as an industry, I was struck by a recent statistic, construction as an industry drives over 30% of all CO2 emissions. It’s an extremely polluting industry, an inefficient industry, and I think there is tremendous innovation that can occur over the next decades to improve how we build and actually how we think about efficiency.
Andy: Well, you know, I think you made a really interesting point, Lorenzo, that a lot of the change, you know, obviously government regulation has a role in change. But if the consumer, if the end user sees a financial value or a usability value, then that just creates natural demand. You know, so the windows I think the windows are a perfect analogy, most homeowners kind of understand you know, the benefits of high-quality windows, or the drawbacks of old windows or low-quality windows. You know, in my experience, the higher quality materials, even regardless of eco-friendly or not, you know, the higher quality materials, they can save in the long run but they have that higher upfront cost. So, you know, with your strategy, does it limit you to building luxury housing? Does it limit…like in multifamily does it limit you to class A multifamily in residential? Does it limit you to luxury residential, just because the, you know, if you’re paying a higher cost for materials, it almost, by default, places you in the luxury space, is that right?
Lorenzo: We like to believe that we are actually, you know, affordable. And if you think about the stack, our sweet spot is, you can think about these themes across that value chain. And initially, we focused primarily on luxury housing and the top end of the spectrum. But we’re now moving right in the sweet spot. And if you look at some of the developments that we’ve done in the northeast, places like Jersey City as an example, these are…I wouldn’t describe them as luxury building at all. We can apply these concepts, build more efficiently, and actually control construction costs. We do so primarily by sourcing materials from places that have optimized these concepts, optimized both in terms of cost, and efficiency, and durability. And so, we source a lot of our materials from Europe where some of these technologies are a little bit more advanced.
Andy: Well, Lorenzo, it’s interesting, I hear Europe, I think expensive, you know, I think Italian marble or, you know, I think expensive. But you’re saying that there are the lesser-known material suppliers that are more eco-friendly but that also hit a competitive price point?
Lorenzo: Definitely. I think that, you know, if you look at places like Poland, for example, we import a significant amount of materials for Poland, where we get a custom-made product at a price that is extremely competitive relative to some of the prices that we’re seeing here. We also import woods from Eastern Europe, custom millwork from Italy. So, every time you hear custom-made, you think, pricey, but actually…
Andy: Yeah, an alarm goes off in my head, Lorenzo.
Andy: But I actually, I think, I honestly think quality when I hear custom made, because it’s, I mean, in development, you know, for better or worse, my thought in residential is, if it’s not custom, then it’s going to be built for cost efficiency which ultimately means cutting corners, then that goes back to the windows that you discussed. I think every builder probably knows that higher-quality windows can probably save money in the long run. But if it increased costs 20%, 30% upfront, and the consumer doesn’t wanna pay that upfront, then what do you do right? You just have to…you end up going with the cheapest supply?
Lorenzo: Yeah. Look, Andy, I’ll give you an example for the lens of investors that I’ve made recently to an investor in a conversation where I was asked exactly the same question. And my point to them was, think about two buildings, side-by-side, 123 Main Street and 121 Main Street. And one is built with better designs, better materials, better installations of those materials. And ultimately, with long-term efficiency in mind, same cost, same neighborhood, even to some extent, the same price, the same selling price, our asset is better. Why? Because of the reasons that I described before.
And so, the buyers will gravitate towards our assets versus our competitor’s assets. And we believe that over time, we can generate a premium assets that at the end of the day buyers wanna pay for because of that differentiation. And we’re noticing that in many places where, you know, we’re releasing assets at the same time as competitors, where I’ve only anecdotally heard a story where one buyer came to visit one of our assets and this lady said to her husband, “Well look, the property down the block is exactly the same price, but this is better built and better materials. And look at these closets.” And, you know, these things actually matter for people that are buying either their first home or a home for their family and we feel that it’s an extremely important theme to focus on.
Andy: Yeah, absolutely. And, you know, it would also occur to me like in multifamily, if you’re buying an asset like value add, like a turnaround and you’re only going to hold the asset for two or three years and then flip it, financially, who cares, right? Like, who cares what quality of windows, what quality paint, what quality, anything really, but just from a financial standpoint. But if you’re building, if you’re developing a multifamily asset that you plan to hold for 5, 7,10,12 years, in that context, obviously, the higher quality in materials, they’re gonna lower your operational costs, lower your CapEx over the long-run.
Lorenzo: Absolutely. And the selling value of that asset as well, over time, is stronger if you build better relative to something that, as you mentioned before, is build cutting corners and not really focused on these themes. So, yeah, short-term and long-term, the economics make sense and the rationale makes sense.
Andy: So, how about then from the investor side? So, I know, you know, some investors, right or wrong, I think they associate impact investing or ESG with potentially lower investor returns. So, does this strategy… I mean, you’ve kind of alluded to the idea that, you know, you’re not giving up anything in terms of price competitiveness, but how about from the investment side? Is this sustainability? Is the higher quality materials, is that an opportunity to enhance returns? How does that affect, you know, the investor model?
Lorenzo: Look, at the core of our belief is that our strategy will improve investors’ returns over the long run. We’ve had performances that are extremely competitive and actually, compared to other developers and similar strategies have overperformed. So, we’ve been known for 40% IRR in 2020 and 2021. And so, our target, on an annualized basis, is 20 plus percent. And those are very healthy returns in the space. We believe that to drive performance, you need to do three things very well. The first thing goes back to the very first point I made is identify neighborhoods, zip codes, where asset appreciation is actually occurring. And be certain that you’re focusing on data as a starting point. I think in this in our industry, oftentimes, the analysis, the initial analysis of the market is not robust enough, and I think we can do better in that initial analysis.
The second point is really control of construction. I think there are many middlemen, subcontractors, general contractors, everybody needs to be rewarded for the work that they do. But proper control of that chain, I think, is extremely important. And we’ve put in place a number of processes to have visibility of the underlying cost of our material, of the underlying cost of our labor. And ultimately, make sure that we protect margin for investors as much as possible. And then, the final piece is really focusing on sensitizing the end buyer on why these assets are better and really generate a premium on the exit side. And we’re starting to really see that evolution where investors that are buying their first home or moving out of the city, in the case of Jersey City, people moving outside of New York into Jersey City, really looking at this from a long-term standpoint and valuing our construction methodologies and the efficiencies that we bring to multifamily housing.
Andy: That’s interesting. So, I have a more tactical question, I guess a more granular question.
Lorenzo: Yeah. Of course.
Andy: So, you know, thinking about sustainability and higher quality materials, and you’ve kind of referenced this, so I think it’s…maybe this is your secret sauce. So, you could, you know, share as much as you’re willing. But among sustainable quality materials, what are the specific things that give you bang for the buck that ultimately pay for themselves financially with a certain holding period? And are there any examples of, you know, sustainable type building that is pure luxury? You know that financially doesn’t really make sense right now, because, obviously, you kind of have to sort through these from that cost-benefit analysis standpoint.
Lorenzo: Yeah, look, it’s very important. I’ve been focused on this since day one. It’s important that we balance this evolution. It’s not a revolution, it’s an evolution in our space. And unless we drive return for investors and efficiency for end buyers, this evolution will be slower than what it should be. So, we ultimately always make decisions that are looking at the recurrence for these two very important stakeholders, the investors and the end buyers. But let me give you two very specific examples on some of the materials that we’re starting to source that help us increase efficiency but also control the costs.
One example that I love to give because it’s an interesting story. And it’s, to some extent, reinforcing in how we can leverage innovations in other industries as well. I recently met with a rice producer in the northern part of Italy. And I didn’t know this, but when you produce rice, about 70% of your production is basically waste. And so, that waste gets burned. And of course, it creates CO2 emissions. And this company actually started innovating and leveraging the waste from their production to build insulating materials. So, they leveraged the waste of rice production. If you’ve ever burned rice in your cooking experiments…
Andy: Well, you know, that makes me think, the burnt rice and the rice cooker has the best taste of any of the rice. I don’t know if you…
Lorenzo: Well, when you burn rice, you think about this rice cake type of structure. And we’ve discovered through a number of different experiments that that material is extremely insulating, better than many other materials that have been used in construction last longer, less polluting, and very cost-efficient. So, we started, as an example, experimenting using these materials, building strategic partnerships with companies like the one that I just mentioned. And that’s how we protect margins, source innovative products, and make sure that we are at the frontline of innovation to always build better and improve performance. And just to use that example, the cost differential between using those materials and the traditional materials that are used for insulations factors in difference, which allows us, of course, to improve the performance for investors.
Andy: Interesting. Is there any… you know, in that luxury segment, are there any eco-friendly or sustainable type of things that people do that are negative ROI? I mean, that, you know, people are free to do them. But you know, is there any specific material or I don’t know, solar or something where you say, “That’s nice, but that just doesn’t make financial sense right now?”
Lorenzo: Yeah, look, I’m a fan of solar but done well. And I think, oftentimes, I see projects, especially in luxury buildings, where solar is I would describe it as a good…as a…
Andy: Gimmick, or?
Lorenzo: Almost like a gimmick, right. It’s more personal branding rather than actual economics. If you do solar well, and you can see a number of properties, for example, in California has done solar very efficiently where they’ve reduced their energy costs almost to zero, then it makes a lot of sense. But to do solar well, I think we also need to innovate how we think about architecture. An example I’ll give you, especially in the high-end real estate, luxury, real estate, we’ve traditionally built a 90-degree angles. If you think about most of our homes, most of our buildings are in 90-degree angles. If you think about nature, our bodies, plants, trees, they’re oftentimes, if not always, in cellular shape. And there is a reason for that, it’s much more efficient to capture natural light, to capture sunlight, to facilitate the flow of water. And there are many other examples that I could mention.
And so, in luxury homes, I think there is an opportunity to think about different architectures that may be more expensive from a construction standpoint but where the returns from an efficiency standpoint might be more significant than simply putting solar panels on the roof.
Andy: Understood. Okay, that’s interesting. You know, I had one other question, it seems like Shape Equity Partners, you’re doing a lot of innovation just in terms of materials sourcing and creative use of materials that a lot of competitors would be overlooking. But given that you’re sourcing a lot of them from Europe, did you see any disruption? Are you seeing any disruption from, you know, the ongoing supply chain issues, you know, the Russian invasion of Ukraine? How has this affected your business in the last 24 months?
Lorenzo: It’s had an impact. I think it’s undeniable it’s had an impact. I think the most important aspects of this that we can actively manage, is providing visibility to our suppliers as early as possible. So, to some extent, in most of our projects we have, as we start due diligence and when we have a pretty strong commitment from our investors to move ahead, we can start building proper construction plans and start sourcing these materials and scheduling. They deliver these materials sometimes even 9 to 12 months in advance. And so, we’re less impacted by supply chain issues.
The biggest issue, frankly, has been at the border right? Once the material arrives, now we’ve seen things being blocked at the border for a couple of months, sometimes, but we’re trying to manage that proactively and making sure that we give visibility to our suppliers. Now, I mentioned Europe, our goal is to actually source some of these materials and accelerate some of the innovation here in the U.S. as well. We’re exploring some interesting partnership in the Midwest with millworkers, window factories, and some service providers that are innovating in the theme of efficiency.
Andy: Yeah, that’s interesting. I mean, ultimately, I would think in the name of efficiency, as much as you can locally source is even better. But I mean, I can only imagine the complexity in supply chain for developers in today’s day and age, especially given, you know, the challenges of the past 24 months. But it sounds like you’re very proactive. And I can only imagine that that’s the best way to be. Lorenzo, I can’t thank you enough for joining us today. And just, you know, giving us some insights into some cutting-edge building practices. So for our viewers and listeners, if you have any investor potential investors who are interested in Shape Equity Partners, where can they go to learn more?
Lorenzo: Well, Andy, first of all, thank you for having me. It’s been a pleasure talking to you and sharing some of these themes. I hope you felt the passion for what we’re doing here at Shape Equity. If you wanna learn more, please visit us at shapeequity.com. And I look forward to meeting hopefully in person with you, Andy, and anyone that would be interested in some of these topics.
Andy: Sounds great. And we’ll be sure to link to that website in our show notes page, which our show notes are always available on altsdb.com/podcast. Lorenzo, thanks again for joining us today.
Lorenzo: Thank you very much.