A&E 2016 Meeting Report: Do we change the design – or design the change?
(for a print version of this report, click here.)
“People are messing with our stuff,” declared NAREIM president Gunnar Branson. “The users of our real estate are using it for different things than we designed them to be – turning traditional office buildings into creative spaces, using retail spaces differently, even turning their homes into hotels. Investors are driving change as well. They want more control, more oversight, and ultimately more information. They are pushing us to provide the same level of transparency and low cost of other investment vehicles.” The old way of doing this business will not continue, and everyone in this business is required to stretch themselves beyond old limitations.
During the NAREIM Architecture & Engineering meeting last Fall at The Torrey Pines Lodge in San Diego, the discussions focused on very physical, very real, environmental and construction challenges – and questioned how design and planning can help create the resiliency all investment management firms will need in the years ahead.
What about the water?
“1075 is a magic number in The Colorado water compact and for the 7 member states,” said Gregory Herriman, head of Engineering and Construction for Deutsche Asset Management, “when Lake Meade drops below 1075 feet, automatic cuts to water supply go into effect. Lake Meade has been on the edge of that level off and on all year.” Another interesting number is 80. “80% of Los Angeles water is imported from elsewhere.” We need water more than we need gas or milk however most people couldn’t tell you the true cost of a gallon of it. As the old saying goes, “what goes unmeasured goes unmanaged.” The price per gallon of water is rising faster than any other utility.
“Many people think that water scarcity is only a problem on the west coast. It is an extreme problem there, but half of Massachusetts is also in a constant state of drought,” according to Herriman. It’s only a matter of time before the problem expands. So what can we do? There are many updates to EPA regulations attempting to help. For instance, the minimum levels of PCB’s now allowed in your wash-down, or the new requirement that all dumpster lids must remain closed. However, “what they’ve really done is spread out the ability to give us more fines.” Is that really helping?
Ben Slick, VP of Business Development for Hydropoint, argues that thoughtful conservation, rather than government regulation, is the way to go. The penalty for water waste is far more severe than any fine. “When you leave your air conditioner on it wastes money but it doesn’t really hurt anything. When water goes where it’s not supposed to it creates real problems. Water can be nefarious stuff,” according to Slick. “40-70% of the water we use in the country goes to irrigation. And much of that irrigated land is over watered.” This is due to the common practice of implementing a basic timer switch to operate the sprinkler and good old-fashioned guess work to decide how much time it should be running. Upon closer inspection, the actual needs change from season to season and year to year. Also, if a sprinkler head malfunctions ½ a mile away, your basic timer will not catch the problem. “Ever wonder why you have to reseal your parking lot every couple years? There’s a good chance that irrigation runoff is accelerating the degradation.” Big Data can solve the problem quite easily. “Simply changing the control device you use can save you quite a lot.” Many of these systems do not require the entire system to be overhauled, just the control unit. “If zone 2 is running outside the threshold at 3am, these systems will automatically shut it off.” You’ve just saved hundreds of gallons of water.
The water problem is big – but the solution may be as small and as simple as smarter controls.
What about the pipes?
Another important way to save money and improve the environment is to build correctly and maintain as needed. A broken sprinkler head outside may degrade your parking lot, but a leaking pipe behind a wall can be much more devastating. “If your water is outside the standard PH level it can degrade copper pipes over time,” says Lloyd Meissner, Engineer for Crane Engineering. Water and metal don’t mix very well. A photo of any old shipwreck can tall you that. However copper pipe is still the best choice available. “But you have to use the right pipe the first time.” Meissner recounted a story of moving into a 10 year old building with a leaky sprinkler system. “10 years in they had to replace the whole system because they used the wrong pipe to begin with. It may be cheaper initially to use schedule 10 pipe as opposed to schedule 40, but when you go to repair it, the incredibly thin walls of the schedule 10 pipe make that very difficult.” It sounds overly simplistic but it’s true: Thicker is better.”
Tiny missteps in initial plumbing can create serious problems down the road. “An edge that wasn’t de-burred before being soldered in will create turbulence, which will lead to pitting and erosion. Resulting in untimely and expensive repairs,” warns Meissner.
So sustainability and environmental concerns should be addressed in both old ways and new. Cutting edge green building must also include basic steps like water tests. “Even if you’re not going to do extensive testing on your pipes, at least do a water test. It’s the simplest and cheapest way to give you a good indication.”
How much thought is going into examining the pipes in your acquisition due diligence? Depending on the building, this small detail could blast a very big hole in anyone’s pro-forma.
Are we making real progress on sustainability?
Does building to a higher standard really increase the bottom line? Will it attract more investors?
“There is a return on investment for sustainability. It’s good business and it is the responsible thing to do,” says Gary Holtzer, Senior Managing Director and Sustainability Officer at Hines. “While all of the measuring tools and benchmarks out there are beneficial, the real magic of sustainability happens at the property level.” Hines operates in 20 countries with investors from all points on the globe. “We have to tailor each property to the investor. If that person is Dutch they will be all over sustainability. If they are from the far east, maybe not so much.” While Europe is seen as the scion of sustainability, “it is much easier to get energy tracking data in New York City that it is in Paris. The US makes it very easy to quantify usage compared to just about any other country.”
“The first building to get an Energy Star Label was in St. Louis in 1999,” said Dave Pogue, Global Director of Corporate Responsibility for CBRE. “By 2006 we required all of our buildings to report to Energy Star so we could use it as a benchmark.” In 2005 about 5% of institutional grade buildings in the 30 largest markets had Energy Star Ratings and only .5% had LEED. In 2016 over 40% of commercial office building space in those markets now has either certification, or both. If you break that data down into classes of buildings the percentage goes up. “These days if you’re a big building in a major market you have to be green. It’s not even unique anymore. If you’re not LEED you’re not a class “A” building.”
However, LEED is a benchmark that is focused on mainly environmental concerns. GRESB is a global benchmark that focuses on environmental, social, and governance concerns (ESG). “This is where global markets may have us beat,” says Pogue. “The Dutch are just as concerned with labor practices and legislation, about how a company thinks and what it does, as they are about energy usage.” But trying to compare the US to France, The Netherlands, and Singapore raises an interesting problem. “It’s mind numbingly impossible. There is no consistency,” says Pogue. There is no benchmark for the benchmarks.
What is the cost of building green?
“You can simply build to code or you can make marginal investments for marginal benefits down the road,” says Dan Winters, Head of North America for GRESB. Whether you build to LEED, GRESB, Nabors, Green Star, or any other benchmark, “you can use these ratings at financial moments of truth: leasing, sales, acquisition, disposition, or capital raising.” When an LP makes an investment of hundreds of millions of dollars it allows them to have a better idea of how your company operates and where it sees opportunities. “Transparency is the key to any successful capital market and GRESB is a way to add transparency.” Their very mission is “to enhance and protect shareholder value.”
“Five years ago we thought that green buildings were going to save everything,” mused Andrea Chegut, PhD Director of The Real Estate Innovative Lab for MIT Center for Real Estate. “They were going to reduce carbon, solve our energy problems, solve our water problems, and reinvent the built environment.” But after living with these benchmarks for a decade or more, “it is now apparent how difficult it is to take an innovation from the peak of its expectation into standard practice.” But this diffusion of an innovative idea into the market has a pointed effect on the bottom line. “Green buildings have 2-5% higher rents, 3-7% higher effective rents, and 11-13% higher transaction values.” The loud and obvious counter argument is, “but it costs more to build!” So Andrea set about the task of finding out if building green was actually more expensive and by how much. After a couple years of sifting through construction data, “We found that, on average, it is not statistically or economically more expensive to build green.” Over the course of the construction period there is net effect. “Interestingly, we found that the single item with the biggest cost differential was the design phase which is what the people in this room deal with the most.” Because this is also the first phase of development when information on the future of the development is incomplete and capital is scarce, green building seems to be more expensive than traditional design. It can start out to be so in some cases, but as Chegut’s research demonstrates, the total cost of construction evens out by the buildings completion.”
What about building brown?
Federal law states that if you own a site with environmental contamination, you are responsible for the cleanup. Even if you acquired the property without knowledge of the situation, even if that contamination got into the water table, even if it has migrated beyond property lines. It’s a buyer beware situation and cleanup can take years. “Working on the Atlantic Station brownfield development, it took 6.5 years from contract to revenue generation,” says Gerald Pouncey, Partner at Morris, Manning, & Martin, “Most projects can’t take that kind of timeframe. You won’t have any investors.” This presents a compounding problem: if there is no incentive to clean up these sites and repurpose them, if there is no consideration for the added complexity and expense of the work that must be done, then “people just stay away from these types of deals.” Which leads to ever present contamination.
After that project, and the obvious problems it illuminated, a former governor of Georgia enlisted Pouncey to, “find ways we could incentivize this type of development without changing the federal law.” They came up with what they call the “Georgia Brownfield Law” which limits the owner liability to the soil within the property limits. It releases them from responsibility for the water table or any contamination outside the property that may have originated within property limits. “22 years after the federal law passed we saw 200 properties redeveloped in Atlanta. In the last 12 years since we passed the Georgia Law over 400 properties have been redeveloped. One of which is the BeltLine.” So obviously the law worked. “There are now mechanisms in place in 44/50 states that ease redevelopment of urban cores.” Could these laws be contributing to the unprecedented growth and retention of urban populations? Might they have created a tipping point that makes staying in the city more attractive in the long term? One thing is certain, many of the most interesting and innovative projects of the last 15 years wouldn’t have happened without them.
What about urban resilience to future problems?
“With climate change and the rising sea levels, the implications to commercial real estate are enormous,” warns Chris Wilson, Managing Director for LaSalle Investment Management. “For those of us with US properties with coastal proximity – such as lower Manhattan, The Boston Seaport District, Miami, South Beach, or New Orleans, sea rise risk and the potential for increased storm risk and flooding is a growing concern – a risk that capital markets over time will eventually begin to recognize and price into commercial real estate valuations. In Europe, roughly 50% of major urban centers are within two meters of sea level. And in Asia Pacific, many major urban centers have similar coastal proximity with increased sea rise concerns.”
“With so many people migrating to urban areas that means more populations are exposed to risk,” says Doug McCoach, VP of Calliston/RTKL. When Hurricane Isabel hit Baltimore in 2003 the whole city flooded. Verizon had a technology hub there with the entire infrastructure in the basement. McCoach and his team were tasked with getting the system back online. “Our solution relied on bringing in generator sets and trailers to maintain operation until the water receded but this was an entirely reactive approach. We knew we needed to be more proactive.” How do you protect important communication hubs that are in flood prone locations?
“Corporate America is sitting on a treasure trove of distressed property,” says McCoach. But they have been without a quantifiable way to assess the risk involved in acquiring these properties. CRTKL has created just that. “We’ve done land surveys all over the country that can show, with great accuracy, the value opportunities for redevelopment of undervalued or contaminated properties.” Their work on Hastings on Hudson, Sao Paulo, The Coler Hospital in Queens, and the East Side Resiliency project on the south tip of Manhattan, has proven that assets can be protected from rising sea levels. “Properly done, these redevelopment can greatly increase property value and improve lives.”
“We all have had our wake up call,” says Edgar Westerhoff, National Director of Flood Risk Resiliency for North America at Arcadis. Hurricane Katrina, Hurricane Sandy, and various other natural disasters have made it painfully obvious how vulnerable our great cities are. “Half of New York City was without power for a week. This was devastation. But New York has made tremendous progress in studying what the water will do and planning for that.” One way New York is approaching this offensively is reinforcing the southern tip of Manhattan with removable walls that do not damage historic buildings. “However this system takes roughly 6 days to set up, which will not work in the case of a hurricane.” So Arcadis designed walls that flip down automatically in the case of an immediate need. When not in use, they are a canvas for artwork that beautifies the cityscape. The old truth of, “build on high ground” has never been more pertinent. But we cannot simply abandon hundred of billions of dollars worth of prime assets. Advancements in levies and preventative architecture can do a lot to mitigate the threat but investors and developers alike will be thinking very hard about future opportunities and their proximity to floodplains.
There are the obvious, front of mind, issues associated with sustainability and resiliency: decrease fossil fuel dependency, find alternative energy sources, reduce the carbon footprint, and use sustainable building materials. There are also more nuanced day-to-day steps we must take: efficiently manage existing resources, employ basic good building practices, collect better data, and carefully adopt new tech.
The architects and engineers are now tasked to lead the innovations that the investors and users of buildings demand. This is nothing new, with the advent of the automobile architects and engineers were tasked with designing intricate roadways, parking, and urban centers that would now revolve around a completely invasive form of transportation. The same was true with the advent of the light bulb, central HVAC systems and the Internet and any number of other innovations. Once again, we have to build for the people who live there, once again we have to adapt to a changing world.← 2017 Compensation Survey Underway L&C 2016 Meeting Report: What do we do now? →