Viewpoints

Dollarable Resilience: The Future of Sustainable Real Estate Investing

Posted on June 28, 2018 in Viewpoints by admin

By Eli Zoller, 2018 NAREIM Intern

In his fight to save the Hetch Hetchy Valley in northern Yosemite National Park in 1908 from being made into a reservoir to serve San Fransisco, John Muir wrote to the American Civic Association and the US House of Representatives. Pleading for its preservation, he said “Nothing dollarable is safe, however guarded.” Muir lost. Perhaps he was simply outnumbered. Likely, his passion for the far side of a hotly contested issue made compromise impossible. Maybe – just maybe – he had no idea just how universally right he was given the scope of overwhelming influence that free markets would have on our society. Could he have imagined that he might be addressing the things we’d build as well as those we’d destroy?

Today, as data validates the realities of climate change, the real estate industry would be wise to heed Muir’s words – but, perhaps, with a different perspective. Ocean front property and coastal metropolitan areas are seeing all-time high valuations.  As sea levels begin to rise, these urban properties will eventually find themselves underwater – and those once “dollarable” assets found in numerous investment portfolios will suffer significant losses. However, rather than fleeing risk, the implementation of resilience and adaptation to the changing climate will not only produce improvements to our planet but also to our profit.  What if real estate began to collectively accept resilience to climate change, not merely as defensive, but rather as dollarable?

The potential for enhanced value is here now – and it’s sitting along side the real estate industries involvement in combating climate change through sustainability, resiliency best practices, and the unmatched power of one of the largest asset class in the world.  Now, if John Muir had odds like THOSE…

…but the question for our times is: how?

To better understand what comes next, observe old adage: “Prepare, adapt, or migrate.”  These hazard reactions effectively relate the keys to seeing the real estate industry’s way towards profitable resiliency.

Migration

While there are numerous humanitarian imperatives that strike at the heart of the need to combat climate change, it’s imperative for real estate to see the strategic immediacy in counting the disproportionate effect that climate events have on lower-resourced communities.

While this demographic is experiencing climate risks more immediately and more dramatically than those with greater resources, the financial effects of these differences are felt throughout the real estate industry. Typically, this community consists of renters of property with little to no recourse against extreme climate events. In addition, their ability to absorb shock to their livelihoods are equally disrupted. In the aftermath of Hurricane Harvey, for example, approximately 25,000 people in the Houston area lost their jobs – as reported by the New York Times and The Houston Chronicle. Why? Most of them couldn’t make it to work due to impassable roadways and no personal means of transportation.

The wealthy may have the ability to withstand these scenarios, but the underprivileged are unlikely to rebound without their prior employment. Through sheer grit and determination, they will pack up and leave with no need to return. As a significant majority of the workforce, so heavily disrupted by climate events, production dramatically decreases taking GDP with it. Joyce Coffee, Founder and President of Climate Resilience Consulting, points directly to how real estate should begin to evaluate this relationship more closely. “Inequitable places tend to show significant decreases in property values. GDP is always distorted and eventually lowered in places of inequity, and real estate investors understand that declining GDP has a direct impact on their bottom line.” High priced assets may have protections against storms and floods, but there is no protection for a single building against declining value due to a drop in GDP.

Where those who struggle to survive are migrating after a disaster strikes, those with greater advantages are fleeing potentially hazards for higher ground before the rains. These demographic patterns have resulted in the systematic displacement of lower-resourced communities in what is recognized as climate gentrification. As those who can afford to re-locate strive for an inland utopia, segregation and economic disparity increases resulting in financial cost to all.

In Spring of 2018, a joint report by the Metropolitan Planning Council and Urban Institute was released detailing the financial effects of Chicago’s segregation (Chicago being a tragic model for racial disparities similar to those in areas of climate gentrification).  “If metro Chicago were less segregated, it could see $4.4 billion in additional income each year, a 30 percent lower homicide rate and 83,000 more bachelor’s degrees. […] Not only low-income people and communities pay the price, but segregation hampers the economy and quality of life for everyone.”

When a climate disaster strikes, lower-resourced individuals and the disenfranchised alike understandably look to government assistance. However, disparities such as those outlined by the MPC remain widely  unaddressed. Ineffective or nonexistent policy from local governments have dramatic financial impacts on social safety nets, negatively effecting the entire tax-paying public on multiple fronts. These same miscalculations that will eventually precipitate a drop in GDP in climate hazardous parts of the country are being employed in the safe havens as well…and the real estate industry is invested heavily across all of these areas.

When people find themselves in a location where they can’t work, or they can’t live, they move – and no matter what, buildings won’t move with them. Migration is not a climate resilience solution for anyone. It’s time for real estate to engage in a drastically altered perception towards resilience so that we might improve the bottom line, rather than continue the all-too-common mistakes of our recent past as the waters continue to rise.

Adaptation

Even in when statistics reveal an immediate need to adapt, more often than not, the inability to do so is directly linked to ones resistance and subconscious fear of change. Shocking to some, obvious to others – there are still very few market drivers towards improving climate resilience for commercial real estate. Too much of the instinct that has driven the antiquated methods of value-add real estate acquisitions don’t factor in the kind of readily available data clearly identifying high-risk property locations.

FEMAs Stafford Disaster Relief and Emergency Assistance Act does provide resources to rebuild and, if necessary, act as an insurer after a disastrous natural event, while doing nothing to increase resiliency for land use and building practices. Some may take this as an indication that exposure must not be all that entrenched in our current holdings, however presumptions like those assist in creating a distorted view of false security.

In May 2018, Nils Kok, Chief Economist at GeoPhy, along with Ali Ayoub, published their findings examining the exposure of all properties held by 133 equity REITs with assets in the U.S. as of the first quarter of 2017. “As it turns out, only 2 REITs are not affected by flood risk. The other 131 REITs are affected by flood risk— for these REITs, on average 87% of the portfolio measured by size (square footage) is exposed to at least some flood risk, as defined by FEMA. Looking at assets that are exposed to high risk, according to FEMA, about 5% of the average REIT portfolio is affected. That number may be small, but the value-at-risk is of course much higher.”  Dealing with a disaster after it happens isn’t helping anybody’s profitability. If someone were to try and sell you a boat with an 87% chance of sinking, you’d laugh them out of the room.

We’ve seen the damages that climate change related events have on various communities around the country, especially and significantly on our coastlines; and yet, these markets inexplicably remains un-phased.  Joyce Coffee offers insight into why this might be, saying, “People still desire to live on the coast. While the numbers show that there has been damaged property in areas that will soon be less tenable to live in based upon the scenario of climate change, we are not necessarily seeing that the market understands those changes.” How does market analysis like that make any sense? A market with rising values in risk-prevalent areas is an illusion suggesting that climate resiliency doesn’t require immediate attention within a portfolio. Have the repeated habits of investment managers seeing 5 year holdings as ‘long-term’ distracted our attention from greater profit through resiliency? Or is it simply that the information hasn’t evolved into a generally accepted factor against value-add risk?

Giselle Gagnon, Senior Vice President of Strategic Resources Group and Advisory Committee member of the Intact Center on Climate Adaptation sees the challenges facing investment managers when it comes to analyzing resiliency. “It’s a big assignment to tackle. It’s not necessarily a lack of awareness of the issue, but rather the level of opacity and ambiguity that surrounds it.  For many, the struggle is ‘where do we start?’”

As some understandably struggle with how to proceed, improving methods for underwriting are enhancing foresight while simultaneously exposing the financial folly of short-sightedness. The recommendation of Scenario Analysis by the Task Force on Climate-Related Financial Disclosures (TCFD) reenforces the markets need for evaluation methods that “enable companies to start thinking about what might happen and build resilience to that range of plausible, but divergent, future worlds” as described by Fiona Wild, Vice President, Climate Change and Sustainability for BHP Billiton.

The TCFD feels strongly that this analysis represents an example of the tools that will improve risk assessment over time. As that happens, not only will Scenario Analysis (and tools like it) enable a more proactive financial approach, but the auxiliary effect will be exposed portfolios decreasing in value without the physical damages of a hazardous climate event on their property.

Even though the miscalculations of the past have cost land, money, and population, the solutions are readily available.  We’ve already recognized them; now it’s time to acquire the instinct to trust them.

Preparation

Ignoring the cartoon character real estate villain who cares nothing for no one, everyone with property value on their balance sheet appreciates that healthy populations make for rising equity. By any measure, climate change poses a direct threat to that success. Solving big problems require big changes. Commercial real estate is in a unique position to reinforce societal improvements and better fiscal practices on an investment level to combat the risks of seismic events.

It’s time to look beyond the fence lines of our property holdings to seek the kind of political, social, and regulatory support needed to enable proactive leadership towards preparedness that everyone needs. The time has come for commercial real estate to quell hesitations and embrace a firm revolution of resiliency based on two grounding principles: we have all of the resources and everything to gain.

To be certain, change will come with growing pains for real estate and local governments alike. As Joyce Coffee emphasizes, “Preparation, building differently, and investing in helping the cities around us to help mitigate risk are generally the things that the real estate industry has paid very little attention to. The total value of any property has everything to do with whether healthy water will be available, the roads around it won’t be flooded, and the electricity will be able to withstand a major storm. Taxes will be raised, rates will be raised, and funds will be used to maintain seashores, increase infrastructure resilience, and to invest in changing design guidelines.”

Further challenges are sure to arise when examining areas where resources for change aren’t as readily available. While the investment exposure may not be found directly in these areas, more often than not commercial real estate is heavily invested in the neighborhoods surrounding them.  These middle income properties are going to find themselves behind when the land around them is overwhelmed. Their exposure is dramatic, even if it hasn’t been realized by direct contact with a climate event. If we engage these more desperate municipalities in seeking solutions, property values within and around them will reap significant benefits in the immediate and long-term.

While this kind of approach has not yet achieved industry best practices, companies are taking tremendous strides to incorporate informed investment strategies to meet these new goals. Bentall Kennedy Group, as an example – with over 550 institutional clients and $36 billion AUM – have released their corporate responsibility summary within this past second quarter of 2018 with an entire focus on “Driving business through sustainable action.” “Our sustainability strategy is informed by a robust approach to social, governance, as well as environmental strategies designed to maximum long-term value for our clients” remarked Giselle Gagnon. And it shows, as Bentall Kennedy reported to have $9.2 billion in LEED certified assets in 2017 and significant waste diversion, water consumption reduction, and utility and greenhouse gas reductions adding up to a savings of $3.77 million dollars.

Creating environmentally and socially responsible properties for tenants to live, work, and play may be the winning strategy moving forward, and Giselle Gagnon reminds us that “There are many industries with a stake in appraising climate risk. Appreciating the interplay between the investment, insurance, and banking communities (those that own, insure and finance real estate) points directly to a need for broad collaboration and understanding of investment risk mitigation.” All the more reason to act now towards incorporating sustainability and resiliency into a business context.

As investors begin to see these methods increase profit margins, it is crucial to consider the following factors in the first stage of any real estate investment:

All of this information prepares us for better investment, better returns, and a better society all at the same time…but it’s up to real estate leadership to influence this necessary change. Portfolios can do better. Local government can to better. The underprivileged can be better supported, as this is clearly not a “poor person’s issue” any longer. It’s time that investors and managers understand that uninfluenced market trends are part of the problem; therefore, new strategies must be a part of the solution before the market shifts in the worst possible way, as Joyce Coffee suggests, “There’s going to be a moment when someone is going to lose VERY big due to unchecked climate risk; changing the tempo of who buys what and where. Without these changes were inviting enormous market failure.”

———

Should you have the pleasure of seeing Yosemite in person, you may find yourself struck by the vastness of it all.  With so many mountains, valleys, forests, and bodies of water in one dense accumulation of land one might expect to feel distracted; but no. It all seems to come together in perfect harmony. Ironically, some could feel the same way about cities like San Francisco.  All of the humanity, industry, and culture assimilating in one ecosystem of success. John Muir didn’t care much for cities. Swaths of “Thousands of tired, never-shaken, over-civilized people” he called them. He also said, “Most people are on the world, not in it — have no conscious sympathy or relationship to anything about them — undiffused, separate, and rigidly alone like marbles of polished stone, touching but separate.”

The admiration that exists for John Muir is unimpeachable, and it’s hard to believe that cynicism came naturally to him, but he could not see what we see today.  San Francisco doesn’t need the Hetch Hetchy Valley now, just as the real estate industry doesn’t need to repeatedly become victim to society’s inability to co-exist in combating climate change. Our cities, our business, and our planet could all be better.  And WE have the power to be the leaders in an industry that might see that potential become reality.