S&I 2017 Meeting Report: Pay Now or Pay Later

Posted on May 2, 2017 in Viewpoints by Admin

_L2A6198“ The human race is challenged more than ever to demonstrate our mastery – not over nature, but of ourselves.”

– Rachel Carson

(For a print version of this report, click here.)

Sustainability, despite skepticism in some quarters regarding global warming, has become almost universally embraced as a good thing to do in commercial real estate. It’s efficient, it is valued by the best quality tenants, and is welcomed by most as an aspiration. The practice of sustainability takes many forms, has many staunch advocates, and has a growing number of benchmarks, but is it entirely clear that sustainability is more than just the best interest of the planet, but also of the investors? Is sustainability a special thing we do, or is it an essential part of investors’ operations? Is it more than an operating or construction guideline – perhaps even a strategic imperative for acquisitions? Are we thinking and acting upon sustainability first, second, or third when considering an investment?

Everyone agrees with sustainability, but does everyone do it? Or rather, is there someone in the office that worries about LEED certification while everyone else continues business as usual? As Gunnar Branson, CEO of NAREIM pointed out, “It might be harder to change behavior than it is to change your mind. Everyone agrees wholeheartedly that sustainability is important, but if we are brutally honest with ourselves, I’m certain that all of us in this room are still behaving in unsustainable ways – perhaps in the last 24 hours. Maybe I left the lights on this morning when I left the house, maybe I ran the lawn sprinkler longer than needed, maybe I threw something away instead of recycling. We might agree with sustainability, but to truly transform, we have to make it a core part of our every-day behavior, whether we’re at home or putting real estate investment capital to work.”

The hard work of integrating sustainability into everything we do is a very real challenge.

How can that be done?

To find out, NAREIM hosted it’s first gathering focused entirely on sustainability. Co-hosted by NAREIM underwriter, GOBY, Inc. The meeting was held in a bank vault originally built in 1930 that is now a modern meeting facility. Over a full day, attendees explored evolving technology, thinking and standards as well as “next steps” for sustainability and investment management.

What is the value of GRESB for investors and managers?

Dan Winters 2“GRESB was originally started for several institutional investors,” explained Dan Winters, Head of The Americas for GRESB. “And our entire focus is on enhancing and protecting shareholder values. We do it through a focus on Environment, Social, and Governance issues (ESG).” Everyone wants to build the cleanest buildings with the best working environments that foster healthy, happy, productive employees, but what is the risk, what is the value? “We try to tease out the answers with our work,” and find out what really creates sustainability, mitigates the risk, and ultimately adds value to a portfolio. They do it by looking more broadly than the sustainability of an asset. Unlike Energy Star, Green Globes and LEED, GRESB expands the focus beyond the physical assets, “We rate the companies themselves.” After all, an investor invests in a company and it’s people more so than just the buildings. “We play at the portfolio level.”

According to Winters, “Investors are demanding that managers participate in GRESB while they have their money in a fund.” If this doesn’t give credence to the thought that a benchmark like GRESB impacts investment quality for the better, what does? “Investor side letters are even starting to demand minimum scores.”

Roxana IsaiuBut it’s not just investors demanding change. According to Roxana Isaiu, Director of ESG & Real Estate at GRESB, managers are using their report as a differentiator. “If you score well you can send the report out to investors and show them how well you did.” Because GRESB focuses on the entire portfolio and the people managing that portfolio, it’s an incredibly strong vote of confidence, not only for the quality of your properties, but the quality of your portfolio as a whole and it’s management team.

How does the new WELL standard for health and wellness impact your business?

“In 1976 at the Philadelphia Bellevue Stratford Hotel a conference was held by the American Legion,” recounted Brenna Walraven, President and CEO of Corporate Sustainability Solutions. “Unfortunately, Legionella was growing in their cooling tower and 135 people were sickened. 25 people died. Just because the lobby looks good doesn’t mean a building doesn’t have meaningful air quality problems.” The impact of basic maintenance and proactive upkeep is incredibly important and quite often under discussed. Erecting buildings with sustainable materials, circadian lighting systems, and state of the art air filtration systems dominates the conversation on sustainability, but as history has shown, the quality of the indoor environment can be a matter of life and death.

Brenna Walraven“The WELL Standard is a rather new benchmark that takes into account indoor air quality,” says Walraven. “There are 25 different studies that connect productivity gains to indoor air quality. Harvard came out with a study that showed our very cognition is increased by good air quality and flow.” Per the old question, “what are the risks?” It is becoming increasingly risky to not adhere to these standards. “ASHRAE has come out with a standard for maintaining your HVAC systems. This means that legally, you have a responsibility to perform to these standards otherwise you can be held liable.” The benefits are becoming increasingly obvious, and the risks increasingly dire for failing to adopt a serious approach to the standard.

The public is becoming very aware of the importance of these measures, “It won’t be long before some young employee walks into work with an app that measures air quality and exclaims, ‘I can’t possibly work under these conditions!’”

Chris Pyke“We have been talking about this since the 70’s,” said Chris Pyke, Chief Strategy Officer at Aclima, “And back then, we, as an industry, were the problem. Our credibility for being good managers of the indoor environment is pretty marginal.” Harvard has proven that conditions that we and our tenants experience on a daily basis have a negative impact on cognitive function. In other words, “The buildings we live and work in are actually making us stupider. They are way below ocean grade levels.” A nuclear submarine operates with a carbon dioxide level of 5000 ppm’s. “That level gives you headaches, makes you lethargic and puts you to sleep. It turns out one fifth of that level makes you a substantially worse decision maker. We don’t manage our buildings to 1000 ppm’s, but it turns out we should. And that makes a lot of sense.”

Anything that is well managed will ultimately lower cost. Tenants do not want to be experts in real estate. Nor do they want to be experts in indoor air quality, “they expect that you are doing that for them,” according to Walraven. It’s only a matter of time until the clear connection is drawn, between indoor air quality and higher NOI.

How Are Environmental Regulations Changing?

“Cities like New York, Boston, DC, and San Francisco have bold goals,” according to Cliff Majersik, Executive Director at the Institute for Market Transformation. “They want to reduce carbon emissions 50% by 2030 and 80% by 2050.” It has been found that 50-75% of greenhouse gas emissions come from buildings. “Only a fraction are government owned and new construction only accounts for about 1% of the total emissions. So you have to focus on the buildings that are already there.” This means that the CRE industry is directly in the crosshairs for regulatory reform and will have to bear the brunt of the burden to meet those goals. “You have a series of mayors and elected officials that have run campaigns pledging to achieve these levels of reduction, but they are still working to figure out how to achieve it.”

Many states now require businesses that manage properties over 20,000 sq. ft. to Energy Star Benchmark their buildings. Energy Star is effectively the standard for the CRE world but sometimes adhering to that requirement is difficult. “In order to benchmark a building you have to be able to measure how much energy your tenants are using,” noted Majersik. This information is not always easy to obtain. “How many of you have had difficulty getting access to tenant information?” His question was answered by fairly uproarious laughter. “It can be difficult to say the least. California however is being very proactive about this problem.” As of January 1st 2017, California requires all utility companies to provide energy usage information to consumers. “Now this is aggregated information, but on a building level you get the data that you need.”

Cities are striving to move the needle on environmental improvements. In an effort to do so, some are going as far as offering free environmental audits to identify where owners could make improvements and save money as well as improve the environmental impact of their buildings. The audits are intended to incentivize owners to do the work of their own accord.

As more and more research is done and more and more studies prove the importance of reigning in our emissions, the governmental regulations are sure to increase.

How should buildings prepare for natural disasters?

Bob Best“Natural Disasters are a way of life now,” Said Bob Best EVP and Director of Sustainability & Services for JLL. “Something that most people forget is that you have to have a plan that can be implemented while the disaster is happening that can lead you into recovery.”

“Hurricane Sandy was an enlightening event,” said Best, “Because all forms of communications went down. Even the satellite phone system was non-functional.” Up until that point JLL had been offering an online disaster protocol service for the buildings it managed. “Well that only works when you can get online!” Best offered a tip: “There are these things called three-ring binders and we discovered that every manager has to have one of these at their home filled with the disaster plan.” Binders don’t lose functionality if the power goes down.

Best showed a photo of the Goldman Sachs Building at the southern tip of Manhattan with all it’s lights on, while the rest of Manhattan, up to 37th Street no less, was dark. “It was one of the only buildings with power and without flooding because the building manager knew what he was allowed to do.” The other critical element to keep a building up and running is cash. “You have to have a good amount of cash on hand, 10 or 20 thousand dollars, because you have to buy fuel for generators and they can’t take MasterCard when there is no electricity or internet.” Building managers have to buy fuel on street corners and those without the means to purchase fuel don’t get any.

JLL offers an online preparedness program to all their clients. “The first question is what kinds of disasters does one need to be prepared for?” If you’re in California, you need to worry about fire. If you are in New Orleans, you need to worry about water. How you prepare your property managers and staff can have serious consequences. “When Katrina happened we managed to get some resources down there, including some of our more adventurous chief engineers. Somehow they talked their way past the National Guard and into the flooded areas. They had an aluminum rowboat which they used to row into the lobby of the building to make sure everything was ok.” If you’re familiar with electricity and water you understand why this might be a bad idea. “For years we applauded these guys as heroes, but then realized that they could have been seriously injured or killed by their ‘hero’ tactics.” Yes, we have assets we are trying to protect, but ultimately “it’s about the people. Not the physical assets.”

How is solar power changing the grid?

Matt Eggars“The utility grid has been called the greatest machine ever built by historians and academics and there is good reason for that,” mused Matt Eggars, VP of Yardi Energy. “It is the one invention that has most improved our standard of living.” The uptime on the grid in America is 99.9% and it operates at a flat cost, “if you need electricity at your new residence or office you just call them up and zip, you’ve got power.” We don’t think about our access to electricity. It just is and always will be…or will it?

The power grid is aging and more and more people are installing solar, wind, and in some cases hydro power for their homes and businesses. As the cost of solar and other alternatives is reaching parity with traditional sources, more people are starting to go “off grid.” So what happens to a vast interconnected system that operates at a flat cost if an increasing percentage of people stop paying in? The cost goes up for those still buying electricity from traditional sources. “But this tips the scales even more because now the cost of grid energy is actually going up while solar is going down. This will convince more people to go solar thereby raising the price on grid consumers even higher and ushering in a power grid death spiral. As more leave the grid, the cost to remaining consumers increases at an exponential rate and can very quickly end the viability of the grid itself.

By definition, departing the grid will accelerate exponentially. The more people leave, the more expensive electricity is, the more compelling it is to change, the faster it will happen. This, like so many other economic changes, will not be gradual. The shift, once it gains a little momentum, will happen very quickly.

Sustainability, wellness, energy security, and disaster preparedness are becoming much more than issues for engineers to concern themselves with. These are clearly strategic issues that can define the value and even ongoing viability of any asset and any investor that holds it. “Technology, regulation, and continued environmental stress have changed the rules for real estate,” noted Branson in his conclusion. “Investors can no longer operate the same way they have for the last 50 years.” The riskiest strategy at the moment seems to be business-as-usual.

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