• Mon. Nov 28th, 2022

Environmental Performance of US Commercial Real Estate | United States

ByWillie M. Evans

Sep 15, 2022
1. Run the Numbers on LEED Certified Multi-Family and Office Buildings

Due to the increased energy load on city assets and city power grids, city asset owners are likely to see cost increases in the near term, which will put additional pressure on rents to cover these rising costs. . Owners looking for space to meet their needs can therefore look to other markets where the damaging trends are not as prevalent and where the costs of operating these assets are not as high. This could mean a changing portfolio environment for asset managers.

While some tenants may leave to save on energy costs, the majority who stay put will seek out the most energy-efficient and cost-effective locations. Clients seeking updated assets that hold LEED or similar certifications may not necessarily avoid the higher improvement costs in the short term, but data indicates they are likely able to reap the returns in the future. term on a revenue per available square foot (RevPAF) basis. RevPAF combines the effects of occupancy and rents into a single variable, and recent studies have shown that higher rents more than compensate for the slightly lower occupancy of LEED certified assets. Cushman & Wakefield recently conducted an analysis in March 2022 for the Gateway-Plus markets (defined as New York, Los Angeles, Chicago, San Francisco, San Jose and Washington, DC) aimed at uncovering any measurable premium for rents and income for LEED-certified multi-family assets. The analysis controlled for asset class (Class A only) and quality while selecting CBD and urban submarkets comprised of 50 or more units, with an emphasis on rental and sale rates.

The following graphs illustrate the actual LEED Certified vs. Non-Certified Rent Premiums and LEED Certified vs. Non-Certified RevPaF for multifamily properties from Q4 2020 to Q4 2021:

Environmental performance of CRE in the United States – LEED vs non-certified rent premium

US CRE environmental performance – LEED vs RevPAF non-certified

2. Define direct and indirect effects of climate change on assets

For the purposes of this discussion, we define the direct effects of climate change on US commercial real estate assets as effects arising immediately from global warming. Examples of this include the increase in the number of severe weather events per year (i.e. this can be contrasted with the indirect effects of climate change on U.S. commercial real estate assets, which we define as the effects resulting from the impacts of global warming. Examples of these include changes in human population migration patterns such as emigration flows, increased demands on limited water sources, and reduced air quality in the As discussed in more detail in the next section, both can have a profound influence on properties.

3. Identify possible future effects of climate change on assets

While a national consensus has largely been reached regarding the current increase in global temperatures and the direct link to human activity, the future effects of this warming are still under discussion. This is particularly true with the consequences that result from negative climate externalities, such as changes in migration patterns, and more specifically, emigration flows due to disaster displacement.
Disaster-related displacements may occur less frequently than more direct effects like the increasing number of hot days per year in some metropolitan areas, but that does not mean that their effects are less detrimental. Looking at examples like Hurricane Katrina in 2005, the U.S. commercial real estate market could see a decrease in rental velocity, a sharp rise in vacancy, and an erosion of the talent pool in future disaster-affected areas. These represent a major long-term problem for business market fundamentals if the frequency of emigration increases and could ultimately lead to a rebalancing or reshuffling of domestic property portfolios.

Not only do negative climate externalities such as in-migration from flooding add significant pressure to commercial real estate fundamentals, but also to their assets and operations, leading to a negative collateral impact on a company’s image if it stagnates or stops for an extended period. While the accuracy of weather forecasting models has improved dramatically, allowing businesses to proactively respond to extreme weather conditions, it is inevitable that a weather event will be more damaging than expected. According to researchers at the University of Colorado, the incidence and intensity of these events are expected to increase, meaning owners and occupiers of industrial properties will need to be proactive in implementing strategies that can help mitigate risk (Bernstein, Asaf et al, 2018).

Cities and climate change

In some cities where these negative effects have occurred, steps have been taken to ensure that the future risk of damage to infrastructure is mitigated and the above effects are minimized. After Hurricane Katrina devastated Louisiana in August 2005 and caused approximately $161 billion in damage, $15 billion in funding was approved for various mitigation projects.

In September 2018, the City of Houston passed a floodplain ordinance in response to Hurricane Harvey, which caused damage estimated at $125 billion. The ordinance, known as the Chapter 19 Code of Ordinance, requires new developments to be built 24 inches above the 500-year-old floodplain instead of 12 inches above the 500-year-old floodplain. 100 years, and increases attenuation fill requirements.
Similarly, New York City has taken extensive steps to ensure that the devastation caused by events such as Hurricane Sandy in 2012 is properly addressed. The event caused an estimated $70 billion in damage and led to significant measures to protect much of the city’s most valuable real estate, such as the Lower Manhattan Costal Resiliency (LMCR) project and the Battery Park project. City Resiliency (BPCR). Representing billions of dollars in climate change mitigation efforts, plans include flood walls along the waterfront buried in the landscape, overhauls to stormwater infrastructure and infrastructure upgrades piers, quays, water transport terminals and waterfront pedestrian access points.

The SEC and climate change

Cities are not the only entities taking action to ensure climate change is addressed for years to come. The United States Securities and Exchange Commission (SEC) proposed a rule at the end of March 2022 that would require public companies to provide detailed information on the level of climate-related risk to which they are exposed; their climate risk management process; how their business model, financial performance and future earnings prospects may be affected; as well as the net financial impact of climate-related events they have experienced. In addition, the pending rule would require all public filers to disclose their direct greenhouse gas (GHG) emissions, any indirect GHGs, and any additional GHGs resulting from its value chain activities.

4. Assessment of insurance costs against regional climate risk

Mapping location-specific environmental risks through rankings allows investors to more effectively manage their portfolio of assets when different levels of risk are involved and, importantly, to protect those assets with different insurance policies based on that risk. .
As the incidence and severity of catastrophic weather events increase, the cost of insurance policies also increases in regions most likely to be affected by these events. According to data collected from the National Oceanic and Atmospheric Administration (NOAA), the costs of climate-related disasters over the four-year period from 2015 to 2018 totaled $500 billion, nearly double the cost of $254 billion. dollars from the previous four-year period from 2011 to 2014. As property damage costs rise, insurance companies are expected to pass the costs on to owners, which means owners need to be prepared to absorb any passed-on insurance premium increases. Typically, improvement costs have been mitigated by alternative sources of capital, such as catastrophe bonds and, more recently, green bonds, which can be used to improve the green rating of owners’ portfolios while allowing for flows. potentially higher future cash flows.

After identifying that asset hedging costs will be higher in high-risk areas and outlining several methods to mitigate these costs over time, quantifying this risk to owners is the next step to protecting them and themselves. their wallets. One way to do this is to use risk analysis tools, such as a model portfolio analysis performed by Lockton Companies and National Real Estate Advisors, LLC. The analysis tool measured the risks associated with disasters such as inland floods, tornadoes and hurricanes (including coastal storm surges), concluding that the catastrophic risk of hurricanes is by far the greatest of these disasters and that the metropolitan area most at risk is Miami. , with an average annual loss of $767,000.

The following chart shows a model portfolio that determines asset value and average annual loss based on risk exposure in various markets, as found by Lockton Companies and National Real Estate Advisors, LLC in 2017.

5. Recommendations for sustaining a portfolio

Although the effect of negative climate externalities on US commercial real estate varies, market participants should continue to future-proof their portfolios.