climate risk

You have checked all the boxes on your due diligence checklist; but have you assessed the Climate Risk of Your Real Property Investment?

By Paul L. Jones, CPA, May 13, 2019

In his legal commentary posted on April 1, 2019, my colleague, Rick Jones, a partner with Dechert LLP, a leading law firm serving the Commercial Real Estate Debt Market, opened with “I’m finally writing about climate change… not because 97 out of 100 scientists are shouting at us incessantly about the need to do something, but because I am dead certain that there are real and fairly immediate risks associated with the public reaction to the perception or awareness (take your pick) of the climate change risk which will drive regulatory intrusion on both the state and federal level, will drive legislation and moreover, will inform market reaction to lenders, investors, developers and their properties because of their climate change posture or profile.”

Engineered CItyThe esteemed Mr. Jones continues: “Where do we start?  We are already seeing some commercial real estate owners begin to adapt to regulatory change.  Look at the fantastic engineering marvel which is the Hudson Yards, built 40 feet above sea level, with its storm management system and its fortress-like power system designed to survive a mega storm.  That’s expensive.  It was clearly purpose driven.  We should ask what made them, a bunch of smart folks, put up the money.  I guarantee it wasn’t frivolous.  I would suggest to you that it’s a sign of things to come.  More generally, we are also seeing more solar, more green building technology and more innovations in engineering and in general more willingness to pay real money to address environmental concerns.”

New York has a wet climate, and water – from hurricanes, flooding, storm surges and even blizzards – is one of its primary environmental challenges throughout the year. Of course, buildings in NYC also endure seismic activity, high heat loads in the summer, power outages, manmade disasters like those produced by terrorist attacks as well as high humidity and year-round precipitation.

On the Pacific coast, seismic considerations are a primary concern as well as danger from wildfires, flash floods, and drought.

For most of my career serving the real estate industry, I have primarily conducted due diligence and providing underwriting and financial feasibility analyses for buyers, investors, lenders and capital market participants.

We usually start with a checklist of due diligence and underwriting items which typically includes:

  • reviewing historical operating statements and related reports,
  • abstracting leases and tenant correspondence records,
  • getting a title abstract, checking the flood zone,
  • obtaining and reviewing a property condition assessment (PSA) and a Phase 1 environmental site assessment (ESA), and
  • evaluating all legal and contractual arrangements that may affect the income and expenses of the property.

But, if you are like most real estate investors, you have missed one item which affects all properties and portfolios: the risk resulting from climate change and sea level rise as well as man-made hazards: You still do not know how sustainable and resilient the income and future value from your investment is.

Beginning about five years ago, my clients started to ask questions regarding the potential effect of climate change and sea level rise on the sustainability and resiliency of the property.

  • It is important to note that the risk to real property assets – which are immovable by their nature – exists regardless of whether you believe humans have caused climate change, or not.
  • In fact, my client chose to divest of assets in Miami in order to buy assets in locales without the risk of sea level rise and our screening process involved an informal, yet substantive, assessment of the risk from climate change – no matter the location of the property.

In an article entitled “What does resilience mean for commercial real estate” by Ryan M. Colker published in the September/October issue of BOMA Magazine, he opens with the following observation:

Around the world, the frequency, intensity and impacts of natural disasters are increasing. These events can significantly affect the social, economic and environmental functionality of communities. The ability of commercial buildings and the businesses they house to adequately prepare for such events and quickly return to full operations—a quality known as resilience—contributes significantly to a community’s ability to bounce back. In addition to the community-wide impacts, the state of individual buildings also can affect the long-term viability of the businesses that occupy those buildings.”

For a multi-family, commercial or industrial building, we at Emerald Skyline define building resilience as “the ability of the systems and structure to protect, maintain or restore the value of, functionality of, and income generated by a property after a damaging event or calamity – whether it is from a weather event or a man-made circumstance – within a pre-determined acceptable timeframe.

  • A widely-cited 2005 study by the Multi-hazard Mitigation Council (MMC) of the National Institute of Building Sciences “documented how every $1 spent on mitigation saves society an average of $4.
  • In a 2018 interim update report by the MMC found that costs and benefits of designing all new construction to exceed select provisions in the 2015 IBC and the IRC and the implementation of the 2015 International Wildland-Urban Interface Code (IWUIC) resulted in a national similar benefit of saving $4 in future losses for every $1 spent on additional, up-front construction costs.

In a report published last month (April 2019) by the Urban Land Institute (ULI) and underwritten by Heitman LLC (Heitman) entitled “Climate Risk and Real Estate Decision-making,” the authors note that:

“In 2017, the year Hurricanes Harvey and Maria hit the United States and storms battered northern and central Europe, insurers paid out a record $135 billion globally for damage caused by storms and natural disasters. This figure does not represent actual damages, which in the United States alone equaled $307 billion, according to National Oceanic and Atmospheric Administration estimates.”

In the Foreword, Ed Walter, Global CEO, ULI, and Maury Tognarelli, CEO, Heitman, highlight the need to address sustainability and resiliency:

“Failure to address and mitigate climate risks may result in increased exposure to loss as a result of assets suffering from reduced liquidity and lower income, which will negatively affect investment returns. At the same time, investors who arm themselves with more accurate data on the impact of climate risks could help differentiate themselves and benefit from investing in locations at the forefront of climate mitigation.

And the industry – especially among institutional investors – is taking note. “Many leading investment managers and institutional investors are undertaking flood, resilience, and climate vulnerability scans of their portfolios. These mapping exercises seek to identify the impacts of physical climate risks on their properties, including sea-level rise, flooding, heavy rainfall, water stress, extreme heat, wildfire, and hurricanes. Potential impacts being considered range from physical access and business disruption for tenants to the effects that longer-term temperature increases or increased wear and tear on buildings could have on operating and capital expenditure requirements. The ultimate objective for the investment community is to understand how climate will affect asset liquidity and, as a result, returns, in terms of both income and capital growth.”

The results of the survey conducted in preparation of this report, the researchers found that industry participants continue to rely on insurance companies to cover potential losses from physical damage due to a natural disaster – but they astutely point out that insurance “does not protect investors from devaluation or a reduction in asset liquidity.” They categorize the climate risks either physical or transitional risks as follows:

  • “Physical risks are those capable of directly affecting buildings; they include extreme weather events, gradual sea-level rise, and changing weather patterns.
  • “Transition risks are those that result from a shift to a lower-carbon economy and using new, non-fossil-fuel sources of energy. These include regulatory changes, economic shifts, and the changing availability and price of resources.

“The location-specific physical threats posed by factors such as sea-level rise, hurricanes, wildfires and forest fires, heat stress, and water stress are among the most easily observable risks to real estate investment. They are a particular concern since many key markets for real estate investment are in areas exposed to the physical impacts of climate change.

These risks and their potential impact on real estate is summarized in the following table.

types of risk

So far, according to the ULI report, “…most investment managers and investors for directly held assets currently use insurance as their primary means of protection against extreme weather and climate events.” However, “leading companies in the industry … are modifying existing decision-making and management processes to add climate and extreme weather-related factors to those being considered alongside other risks and opportunities.

The National Infrastructure Advisory Council (NIAC) in a 2009 repot characterized resilience as having four key features known as the “4-Rs”:

  • Robustness: the ability to maintain critical operations and functions in the face of crisis.
  • Resourcefulness: the ability to skillfully prepare for, respond to and manage a crisis or disruption as it unfolds.
  • Rapid recovery: the ability to return to and/or reconstitute normal operations as quickly and efficiently as possible after a disruption.
  • Redundancy, back-up resources to support the originals in case of failure that should also be considered when planning for resilience

From the Whole Building Design Guide, a program of the National Institute of Building Sciences (NIBS), understanding the relationship between Asset (Building) resilience and the community’s resilience requires an understanding of the distinctions and relationships between risk, resilience and sustainability as follows:

  • Risk is expressed as the relationship between a particular hazard or threat that may degrade, or worse, devastate, the building’s security, operations and functionality and the consequences that result from this degradation of performance.
  • Resilience is the ability of a building or asset to recover from, or adjust, easily to misfortune or change. The ability to prepare and plan for, absorb, recover from, or more successfully adapt to actual or potential adverse effects as reflected in the aforementioned Four Rs.
  • Sustainability of an asset is determined by its ability to meet the needs of the present while being able to maintain its functionality over time without not being harmful to the environment or depleting natural resources.

The following diagram created by Mohammed Ettouney and Sreenivas Alampalli in their books on Infrastructure Health in Civil Engineering, presented the relationship of threat, vulnerability and consequences to risk as follows:

riskreward

Recognizing the need for sustainability and resiliency due diligence, Emerald Skyline Corporation has developed a Sustainability and Resiliency Assessment (SaRA Rating©) Rating system to provide commercial real estate investors with a complete picture of the risk associated with a particular property or investment. The information not only helps investors and owners but also provides lenders, insurers and tenants with information relevant to their decisions.

SaRA Rating© incorporates an assessment of the physical attributes of the property – including incorporation of information obtained from traditional due diligence procedures with additional procedures to determine the relative risk, resiliency and sustainability of the property over the investment horizon.

  • The physical review of the property is conducted in conjunction with the Phase I environmental site assessment and the property condition assessment and includes a review of the property’s resiliency features like hardened walls, raised electronic and network connections, secondary systems.

No building operates in a vacuum: Its resiliency, in particular, is directly connected to its location and is directly affected by the surrounding neighborhood, the community, and natural and man-made risks (hazards).

Based on a property-specific assessment including use of mapping services, our team of professionals evaluate a building’s resiliency and sustainability resulting in a rating from 1, not resilient or sustainable (High Risk) to a 5 (Highly Resilient). Our objective is to provide investors with the information they need to make prudent investment decisions that account for the physical, environmental and social risks to the cash flow stream and market value of the building.

At the conclusion of our procedures, we identify land and building improvements that would enhance a property’s resiliency and sustainability. The economics of each improvement or enhancement is assessed in a cost-benefit analysis.

We then evaluate the tradeoffs between performance of a building over its life-cycle and the cost of improving the building systems to ensure its sustainability and resiliency. Accordingly, we evaluate the total cost of ownership (TCO) by determining the capital cost of the property including any improvements plus the present value of the future expenses of operations, maintenance, utilities and the estimated cost to recover from a calamity.

Further, armed with the SaRA Rating© and report, the stakeholders can incorporate current and prospective tenant/user demand for the space in the building given the cost of occupancy and resiliency as well as investor demand and potential pricing for the asset. A resilient and sustainable asset will combine low-cost operations due to sustainably-reduced energy and maintenance costs and managed insurance expenses while maximizing the net cash flow and long-term value of the property.

The objective of all due diligence – including and especially the assessment of all the risks of ownership – is to optimize the overall returns on the investment while quantifying and minimizing the risks and costs to achieve those goals – that is the purpose of Emerald Skyline’s Sustainability and Resiliency Assessment Rating© system – your one-stop resource to measure and manage climate risk in the real estate industry.

For more information, contact Paul L. Jones, CPA, Phone: 786-468-9414; email: PJones@EmeraldSkyline.com

Panel’s Warning on Climate Risk: Worst Is Yet to Come

By JUSTIN GILLIS

MARCH 31, 2014

View original article here

YOKOHAMA, Japan — Climate change is already having sweeping effects on every continent and throughout the world’s oceans, scientists reported on Monday, and they warned that the problem was likely to grow substantially worse unless greenhouse emissions are brought under control.

The report by the Intergovernmental Panel on Climate Change, a United Nations group that periodically summarizes climate science, concluded that ice caps are melting, sea ice in the Arctic is collapsing, water supplies are coming under stress, heat waves and heavy rains are intensifying, coral reefs are dying, and fish and many other creatures are migrating toward the poles or in some cases going extinct.

The oceans are rising at a pace that threatens coastal communities and are becoming more acidic as they absorb some of the carbon dioxide given off by cars and power plants, which is killing some creatures or stunting their growth, the report found.

Organic matter frozen in Arctic soils since before civilization began is now melting, allowing it to decay into greenhouse gases that will cause further warming, the scientists said. And the worst is yet to come, the scientists said in the second of three reports that are expected to carry considerable weight next year as nations try to agree on a new global climate treaty.

Panel on U.N. Climate Change Report

Rajendra K. Pachauri, the chairman of the Intergovernmental Panel on Climate Change, and Christopher Field, the co-chairman of the group that wrote the report, discuss its warning.

In particular, the report emphasized that the world’s food supply is at considerable risk — a threat that could have serious consequences for the poorest nations.

“Nobody on this planet is going to be untouched by the impacts of climate change,” Rajendra K. Pachauri, chairman of the intergovernmental panel, said at a news conference here on Monday presenting the report.

The report was among the most sobering yet issued by the scientific panel. The group, along with Al Gore, was awarded the Nobel Peace Prize in 2007 for its efforts to clarify the risks of climate change. The report is the final work of several hundred authors; details from the drafts of this and of the last report in the series, which will be released in Berlin in April, leaked in the last few months.

The report attempts to project how the effects will alter human society in coming decades. While the impact of global warming may actually be moderated by factors like economic or technological change, the report found, the disruptions are nonetheless likely to be profound. That will be especially so if emissions are allowed to continue at a runaway pace, the report said.

It cited the risk of death or injury on a wide scale, probable damage to public health, displacement of people and potential mass migrations.

“Throughout the 21st century, climate-change impacts are projected to slow down economic growth, make poverty reduction more difficult, further erode food security, and prolong existing and create new poverty traps, the latter particularly in urban areas and emerging hot spots of hunger,” the report declared.

The report also cited the possibility of violent conflict over land, water or other resources, to which climate change might contribute indirectly “by exacerbating well-established drivers of these conflicts such as poverty and economic shocks.”

The scientists emphasized that climate change is not just a problem of the distant future, but is happening now.

Studies have found that parts of the Mediterranean region are drying out because of climate change, and some experts believe that droughts there have contributed to political destabilization in the Middle East and North Africa.

 

In much of the American West, mountain snowpack is declining, threatening water supplies for the region, the scientists said in the report. And the snow that does fall is melting earlier in the year, which means there is less melt water to ease the parched summers. In Alaska, the collapse of sea ice is allowing huge waves to strike the coast, causing erosion so rapid that it is already forcing entire communities to relocate.

“Now we are at the point where there is so much information, so much evidence, that we can no longer plead ignorance,” Michel Jarraud, secretary general of the World Meteorological Organization, said at the news conference.

The report was quickly welcomed in Washington, where President Obama is trying to use his executive power under the Clean Air Act and other laws to impose significant new limits on the country’s greenhouse emissions. He faces determined opposition in Congress.

“There are those who say we can’t afford to act,” Secretary of State John Kerry said in a statement. “But waiting is truly unaffordable. The costs of inaction are catastrophic.”

Amid all the risks the experts cited, they did find a bright spot. Since the intergovernmental panel issued its last big report in 2007, it has found growing evidence that governments and businesses around the world are making extensive plans to adapt to climate disruptions, even as some conservatives in the United States and a small number of scientists continue to deny that a problem exists.

“I think that dealing effectively with climate change is just going to be something that great nations do,” said Christopher B. Field, co-chairman of the working group that wrote the report and an earth scientist at the Carnegie Institution for Science in Stanford, Calif. Talk of adaptation to global warming was once avoided in some quarters, on the ground that it would distract from the need to cut emissions. But the past few years have seen a shift in thinking, including research from scientists and economists who argue that both strategies must be pursued at once.

A striking example of the change occurred recently in the state of New York, where the Public Service Commission ordered Consolidated Edison, the electric utility serving New York City and some suburbs, to spend about $1 billion upgrading its system to prevent future damage from flooding and other weather disruptions.

The plan is a reaction to the blackouts caused by Hurricane Sandy. Con Ed will raise flood walls, bury some vital equipment and conduct a study of whether emerging climate risks require even more changes. Other utilities in the state face similar requirements, and utility regulators across the United States are discussing whether to follow New York’s lead.

But with a global failure to limit greenhouse gases, the risk is rising that climatic changes in coming decades could overwhelm such efforts to adapt, the panel found. It cited a particular risk that in a hotter climate, farmers will not be able to keep up with the fast-rising demand for food.

“When supply falls below demand, somebody doesn’t have enough food,” said Michael Oppenheimer, a Princeton University climate scientist who helped write the new report. “When some people don’t have food, you get starvation. Yes, I’m worried.”

The poorest people in the world, who have had virtually nothing to do with causing global warming, will be high on the list of victims as climatic disruptions intensify, the report said. It cited a World Bank estimate that poor countries need as much as $100 billion a year to try to offset the effects of climate change; they are now getting, at best, a few billion dollars a year in such aid from rich countries.

The $100 billion figure, though included in the 2,500-page main report, was removed from a 48-page executive summary to be read by the world’s top political leaders. It was among the most significant changes made as the summary underwent final review during an editing session of several days in Yokohama.

The edit came after several rich countries, including the United States, raised questions about the language, according to several people who were in the room at the time but did not wish to be identified because the negotiations were private. The language is contentious because poor countries are expected to renew their demand for aid this September in New York at a summit meeting of world leaders, who will attempt to make headway on a new treaty to limit greenhouse gases.

Many rich countries argue that $100 billion a year is an unrealistic demand; it would essentially require them to double their budgets for foreign aid, at a time of economic distress at home. That argument has fed a rising sense of outrage among the leaders of poor countries, who feel their people are paying the price for decades of profligate Western consumption.

Two decades of international efforts to limit emissions have yielded little result, and it is not clear whether the negotiations in New York this fall will be any different. While greenhouse gas emissions have begun to decline slightly in many wealthy countries, including the United States, those gains are being swamped by emissions from rising economic powers like China and India.

For the world’s poorer countries, food is not the only issue, but it may be the most acute. Several times in recent years, climatic disruptions in major growing regions have helped to throw supply and demand out of balance, contributing to price increases that have reversed decades of gains against global hunger, at least temporarily.

The warning about the food supply in the new report is much sharper in tone than any previously issued by the panel. That reflects a growing body of research about how sensitive many crops are to heat waves and water stress. The report said that climate change was already dragging down the output of wheat and corn at a global scale, compared with what it would otherwise be.

David B. Lobell, a Stanford University scientist who has published much of the recent research and helped write the new report, said in an interview that as yet, too little work was being done to understand the risk, much less counter it with improved crop varieties and farming techniques. “It is a surprisingly small amount of effort for the stakes,” he said.

Timothy Gore, an analyst for Oxfam, the antipoverty group that sent observers to the proceedings in Yokohama, praised the new report as painting a clear picture of the consequences of a warming planet. But he warned that without greater efforts to limit global warming and to adapt to the changes that have become inevitable, “the goal we have in Oxfam of ensuring that every person has enough food to eat could be lost forever.”

Correction: March 31, 2014

An earlier version of a picture caption with this article misidentified a station with flooded tracks. It is the South Ferry subway terminal, not Grand Central Terminal.