real estate

When assessing risk and reward in acquiring commercial real estate – be sure to cover all your bases including sustainability and resiliency

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by Paul L. Jones, CPA, LEED Green Associate

It is a great day – you have just put a property you like under contract. Now the work begins…conducting your acquisition due diligence. You know the program:

  • Obtain the deliverables from the seller
  • Research title for exceptions and obtain insurance binder
  • Ensure compliance with building and zoning codes
  • Engage the appraiser
  • Hire an engineer to conduct a property condition assessment
  • Hire an environmental engineer to prepare a Phase I environmental site assessment
  • Abstract leases and agree to the rent roll, check expense pass-through calculations and conclude on in-place and prospective income
  • Analyze the market and assess the property’s competitive profile including Green certification, utility expenses (electricity, gas, water and waste) and resiliency
  • Review all existing contractual relationships and obligations, including property maintenance, service and other agreements, warranties (equipment, roof, elevator, etc.)
  • Obtain property insurance quote and coverage binder
  • Establish the veracity of the operating statements and establish an operating budget
  • Update the cash flow forecast and yield assessment to evaluate the purchase price and desirability of the investment

What if I were to tell you that with all this work, you may not have covered all your bases. Let’s go back to the purpose of your acquisition due diligence: to ensure that you are getting what you thought you were getting and to assess, eliminate or quantify the risk and rewards in the investment.

Just like your market analysis which looks at both current conditions as well as the pipeline of future competition and the affordability of new competitive construction; In a rapidly changing environment, it is important for purchasers and investors in real estate to evaluate the property’s operating and energy efficiency, indoor environmental quality and resiliency as well as anticipate future environmental, regulatory and operating conditions.

Regardless of your personal position on climate change and sea level rise, commercial real estate is going to be affected – and because of real estate’s primary characteristic – it is immovable – the effects can be significant.

  • According to the report, “Risky Business: the Economic Risks of Climate Change in the United States” which was published last summer, “If we continue on our current path, by 2050 between $66 and $106 billion worth of existing coastal property will likely be below sea level.”
  • FEMA is anticipating a 45% growth in the areas susceptible to flooding due primarily from sea level rise by the end of this Century – just 85 years away.
  • According to the Institute for Market Transformation, “fourteen cities, two states and one county in the United States have passed laws requiring benchmarking and disclosure of energy use in buildings.” To learn more about where and under what conditions benchmarking is required, go to org. (FYI – these requirements are soon to affect over 5 billion square feet of space AND the EPA estimates that buildings that are benchmarked save an estimated 7% in energy over three years).

PJ Building Benchmarking

I live in Miami. Last week, we were in the cone of TS Erica which looked like it could grow into a hurricane. Businesses and people in South Florida began making preparations by buying staples like gas, batteries, non-perishable food supplies and reviewed their disaster plans. Thanks God the storm did not materialize and all we had was a hard rain which did cause flooding throughout our community. Climate change and sea rise are similar – you prepare for the worst and hope for the best. It does not hurt that in preparing for the worst, we actually are able to delay the time for the rise to occur (through a reduced carbon footprint). Accordingly, prudent investors are well advised to include the following additional due diligence procedures to assess the sustainability and resiliency risk inherent in the property.

  • Obtain information on the risks the local community experiences due to climate change which could range from increased storm intensity and flooding due to sea level rise, wild fires and water restrictions due to drought conditions, or increased utility usage due to higher average temperatures.
  • Obtain information on new or prospective municipal environmental requirements and evaluate the property leases and operations to determine the ease and cost of compliance.
    • For instance, if benchmarking is going to be required, do the leases in place require the tenant to share utility usage information (if, as is the case with many properties, the tenant pays utilities directly).
  • In an era of increasing utility costs and more efficient lighting, HVAC and other systems, do the leases provide for a proper sharing of the cost of replacing the equipment if it results in a reduction in utility usage? See my article on Green Leases in the Sustainable Benefits archives.
  • Obtain current and prospective FEMA flood maps to ascertain the risk and timeline the property will be in a flood zone in the future.
  • If the property is not a Green-rated building (LEED, EnergyStar, etc.), have the engineer assess the age and efficiency of the building systems.
  • From your insurance agent, obtain information regarding anticipated future availability and rate increases.
  • In evaluating the competitive leasing market, evaluate the relative absorption, rents, occupancies and tenant quality of Green buildings vs. traditional buildings to determine the market demand for sustainable buildings.
  • Evaluate the building’s ability to absorb and recover from to actual or potential adverse effects of stronger storms (wind and rain), higher storm surge and more frequent flooding in coastal areas or tornados, wildfires and dust storms in other areas. Each location has its own set of risks. Some resiliency due diligence questions to ask are:
    • Is the building site and entrance flood-proof?
    • Is the landscape design hazard-resistant?
    • Does the building have back-up power systems including HVAC and water)?
    • How secure is the interior environment from damage due to higher storm intensity?

The checklist of due diligence items and questions to be answered with regard to a property’s sustainability, resiliency and ability to comply with ever evolving government, insurance company and tenant requirements needs to be customized based on the location of the property as well as its class and quality.

In a November 2014 article, “Do-or-Die Due Diligence, Auction.com Vice President Andre Cuadrado warns “The due diligence process is one of the most important, yet challenging aspects of investing in real estate. If it’s not conducted thoroughly with a keen eye, an investor could end up with bad deals and lose millions of dollars.”

Cuadrado advises investors to spend the time and resources necessary to conduct due diligence thoroughly. “Some people try to save money on the process,” he notes, “but it’s expensive to be cheap when conducting due diligence, as your investment may end up not being what you thought it was.”

Remember, as Sun Tzu is quoted from The Art of War: “Every battle is won before it is even fought.” This is true for real estate investing as well – complete and thorough due diligence is the key to risk reduction and profit enhancement.

The breadth and depth of our experience and understanding of commercial real estate due diligence, sustainability and resiliency, Emerald Skyline Corporation is uniquely qualified to be your advocate in planning and executing your due diligence needs.

Now, let me tell you about this…

10/22/14

PJ Picture
By Paul L. Jones
, Founder,
Director, Financial Advisory Services for Emerald Skyline Corporation

 

I freeze…become paralyzed in the face of danger or uncertainty. It is something that I am getting better at as I age but I still tend to become a deer in the headlights from time to time. In heated discussions, I never come up with the one line “Buzzinga” response until later – sometimes days later – when it is too late to be effective.

Does this happen to you?   Or, are you one of the blessed people who know just the right response to any situation without giving it a second thought? Do you see a situation and instantly know and take the correct action to save the person from going into the undertow or stop the bleeding from a kitchen knife cut or have just the right response to win the debate?

We all respond to new circumstances differently. Some freeze, some panic and run, others deny what is happening like a child who pretends people cannot see him when he pulls his “magical” covers over his head. And, then, there are some charge forward full speed ahead.

Again, if you are like me, once you get over the shock of “is this really happening?” you assess the situation, spring into action and work feverishly to correct, or save, the situation….

Based on the muted reaction, or the “I am not a scientist so it does not exist” position of a significant number of our civic, community and business leaders, either they are in shock that the world’s climate can change so rapidly or they are in complete denial which is worse. The fact that many large American cities ranging from Galveston and New Orleans to Tampa, Miami and even as far north as New York City will be faced with significant issues from the rising sea level is still being debated among politicians reflects a similar approach to reality as the child with the magic blanket.

The news of global warming, now more appropriately referred to as Climate Change, is not new. Scientists have been ringing the warning bell for at least two decades. And yet we still do not want to believe.

Well, we are now starting to see the effects. Storms like Hurricanes Katrina and Sandy, increased flooding in cities like Miami Beach, increased tornado activity, the hottest year on record, and shrinking shorelines caused by sea level rise are now featured in the news on a regular basis.

Many government officials responsible for protecting the public from such events are joining in the chorus to raise awareness in order to make their job of obtaining public approval for a budget to install and maintain systems and equipment to reduce the damage from the effects of climate change feasible.

Yet, it is the real estate community that seems to most want to stick their head in the sand….For instance, last July, the Miami-Dade Sea Level Rise Task Force issued its report and recommendations. Shortly afterwards, the Miami Chapter of the American Institute of Architects held a meeting with Harvey Ruvin, Miami-Dade Clerk of Courts and Chairman of the Task Force, presenting the report. The meeting, which was broadly announced, had fewer than 100 attendees and almost no one from the real estate community was in attendance.

As reported in the June 2014 report “Risky Business: A Climate Risk Assessment for the United States”, it is apparent that climate change and sea level rise are going to have significant effects on the American global business community – and real estate, which has a particular distinction of being immovable, is going to be more impacted than most industries.

And yet. And yet the real estate community is acting as if it is business as usual. The level of interest in doing a sustainable retrofit has yet to make a significant impact on the market – especially for properties that are not seeking credit-quality tenants whose corporate sustainability policies encourage occupancy in LEED-certified buildings. (According to an article entitled “What’s Sustainability Wroth to Tenants?” by Paul Bubny of Cushman & Wakefield in the 10/28/2014 GlobeSt.com national eMagazine, ” Among the 37 real estate and sustainability directors at 23 US-based corporations surveyed by C&W, 74% see value in going to a sustainable building compared to a non-sustainable one.”1

With the obvious costs to upgrade and improve the infrastructure – especially electrical and water and sewer utilities, as well as expected increase in insurance costs, a prudent reaction to the reality of climate change and sea level rise would be to put improvements in place now that reduce the consumption of water and power as well as to make a building less susceptible to damage from major hurricanes, storms and other weather events (like flooding).

We can only hope that real estate owners, investors, managers and tenants will soon realize that the future is now, overcome their “shock” of the impending calamity and start to take action. It is time to take action. The economic, environmental and operational benefits will be immediate and, if done right, sustainable.

And, as in any crisis situation, if you wait too long to take action, the results can be devastating. Let me know if I can be of service.

1 See (http://www.globest.com/news/12_975/national/office/Whats-Sustainability-Worth-to-Tenants-351877.html?ET=globest:e44644:11970a:&st=email&s=&cmp=gst:National_AM_20141027:editorial).

Miami weather forecast …rising tides, flooding and heat

8/13/14

PJ Picture
By Paul L. Jones
, Founder,
Director, Financial Advisory Services for Emerald Skyline Corporation

I live in Miami – it is my home. The other night I was watching the weather forecast. The August full moon, a “super” moon, was on Sunday. The forecaster gave us the news that the weather was going to continue to being in the mid-90s with afternoon thunder storms – summer in Miami, no news there (NOTE: All of the record high monthly record temperatures in Miami have been recorded since 1971). However, the forecaster continued to advise viewers who live on Miami Beach and other low-level areas that they may need their rubber boots in order to get to their cars in parking lots and to watch for flooding along the roadways….This is a fairly recent phenomenon – but one that is going to be a part of the forecast for years to come.

It has been a year since Rolling Stone published its article entitled “Goodbye, Miami” written by James Goodell (7/4/2013 Read more:  http://www.rollingstone.com/politics/news/why-the-city-of-miami-is-doomed-to-drown-20130620?page=3#ixzz3A6oXVFId).

When the article was first published, most of Miami’s leaders scoffed at the article and the idea that Miami may not exist in 100 years. Perhaps it was the publication in which it was published or wishful thinking, but most of Miami’s (and Florida’s) business and political leaders decided to stick their head in the sand and ignore the increasing number of days in which our streets are flooded.

As reflected in numerous studies and many reports and articles, the world is warming. It does not really matter if it is natural or man-made – the facts are the facts – and this one will not be ignored for long. Along with the warming of the earth’s surface is a rising of the sea level resulting from both the melting of the ice caps and the expansion of the water as it warms….It has already risen almost one foot in the past century – and the pace at which it is rising is hastening.

Predictions are that the sea level will rise by two feet within 35 years and by up to one foot per decade thereafter – until the earth’s temperature stabilizes. At these levels – and with no actions put into place – Mr. Goodell’s prediction will surely come true.

The implications are immense: According to the report, Risky Business: The Economic Risks of Climate change in the United States, produced by the Risky Business Project led by former New York Mayor Michael Bloomberg and published in June:

“In Florida, because of porous limestone on which the major southern cities were build, even modest sea level rise comes at significant economic cost. Under current projections, between $15 billion and $23 billion (in today’s dollars) of existing property will likely be underwater by 2050, a number that grows to between $53 billion and $208 billion by the end of the century…An additional $240 billion in property will likely be at risk during high tide that is not at risk today.”

The impact of rising sea levels goes beyond flooded streets and imminent threat to property – and the impacts will grow exponentially as the sea rises and our leaders and citizenry remain immobilized – whether out of denial, ignorance or apathy.

Miami especially is vulnerable because of our low ground level (one quarter of Miami-Dade County is at less than 3′ above sea level) and our porous limestone plateau which Glenn Landers, senior engineer at the US Army Corps of Engineers likens to a block of Swiss cheese in Mr. Goodels’ article. A good analogy for the ground on which Miami (and all of South Florida) is built; but troublesome in the development of global solutions.

To its credit, Miami Beach has started to build pumping stations to reduce flooding – but this is only a stop-gap measure AND is being contested by home owners who feel it reduces the value of their property. This Stormwater Master Plan began with $206 million budget which is estimated to be half of the actual monies needed. The City is starting to raise fees and rates in order to pay for this program.

According to information in the website Sea Level Rise America, (www.slramerica.org), “Property owners of all types including developers, need to understand sea level rise issues and adaptation strategies. Those seeking to sell their properties will have to disclose to potential purchasers that their real property will be impacted by sea level rise and possibly higher taxes imposed by governments seeking to update public infrastructure projects such as storm sewers. Such adaptation projects will be necessary, but some will be controversial.”

SLR America identifies 26 legal and financial implications of rising sea levels on coastal communities – and many of these implications need to be addressed NOW: For instance, let’s take the disclosures in real property sales. “Simply stated, residential (and commercial) property purchasers in sea level rise threatened zones need informed notice and protection.” Just like sellers and real estate agents must disclose hazards due to asbestos and radon and lead-based paint, in order for sellers to be protected from future claims, property sales in 2013, when sea level rise is a known scientific fact, need to be accompanied by the disclosure of the potential impacts of sea level rise on the property.

We are not under water – yet! Last year, the Miami-Dade County Commissioners created a Sea Level Rise Task Force which issued its report on July 1st (Available here: http://www.miamidade.gov/planning/boards-sea-level-rise.asp) and provided six recommendations to the Commissioners. It is important that the real estate and business leaders support these recommendations and encourage the County government to dedicate the resources necessary to create and implement a plan that results in the survival of our fair City.

Meanwhile, building owners and managers can start now to make their properties more sustainable – which includes the ability to withstand increasingly harsh and violent storms with greater flooding from storm surge.

I have lived in tornado zones and earthquake zones and hurricane zones. The true benefit of living in a hurricane zone is that you have 3 – 7 days of advance notice. In those days, we prepare – we buy supplies and protect our properties against the coming storm.   With climate change and the sea level rise, we are given just 40 years to prepare – it is time to start make our preparations – the weather forecast is not changing any time soon.