Nils Kok

How "Financially Healthy" Are Tenants in the U.S. Multifamily Market?

With the S&P up 1.4% through February 2, almost at its highest point ever, we sometimes forget that we’re still in the midst of a health crisis. COVID-19 has also had severe consequences for commercial real estate, with occupancy rates and rents of retail and office properties being hammered across the country.

If you look at the headlines in the Wall Street Journal and trade magazines, however, you might not know that to be the case. Looking at rent collections, which are directly observable for owners and indirectly for lenders and investors via REITs and CMBS pools, the general news has been surprisingly or even exceptionally strong. Rent collections in institutional-grade multifamily properties have held steady. Yet unemployment remains at 6.7% – twice what it was pre-pandemic. And 7.3 million people have dropped out of the labor force, 2.3 million more than pre-pandemic. It makes me wonder: are things as good as the headlines say?

In my role at GeoPhy, I wanted to look under the hood of apartment buildings to see how tenants are really doing. Beyond their physical health, which of course is paramount in the midst of COVID, what is the status of their financial health? To understand that, we built Tenant Credit Profile (TCP) to track the credit situation of tenants aggregated to a building level: what’s the credit card utilization rate, are tenants applying for credit, etc. 

In this report, you find the first snapshot of U.S. multifamily tenants’ financial health as of the end of 2020 compared to a year prior. I focus on three key metrics:
• The average credit score in a multifamily property;
• The average delinquency rate of tenants in a multifamily property; and
• Payment holidays,

The last metric has become especially relevant in the current pandemic. Under the $2.2 trillion CARES Act enacted last March, credit card companies and mortgage servicers that enter into payment holiday or deferment agreements with consumers cannot report those consumers as being delinquent. Their credit scores will not be impacted. We consider payment holidays hidden risks: non-payment risks captured neither by credit scores nor by delinquency rates.

If you listen rather than read -- here's a 40min webcast where I go through the report.

 

Stay Home, Stay Healthy? That Depends on the Home

People spend 90 percent of their time indoors. We are working in office buildings, living in homes, and spend leisure time in shopping malls, restaurants, the gym, etc. However, the lock-down measures currently implemented in most countries around the world are forcing us to spend our time at just a single place -- our own home. Indeed, the mantra across many U.S. states has become "Stay Home, Stay Healthy."

Beyond the direct effects of COVID19 on human health, there is no shortage of news headlines on the indirect implications that the COVID19 pandemic may have on physical and mental health, including the negative effects of reduced exercise, increased mental and psychological stress, and delayed medical procedures. Another important, but overlooked public health issue is the fact that individuals now face prolonged exposure to the indoor quality of their own home and the possible negative health consequences of that exposure.

The big question: is staying home is actually "staying healthy"? Well, that depends. Our research finds that the maintenance status of a home has a significant impact on both the objective and subjective health of individuals, with increased doctor visits and decreased mental health status in homes with deficient maintenance.

Summary version (English)

Dutch version (Economisch Statistische Berichten, 105, 284-286.)

Retail to Industrial? That Depends on the Location

Doing the retail-to-industrial conversion groundwork.

The demise of brick-and-mortar retail as we knew it started more than a decade ago with the ascent of online shopping. The COVID-19 pandemic only accelerated the downward spiral. From shopping malls to neighborhood retail centers, from the well-known strips of retail to high-end Main Street retail, landlords of all stripes are feeling the pain. Look no further than the delinquency rates on mortgages collateralized by retail CMBS (12%) or the stock prices of retail REITs, which are down almost 40% YTD.

But as the Dutch saying goes: “one’s dead is another’s bread.” Industrial and logistics assets have fared phenomenally well over the same decade, and even throughout the current crisis. Riding the growth of online retail, warehousing space demand has been on a tear – for both big box properties and smaller buildings closer to city centers. Indeed, the stock prices of industrial REITs are up by 12% YTD, on average. CMBS delinquency rates on industrial assets are merely a blip: 0.5%.

From Retail to Industrial?

Investors, lenders, cities, and local communities are grappling with the oversupply of retail space. The U.S. has a whopping 25 square feet of retail space per capita, compared to just 5 square feet per capita in Europe. 

And yet, investors and lenders in the industrial space are desperate for more supply. Could there be a win-win in repurposing some of the redundant retail stock into logistics facilities? Something similar has happened before. Oversupply of office space has been turned into hotels and multifamily apartment buildings in the past. Amsterdam in the Netherlands was the poster child, reducing vacancy rates from near 20% to a current 5%. (A rebound in demand helped a bit along the way.)

Much has been said about the (im)possibilities of converting retail into warehouse space. Prologis, one of the world’s largest owners of logistics assets, is somewhat skeptical of the prospect of large-scale retail transformation. 

Prologis’s skepticism is centered on four issues: economic (there may be better use cases, such as multifamily for repurposing the asset), political (zoning), legal (equity and debt holder objections), and physical. The last, in particular, focuses on shopping centers with space for large anchor tenants – traditional malls.

The current need in the logistics supply chain, however, is for smaller spaces. These locations are suitable for so-called “last-mile” distribution and potentially even customer pick-up and returns.

The recent news is about Amazon setting up warehouses in the malls of Simon Property Group, one of the largest retail REITs in the U.S. That begs the question: who else owns retail assets that would potentially be interesting for conversion into logistics facilities? And where to find these assets?

It Starts With…Location Location Location.

Before focusing on the structural aspects of converting a mall into a logistics facility, which needs on-the-ground inspection, an investor first needs to determine which sites make the most sense. The key to answering the question of which retail asset is suitable for repurposing into logistics lies once again in the old real estate adage: “location location location.” The quality of a location from a logistics/delivery perspective is critical to determining demand for the goods shipped from a last-mile facility.

Interestingly, there is significant overlap between what a retailer wants and what an online shop needs: customers and their disposable income. Looking at the almost 13,000 retail locations owned by U.S. REITs (including Main Street retail, well-known districts such as New York’s 5th Ave, malls, and local retail strip centers), we can analyze the suitability and desirability of each asset using demographics, supply, and other location data. 

For example, take Realty Income’s 250,000 square-foot Shelbyville Road Plaza mall outside Louisville, Kentucky. In our analysis, we calculated catchment areas reachable within 15- and 30-minute drives for this and every other retail asset (including the effect of each area’s average congestion delays). We then looked at households and household income within each catchment area. (See image 1 below.)

Will demand support this location?

For Shelbyville Road Plaza, a 30-minute drive reaches 485,000 households, with a median income of $39,000. The aggregate household income that can be reached in 30 minutes from the mall is about $38 billion. That headline number sounds impressive, but we need to compare it to existing industrial/logistics assets across the U.S. Is this location suitable for logistics purposes? 

To enable a quick comparison, GeoPhy developed a “Last Mile Score.” This score takes into account the aggregate household income, the number of households with annual income >$100,000 within the catchment, and other metrics. Higher scores indicate more attractive last-mile distribution locations.

The Louisville asset has a Last Mile Score of 59, making it roughly average across all industrial assets in the U.S. Note that overall, retail assets perform quite well on the Last Mile Score with many REIT-owned retail assets scoring above average. (See table 1 below.)

Can you staff it?

Of course, the suitability of a location isn’t just dependent on the potential demand for goods. Another important factor is the availability of labor. Pre-COVID, finding employees with the right skillset was increasingly difficult for industrial/logistics providers. With recent announcements of hiring sprees by Amazon and Wal Mart, there seems to be no end in sight for demand for logistics jobs.

Going back to Shelbyville Road Plaza, the labor force counts 649,000 people within a 30 minute drive (the labor force participation rate is 63%) and 910,000 people within 60 minutes. Of those people in a 30 minute drive, 113,000 are already employed in Production, Transportation, and Material Moving jobs (PTMM). These are the employees a newly established logistics facility would be competing for. We compared the availability and suitability of labor for Shelbyville Road Plaza to the remainder of the country using the GeoPhy Labor Score. Here, the asset scores 77, which ranks it quite high as compared to all industrial assets across the U.S. (See table 2 below.)  Again, higher scores indicate more attractive locations from a labor perspective.  

Diligence from a distance

We are scoping this location’s suitability, of course, from a higher-level perspective. Before conducting a more in-depth assessment “on the ground,” we can conduct further desktop assessments of the Shelbyville Road Plaza’s desirability for logistics purposes. Without jumping in a car, we can analyze its amenities such as public transportation (frequently used by logistics company employees) and by “dis-amenities” such as crime. 

Data from GeoPhy Evra shows the presence of a bus line right next to the shopping mall. The location does have some crime, but the rate of crime around the mall is quite low compared to the national average: 174 violent offenses per 100,000 people, compared to 531 per 100,000 nationwide. (See images 2 and 3 below.)

These are just some of the hyperlocal stats that can be used to assess the quality of retail assets for conversion to logistics/warehousing facilities. Many other important and relevant characteristics – such as distance to highway ramps, as well as potential ports and airports – can easily be assessed and tracked, without the need to actually visit the asset. Such “diligence from a distance” is a first step for real estate analysts. Whether during the COVID pandemic or in the years after, data-enabled desktop analysis is increasingly useful to investors and lenders looking for investment opportunities and assessing risks in their portfolios.

Moving to Productivity: The Benefits of Healthy Buildings

with Piet Eichholtz and Juan Palacios, PLOS One (2020)

Download

Health is a critical factor for the generation of value by workers. Companies bear substantial costs associated with absenteeism and presenteeism among their employees. This study investigates the impact of the environmental conditions in the workplace on the health and job satisfaction of employees, as core factors of productivity. We provide evidence based on a natural experiment, in which 70% of the workforce of a municipality in the Netherlands was relocated to a building with a design focused on sustainability and health and well-being. We construct a longitudinal dataset based on individual surveys of the entire municipality workforce and include measures before and after the move. The estimation results show a significant improvement in the perceived environmental conditions, as well as in the health and well-being of the relocated workers, measured by the drop in the incidence of sick building syndrome symptoms. Results are heterogeneous based on age: older groups of employees enjoy larger health impacts. The relocation effects remain persistent in the medium term (two years after the moving date). Importantly, a mediation analysis suggests that the achieved improvements in health and well-being lead to significantly enhanced job satisfaction and a 2% reduction in the prevalence of sick leave.

Retail is Dead? Long Live Retail CRE Assets!

Doom and gloom about certain retail assets is justified – but it obscures a much more complex picture

Earlier this week, the New York Times published an article titled “The Big Short 2.0ʼ: How Hedge Funds Profited Off the Pain of Malls.” It explained how some investors recently made outsized returns by betting against retail real estate, specifically malls.

The article ends with a fitting quote: “I’m definitely bearish on malls,” Ms. McKee [a hedge fund investor] said. “But I think it’s a very case-by-case basis. I don’t think all malls are dying.” 

So, which retail assets have promise, and which ones do not?

The Demise of Retail Real Estate…

The retail real estate sector was in demise long before the COVID-19 pandemic hit the global real estate market. The shift to online buying and the “over-retailing” of most locations led to a plethora of bankruptcies and subsequent declines in retail rents and prices. The effects of lockdowns and the unwillingness of consumers to expose themselves to health risks while shopping have further hastened the rapid decline of retail real estate.

While retail rent and price trends are hard to gauge, the stock prices of the major owners of retail real estate are quite telling. Shopping center giant Simon Property Group is down 56% from its peak, shedding more than $20 billion in market capitalization. Unibail-Rodamco-Westfield, a REIT with a global portfolio of shopping centers, is down 65% from its peak. 

Some argue that grocery-anchored retail is faring better. Relative to malls, that is probably true. But even owners of grocery-anchored retail have been battered pretty badly. Regency Centers, a large investor in neighborhood shopping areas (also known as strip centers) is down 36%. Kimco, another large owner of strip centers, is down 42%. 

…And the Double Whammy of COVID-19

The impact of the COVID pandemic has been devastating for many retail assets. Some areas, however, have been and continue to be more exposed than others. 

To determine which retail REITs have the most exposure, we assessed the exposure of each retail asset owned by publicly traded REITs. We overlaid two measures of COVID risk on the respective portfolios owned by REITs and then averaged the total portfolio to model the effects of the pandemic. 

First, we use the GeoPhy COVID Risk Score which has two components: 

1. The percentage of workers in sectors that have been most heavily exposed to COVID’s labour market effects (e.g. people working in restaurants, retail, leisure, etc) at a neighborhood level, and 
2. The local rent-to-income ratio

Neighborhoods with high rent-to-income ratios and large shares of residents working in service-related jobs are most likely to experience significant impact from the COVID pandemic. Retail assets in these areas will likely suffer from reduced spending driven by the reduced disposable incomes of local residents.

Table one below shows REITs’ varying exposures to COVID-related risks. Taubman and Unibail-Rodamco-Westfield – two large shopping center REITs – have average COVID Risk scores of 66 and 65, respectively. REITs such as VEREIT and Kite Realty have lower, more favorable scores. 

Can Surrounding Areas Support These REITs’ Retail Tenants?

Next, we looked at these REITs’ properties through the lens of the recently concluded U.S. Census Bureau’s Pulse Survey data. Census ran this weekly survey for 12 weeks to track the economic impact of COVID, issuing its last report on July 29. Pulse measured the rent-paying behavior of a large, representative sample of people across the nation. GeoPhy used this data to construct Rent-At-Risk, which measures the fraction of residents in an area that cannot pay rent or is unlikely to pay next month’s rent. We again matched Rent-At-Risk to the areas where each publicly traded REIT owned retail assets. 

Exposure to areas where residents are unlikely to make rental payments has direct relevance to owners of multifamily assets. However, we believe it may be an equally relevant indicator for the performance of retail assets in those same areas.

Interestingly, most of the 13,000 retail assets owned by REITs across the US are in areas where a large fraction of the population in rental units is unlikely to make rent payments. This ranges from a “low” of 30% of neighboring tenants being in the Rent-at-Risk category for Retail Opportunity Investments Corporation to 41% for Urstadt Biddle Properties. All retail REITs have more than three-quarters of their assets in areas where the Rent At-Risk is at least 25% (or higher).

Not All Malls Are Dying

Using the same processes, there’s at least as much data to assess which of the 13,000 retail assets owned by REITs are not doomed. Also, it’s easy to identify current retail real estate assets located in highly desirable areas. Perhaps the location is no longer valuable for retail, but assets in these areas might profitably be converted to alternative uses such as residential or logistics/fulfillment.

We first applied the GeoPhy Location Score to evaluate the quality and desirability of the locations where REITs own their 13,000 retail assets. Tailored to multifamily assets, our Location Score measures the attractiveness of areas by evaluating the local housing market, demographics, the presence of amenities, and the incidence of crime.

Using this data, the picture of retail real estate and the REITs owning these assets looks distinctly different. Unibail-Rodamco-Westfield’s assets score in the top-3 of best average GeoPhy Location Score. Its malls are located in areas with highly desirable demographics, strong housing markets, and plenty of amenities. Clearly, while the malls may suffer, the underlying fundamentals for commercial real estate are strong, with potential redevelopment opportunities, perhaps to rental housing.

At the bottom of the ranking is VEREIT, with an average GeoPhy Location Score of 47. That number is well below the average Location Score in the U.S. So, even though VEREIT’s stock price is down “just” 36% to date, the data suggests that alternative use cases for its retail locations are more limited than for other REITs.

Selling Losers, Picking Winners

It’s enticing to follow the investors in the New York Times article into shorting the CMBX6 indices with significant retail exposure. You can write off retail real estate as an asset class that dominated the past, but has no future. Beyond the prospect that those shorts will soon be financially unattractive with broader knowledge of the trade thanks to the publication of the Times’ article, there’s ample opportunity in retail! 

Some retail assets will perform well going forward because they have the fundamentals right. Other retail assets that don’t have a future in retail are located at highly desirable locations, leading to valuable redevelopment opportunities. Finding those assets will be the challenge, but granular, relevant data can give opportunistic real estate investors the edge they need.

Do REITs signal private market pain, too?

Combining GeoPhy COVID-19 Scores with new US Census Bureau data sheds light on REITs’ portfolio risks and valuations during the pandemic.

Co-authored by Ali Ayoub

The COVID-19 pandemic’s effects on the commercial real estate market have been hard to gauge – especially in the multifamily and office asset classes. With the transaction market virtually coming to a halt, there’s very limited liquidity. Changes in property prices are thus challenging to observe. And while it’s clear that the rental market is facing severe headwinds – whether it’s in office, retail, or lodging – its extent is again unclear. 

As opposed to hard-to-observe indicators in the private real estate market, the outlook for REITs is reflected in stock prices on a daily basis. These publicly traded property companies report to investors quarterly. Analysts’ earnings and valuation guidance for REITs incorporate forecasts (and expectations) about the commercial real estate market.

If REIT pricing is an accurate bellwether, there’s indeed some real pain for private market real estate investors to come. Focusing on the housing market, the 12 largest residential REITs were down almost half from their peaks at their low points. Currently, they are still down by 27% (weighted by market capitalization). Perhaps the peak-to-trough numbers reflected an overreaction of the equity market. Current pricing indicates, however, that pricing and rents in the real estate market will see significant downwards corrections in the months and perhaps years to come – unlike Wall Street’s current bullish sentiment.

Assessing REITs’ COVID-19 Risk, Bottom Up

Within the residential universe of REITs, there’s a wide variety of exposure to the effects of the COVID-19 pandemic. Unlike many equities, REIT investments are in buildings. Each property can be identified by address and mapped against a wide variety of data points. GeoPhy tracks 12 residential REITs, which in aggregate own about 2,400 buildings or assets, including more than 500,000 units. (This total excludes single-family residential homes owned by the likes of American Homes 4 Rent and the “units” owned in “lifestyle parks” by, for example, Equity Lifestyle Properties).

We recently adjusted the GeoPhy Neighborhoods algorithm to understand the risk implications of COVID-19 for the multifamily market. Looking at 90,000 neighborhoods across the US, we identified those with the toxic combination of high rent-to-income ratios and large shares of the local labor force (previously) working in COVID-19-impacted industries. Using this data, lenders and investors can learn which of their assets are in neighborhoods with the highest risk of missed rental payment.

A simple overlay of a neighborhood’s  GeoPhy COVID-19 Score and our location data on multifamily REITs shows Equity Residential (EQR) “leading” the ranks. Its assets are most exposed to areas where the economic impact of the COVID-19 pandemic will potentially hit hardest. EQR’s share price seems to reflect this risk somewhat; it’s down 34% since reaching its peak on February 21 this year. 

Mid-America Apartment Communities (MAA) is by far the largest apartment owner among residential REITs. Its giant portfolio is located in areas that are somewhat less exposed to COVID-19 risk than EQR, with a GeoPhy COVID-19 Score of 55.

Rent Roll Risk and REIT Pricing

The potential damage of the current pandemic on apartment portfolios can be measured more directly by recent rent-payment behaviour of tenants in different markets. The National Multifamily Housing Council (NMHC) publishes a monthly Rent Payment Tracker, based on rental payments tracked by a number of providers, such as Yardi Systems. The Rent Payment Tracker shows quite an optimistic view on rental payments, given its focus on class A, high-quality rental units.

The latest data (as of July 13) shows just a 2.5% decrease in the share who paid rent in July 2020 as compared to July 2019. In addition to its focus on high-quality rental units and the most creditworthy tenants, the NMHC Rent Payment Tracker’s other deficiency is its lack of details on payment behavior across geographies and thus across REIT portfolios.

As reported in previous blogs (see here and here), the US Census Bureau recently started to track the economic impact of COVID-19 with a weekly survey that contains both current as well as forward-looking questions. It provides fresh, rich, and highly relevant data to identify what’s going on across the country. 

Most importantly for the apartment industry, Census’ survey asks renters if they paid last month’s rent and how confident they are about paying next month’s rent. This survey offers comprehensive insight across all levels of income as well as the first forward-looking information available in the market about rent.

REITs’ Rent-at-Risk Exposure

We use this Census data to define “Rent-at-Risk” as those households that are either not paying rent or that have no- to low-confidence in paying next month’s rent. The map below shows significant variation in expected rent collection going forward: from 20.5% in Vermont to 60% in Mississippi.

We then overlay this information, which comes at the metro and state level, with the location information of each asset in each residential REIT portfolio. The assets of Camden Property Trust (CPT) are among the most exposed to rent roll risk: across the locations where its portfolio is located, an average of 38% of multifamily tenants are either not paying rent or indicating having low confidence in paying next month’s rent. All its assets are located in areas where Rent-at-Risk is at least 25%. 

Although investors in Camden Property Trust have priced in some of the rent roll risk, its share price is not down as much as, for example, Equity Residential or AvalonBay. Measured by Rent-at-Risk (again, based on Census data), an average of 33% of multifamily tenants in the areas where AvalonBay assets are located are either not paying rent or indicating having low confidence in paying next month’s rent. For Equity Residential, that percentage is 32%.

Of course, different markets have different supply and cap rate dynamics, which also play into asset prices and REIT price formation. As professional owners, REITs know specific characteristics about the tenants in their portfolios’ buildings. If REITs have had a solid track record, we should expect them to be better than average.

The pandemic is so widespread, however, with enormous employment impacts on entire industries that vary across cities. We believe evaluating Rent-at-Risk from the Census survey offers clues into REIT asset performance.

So, which REIT to pick (or avoid)?

REIT analysts and investors face a dearth of reliable, timely, and granular data on the risk exposure and performance of residential investment assets. This gap makes it challenging to accurately price in the extent to which REITs will suffer from the COVID-19 pandemic.

While there are various generic metrics to assess risk at the market level, GeoPhy Neighborhoods allow for the assessment of COVID-19 risk at the granularity of a city block. And Census’ new data allows for the measurement of rent roll risk each week (albeit mostly at the metro level). 

It is clear that the most-exposed REITs have some of the risk priced in when you combine these sources of data, the location of multifamily assets owned by REITs, and the most recent pricing data. (See the chart below, in which the size of the bubble depicts the size of the REIT by market capitalization.) 

For the pessimists, shorting CPT or MAA might be a good opportunity. They rank #1 and #2 on rent roll risk, respectively, while their stock prices are down quite a bit less than comparable stocks. 

Optimists may see upside potential in ESS and EQR, with the lowest Rent-at-Risk percentages (which, by all means, are still significant) and stock prices that are severely battered.

Of course, the numbers presented here paint just a partial picture. Factors like development pipeline and capital flows also play important roles in asset pricing. The advent of new sources of data, however, are helpful for multifamily investors – whether investing in assets or REITs.

Green Building Has a Strong Business Case

[As published on the Network for Business Sustainability]

There’s a clear business case for building green.  

That’s the message from the most comprehensive study to date of the marginal cost of green construction, focused on the commercial property market in the United Kingdom.  

Researchers compared 336 green-certified buildings to some 2000 non-certified construction projects built between 2003 and 2014, matching projects on construction dates and county location.  

They found that green buildings cost 6.5 per cent more to develop on average. However, such buildings have been shown to rent for 13.3-36.5 per cent more. 

“Building green has a clear benefit for developers, investors and lenders, and owner/ occupiers,” said Nils Kok, part of the research team with Andrea Chegut and Piet Eichholtz. Kok is associate professor at University of Maastricht and chief economist at property valuation firm GeoPhy.  

Kok spoke to NBS with Jonathan Flaherty, senior director for Sustainability and Utilities at real estate developer Tishman Speyer in New York. 

Kok and Flaherty agree: Building green makes economic sense, but it has upfront costs, particularly around design fees and construction time. It’s not clear whether those costs will soon diminish.  

The business case for green buildings is important 

Green buildings aim to positively impact the natural environment in their design, construction, and operation. That’s an important goal: buildings and construction represent 39 per cent of global carbon emissions.  

Yet green buildings represent just a small percentage of total building stock.  For example, in 2019, 13.8 per cent of commercial office stock in the 30 largest US office real estate markets was environmentally certified.  

“In order to convince people to do things, you need to show the real data,” said Flaherty. “This [research] is the evidence someone needs to convince their investment committee to allow them to spend 5 per cent more on design fees, because it increases the actual rent returns.” 

Building green provides overall value, despite variation 

The business case for green building should apply in most developed markets, Kok told NBS. “Whether in London, New York, Singapore, Sydney, or Toronto, studies show that green-certified buildings sell at slightly higher prices, rent at slightly higher rates, and typically have occupancy that is a little higher.” (In emerging markets, green buildings may have different costs and returns, due to other market dynamics, Kok said.)  

The higher occupancy rate for green buildings is especially appealing to developers, said Flaherty. With his firm’s green buildings, “we're much more interested in velocity [of renting] than we are in the actual rent number per se. We think that it's much more valuable to us to never have vacant space.”  

While 6.5 per cent is the average additional cost for green building, precise costs will play out differently for different projects. “Developing in different markets has vastly different costs even within the United States,” Flaherty explained. Different locations have different labour markets — e.g., union involvement — and access to materials. As a result, buildings in different cities, even if “literally identical down to the last nail,” will be built “by different trades and different sequences and different ways.”  

Certification levels have different impacts 

Building costs also vary by green certification level. The researchers studied buildings certified through the BREEAM label, the most widely adopted environmental certification system for buildings in the UK. Like many green building certifications, the BREEAM program has multiple levels, from Pass to Outstanding.  

Most green buildings in the UK – 82 per cent — are rated either BREEAM Very Good or Excellent. These are 5-19 per cent costlier to construct than noncertified projects. By contrast, buildings at the lowest levels of BREEAM green certification (Good and Pass) have no environmental cost premium. The “green premium” that certified buildings can achieve also increases with the certification level, Kok noted. 

Upfront costs for green building are an obstacle  

The higher cost of green building comes from two specific construction cost elements, the researchers found. These are (1) design and (2) fittings and finishes, such as lighting and flooring materials. Green building design costs are 32 per cent higher than the costs of conventional building design, and fittings and finishes costs are higher by 32 and 28 per cent. 

While design fees are only 3 per cent of overall green building costs, they pose = a particular obstacle to green construction, the authors write. Developers pay design fees early on, when ultimate project success is uncertain.  

“Design costs have an outsized impact on the construction practices ultimately,” Kok told NBS. “For developers, it's like, "Oh, whoa. That's what I pay upfront before I get a construction loan — my own money goes into a design set and a plan that I can then take to prospective tenants, investors, or owner occupiers for them to take that building off my balance sheet.’” 

Green building construction also takes 11 per cent longer than construction of a conventional building of comparable size, the researchers found. As a result, builders wait longer for cash flow from rentals or for the project to be sold. The average internal rate of return (IRR) for the developer is 2.6 per cent lower (on a relative basis) on a green certified project. 

Will green design get cheaper?  

Kok thinks that learning and competition will eventually drive down both design costs and the longer construction time. He compares these challenges to green building consulting: “That went from niche and expensive to something that many parties in the market can now provide. And the same, I think, is happening with design and construction. It's become more common to integrate energy efficiency and other sustainability features into the design, but it's still emerging. Not all architects and design firms are well versed in that.  

“Design as a profession is not something that changes overnight,” Kok added. “It's a broad field. People engage in continuous education, but some of these things are fairly novel. Still, to me, there's no doubt that costs ultimately will be compressed because green design shouldn’t be more expensive.” 

Flaherty is less optimistic about the uptake of new approaches. Green design and construction are complicated, he says, and relevant fields — architecture and engineering — aren’t structured to meet the challenge. “Architecture and engineering are highly fragmented businesses with lots of sole proprietors,” he said. “It's really, really complicated to design a LEED platinum one million square foot office building. The regular architecture firms and mechanical engineering firms out there cannot build you a triple glass paned facade or a heat recovery system or any number of [green elements].” 

Spreading that knowledge will happen slowly, he predicts: “In small firms, they don't have the cash flow to have people going to conferences and spending hours going to online seminars and learning.” 

Green building benefits occupants as well as developers 

Beyond financial returns, green building has health benefits for occupant, Kok has found in other research. Green buildings have better air quality — e.g., materials that are not offgassing — and stimulate occupants to move, e.g. via accessible staircases.  

These findings on employee well-being may be especially relevant now. “With the COVID-19 pandemic, that notion of health and buildings is central,” said Kok. “On the one hand, buildings are a cause [of the spread]; on the other hand, they can be a preventative mechanism. 

 “If we press on the same elevator buttons or sit too close, that could spread disease. On the other hand, buildings that have high quality air filtration, which green buildings typically have, can really influence your health. I think that post COVID-19, more and more companies will say, "If we have our people in buildings” — which will eventually happen again — “how can we make sure that we keep them healthy?" 

Read the research 

Chegut, A., Eichholtz, P. & Kok, N. 2019. The price of innovation: An analysis of the marginal cost of green buildings. Journal of Environmental Economics and Management, 98,(free access) 

The Impact of Housing Conditions on Health Outcomes

with Erdal Aydin, Piet Eichholtz, and Juan Palacios, Real Estate Economics (2020)

Download

We investigate the relationship between housing conditions and health outcomes using a dataset that tracks 25,000 German households over 25 years. We document that individuals exposed to poor housing conditions report worse mental and physical health, and experience an 11 percent increase in doctor visits, increasing to 20 percent for age groups over 64. The analysis controls for individual, dwelling and temporal fixed effects, and is robust to changes in socio-economic status, lifestyle choices, and neighborhood conditions. As a robustness check, we use home renovations as major a trigger of changes in housing conditions. Restricting the analysis to tenants, whose renovations are paid by landlords, we document that home renovations significantly reduce doctor visits, corroborating the findings on home conditions and health outcomes.

COVID-19 Risks in CMBS Markets

by Co-authored with Luke Fitzpatrick

Freddie Mac recently announced an extension of its multifamily forbearance program, meant to provide needed relief to landlords (and tenants) impacted by COVID-19-related job losses. According to Fitch, 105 borrowers requested relief on some $810 million of multifamily mortgages. Investors in Freddie’s K-Series CMBS offerings may be somewhat relieved. After all, this $810 million represents just 0.03% of the original loan amount for mortgages in the K-Series. 

However, there is a strong possibility that more landlords will seek forbearance as tenants miss rent payments due to the labor market’s continued implosion and as job losses across the country continue to balloon. Indeed, as our most recent GeoPhy Neighborhoods report indicates, K-Series investors shouldn’t be blasé about the risk that COVID-19 poses to their investment.

Originally developed to rank 90,000+ neighborhoods on their investment attractiveness, GeoPhy Neighborhoods synthesizes hundreds of data points. We recently adjusted our algorithm to understand the risk implications of COVID-19 for the multifamily market. Using this data, lenders and investors can learn which of their assets are in neighborhoods with the highest risk of missed rental payment resulting from the toxic combination of high rent-to-income ratios and large shares of the local labor force (previously) working in COVID-19-impacted industries.

Using this COVID-19 analysis, we examined the K-Series data of Freddie Mac – one of the largest lenders in the US multifamily space. The K-Series securities are part of the $3 trillion commercial mortgage-backed securities (CMBS) market. More than 26,000 commercial real loans, including both acquisition and refinancing loans, have been securitized through the Freddie Mac K-Series since 2003. Focusing on just 2019 and 2020 (year-to-date), that number is about 3,400 loans, with a collateral value of $84 billion. Many pension funds, insurance companies, and other institutional investors gain exposure to the US commercial real estate market through the K-Series. The Freddie Mac K-Series program is significant.

We assessed which multifamily properties included in Freddie Mac’s K-Series CMBS are also located in the top 10% of neighborhoods with COVID-19 layoff/furlough risk. We call these high-risk neighborhoods. Of the K-Series’ 24,117 properties, 33% are located in high-risk neighborhoods – three times more than what would be expected if K-Series properties were distributed uniformly across the country. These properties represent around 24% of all K-Series units or individual apartments, 24.4% of K-Series loans, and 24% of total NOI generated by apartments in the K-Series. 

Some states are worse off than others. California, Texas, New York, and Florida have the most K-Series properties of any state. The share of each state’s properties in risky neighborhoods, however, varies widely. Only 17% of K-Series properties in Texas, for example, are in high-risk neighborhoods. Things are not as rosy in New York: 67% of its 2,158 K-Series properties are in high-risk neighborhoods. 

Within the New York metropolitan area, some neighborhoods stand out as particularly threatened. A large swath of high-risk Brooklyn neighborhoods, reaching from Crown Heights to South Williamsburg to Bushwick, contains 202 K-Series properties that collectively earn a net income of $52 million per year. To put this into perspective, this is 27% of all K-Series properties in Brooklyn, and 22% of K-Series loans in Brooklyn. Before COVID-19, these neighborhoods were rated either A or A+. 

Securitization is meant to reduce an investor’s exposure to idiosyncratic risks. However, we found some massive K-Series deals with a risk-concentration that few people could have anticipated two months ago. The largest deal we identified contains over 330 properties in California and Washington. This is a large CMBS deal (with $670 million in loans) with high-quality assets (74% are in A or A+ Neighborhoods). However, over half of these loans are backed by properties in high-risk neighborhoods for COVID-19 layoffs/furloughs.

Some deals are even larger in value and substantially less diversified. One K-Series CMBS deal in Los Angeles is backed by a single property of 4,200 apartments. It is valued at $1.7 billion dollars. This property’s neighborhood is ranked #11 of the more than 90,000 neighborhoods rated by GeoPhy’s COVID-19 risk score. That places it in the top 0.01 percent of all neighborhoods nationally. 

As COVID-19 continues its deadly spread across the country, the direct and indirect economic implications are becoming ever more apparent. With applications for unemployment benefits at 22 million over the past four weeks, some argue we’ll soon be at an unemployment rate of 18 percent. This will likely translate in a wave of missed rent payments that could increasingly threaten landlords’ income and, possibly, lead to mortgage payment delinquencies. This has consequences for the ultimate providers of capital – the pension funds, insurance companies, and endowments that own multifamily mortgages through CMBS securities. 

The timing and extent to which layoffs and furloughs will negatively affect rent payments is unclear; the Paycheck Protection Program, enhanced unemployment benefits, and SBA loan programs may prove effective. However, it is critical for investors and lenders today to use data strategically as they develop plans to assess the potential impact on their portfolios given the scenarios that could play out.

Indoor Environmental Quality and Learning Outcomes: Protocol on Large-Scale Sensor Deployment in Schools

with Piet Eichholtz, Juan Palacios, and Maartje Willibrordse, BMJ Open (2020)

Download

Exposure to poor environmental conditions has been associated with deterioration of physical and mental health, and with reduction of cognitive performance. Environmental conditions may also influence cognitive development of children, but epidemiological evidence is scant. In developed countries, children spend 930 hours per year in a classroom, second only to time spent in their bedroom. Using continuous sensing technology, we investigate the relationship between indoor environmental quality (IEQ) and cognitive performance of school-aged children. The proposed study will result in a better understanding of the effects of environmental characteristics on cognitive performance, thereby paving the way for experimental studies.

What does COVID19 mean for commercial real estate?

Over the past two weeks, we’ve moved pretty rapidly from “a virus in China” to a situation that affects all of us personally. At the same time, the rapid spread of COVID19 has translated into measures that strongly affect the global economy — most importantly, the “lockdowns” that many countries have implemented, in many different forms.

There is no shortage of articles on how the current crisis will lead to a recession, etc. I don’t have a crystal ball, I don’t want to predict where US GDP and unemployment will be in Q2 2020 (it will be bad…), and neither do I want to be either optimistic or pessimistic about the form of the recession and the subsequent recovery (V shape, U shape, recession, depression, every economist and non-economist will have their opinion). But, I do want to give you some perspective on COVID19 and the commercial real estate market in the US. Given that the situation is fluid, this is not an attempt for a 2-year market forecast, but I’d rather give you some intuition about how to think about the crisis and real estate from an economic perspective. There are many great webinars and resources around, I’ve added some to the references at the end of the article.

So….

Understanding the different parts of the real estate market

To start with, the commercial real estate market (i.e. everything but owner-occupied homes) is really three markets, that are very closely related:

1. The market for space — where companies rent office space, where private individuals rent apartments, etc.
2. The market for assets — where investors buy and sell office buildings, industrial assets, multifamily buildings, and where lenders provide loans to these same investors
3. The construction market — where developers build buildings, financed by construction loans.

In thinking about how COVID19 will affect the commercial real estate market, you can’t just consider one part of the system, but you have to look at all three parts in combination.

The market for space (including the construction market) and COVID 19

Demand for space is determined by factors that vary for each property type. Put simply, or oversimplified:

• Demand for office is determined by the number of people employed in the service sector (on the margin, it matters how many square feet each worker requires, which has been going down over the past years, with the increasing use of flexible office space and more work from home);
• Demand for retail is determined by the number of people and their net disposable income (the big disruption here has obviously been the shift from offline retail to online retail);
• Demand for housing is determined by the number of households (quantity) and the net household income (quality);
• Demand for industrial space is determined by 1) the local need for manufacturing, and 2) the local need for distribution (read: the extent to which online retail has displaced offline retail);
• Demand for lodging/leisure/hotels is determined by 1) tourism, and 2) business travel/conventions.

COVID19 affects each property sector in different ways. While long-term effects remain unknown, here are some of the short term effects (0–6 months). Note that I’m focusing on institutional-grade real estate here, so buildings that our clients invest in, not so much the “mom and pop” buildings (i.e. smaller assets in rural markets):

• Office: The office market has been under a bit of pressure over the past years — the WeWork model provides competition to the traditional landlords, and supply of new space has been significant in most cities. For example, Chicago has a 16.7% vacancy rate, which is only slightly below where it was in 2010 (20%). Due to COVID19, most office buildings across the bigger cities are currently standing pretty much empty — employees are working from home. You’d think that’s a big problem, but commercial office space is typically leased for a longer period (on average, 5 years), which means leases won’t be canceled just now because of the crisis. Of course, if companies that lease office space are going bankrupt en masse, that would lead to increasing vacancy rates, but as of now, the current crisis is not necessarily a financial services crisis, but rather a service sector crisis (so, all businesses actually servicing our financial services economy — restaurants, retail, etc), so the likelihood of large financial firms going out of business is small, unlike during the 2007–2010 financial crisis. An important note on providers of flex space, most importantly WeWork — these spaces typically have very short lease durations and many tenants are small businesses that may suffer disproportionally from the current crisis. So, WeWork et al. are in for a ride over the next months, which again is unlikely to lead to their bankruptcy, but it may lead them to cancel leases. Summarizing: the office market won’t suffer much more than it is already doing….
• Retail: The retail sector has been outright depressed for the past decade. The adoption of online retail in the US was expected to be 12.5% in 2020 (it will be MUCH more), and the share in non-grocery is already higher. That means fewer people go to stores, and many stores/chains have gone bankrupt because of lower revenues. That has led to a lot of vacant space on the retail market, much lower rents, and very high vacancy rates. The COVID19 crisis will only increase this “death spiral,” but…not for grocery stores. Using cell phone data from Advan, consulting firm Eigen10 did an interesting analysis of increase in traffic at groceries during the past weeks, and off-the-cliff traffic at all other retail (especially shopping malls). Summarizing: the retail market will continue its freefall, including spruced-up malls (people will be more fearful of going to places with lots of people, for a long time to come). But strip retail anchored by grocery stores and providing basic needs (pharmacy, dry cleaner, flowers, food) will remain. (It’s just that there is sooo much of that type of retail…)
• Housing: Note that I’m strictly focusing on institutional grade apartment buildings, so no owner-occupied housing, no small apartment buildings, or buildings in places where our clients don’t dare to go (Oklahoma, anybody?). The multifamily housing market has done phenomenally well over the past decade — after the financial crisis, many people lost their home due to their inability to pay for their mortgage (you can fill a cabinet with books about the mortgage crisis, predatory lending, etc, so no further words on that here). All those people still needed a place to live, that’s after all a primary need (in the Maslow sense). So, as the homeownership rate dropped from 68% to 62%, the market for rental housing boomed. Beyond increasing rents in existing assets, that also led to very significant construction activity, especially in the higher segment of the market. At this point, oversupply has started to become an issue in some places in the US (NY, most notably), not because there is no demand for housing, but simply because the apartments that have been built are not affordable for the people that most need them. COVID19 will lead to temporary and structural unemployment, and will thus affect the ability of people to pay their rent, but also to pay their mortgage. Sadly, those most affected are not the mid-to-high income earners, but the ones living on lower incomes, from paycheck-to-paycheck, in housing that is non-institutional. For now, laws are being passed that prevent landlords from “evicting” tenants that can’t pay their bill, but that will eventually happen. The multifamily market will thus be affected by COVID19 — more turnover, not necessarily higher vacancy rates (people need a place to live, also those that have to give up their own home), likely lower rent increases, and more trouble for those spots with oversupply (those apartments will be rented out, but at lower levels). But…the crisis won’t solve the shortage/lack of affordable housing, and “affordability” will remain one of the key topics for the next decade. There is simply not enough space to live in places where the jobs are.
• Industrial/logistics space: The logistics space has been the flavor of the decade, perhaps even more than multifamily. As retail has shifted from online to offline, Amazon, Walmart, Zappos, UPS and the rest of the online value chain have massively expanded their real estate footprint. Vacancy rates for logistics real estate are historically low, and while supply has been increasing in some areas, it simply hasn’t been enough to satisfy demand. The COVID19 crisis has two sides for the industrial market: on the one hand, even more shopping has shifted to online, leading both Amazon and Walmart to announce hiring 100,000 additional employees (!!), which all need space to work. So, that’s good news. On the other hand, supply chains and manufacturing has been disrupted, leading to less business for logistics facilities. If China can indeed ramp up supply again, that short-term shock can likely be absorbed and the industrial sector will march on.
• Lodging/leisure/hotels: The sector that is typically most sensitive to movements in the economy is the lodging/leisure sector. Right now, there is no travel, whether it’s tourism or business travel, and hotels are empty. No revenues, but costs are continuing (although Marriott has laid off many of its staff), including real estate leases. Hotels are operated by companies different from the owners, and you can expect many operators to go bankrupt if the COVID19 crisis lasts for more than 3 months.

The market for assets and COVID19

The market for assets is different from the market for space. A big crisis in the space market does not necessarily directly translate into a big crisis on the asset market. The value of an asset is its net operating income (revenues minus expenses) divided by the capitalization rate — that rate reflects a combination of the cost of debt and the cost of equity.

• Cost of debt: Last week, central banks around the world reduced headline interest rates to near-zero. In addition, central banks are buying up bonds and mortgage securities to keep the cost of capital as low as possible. For real estate, that’s “good” news: borrowing money has just become cheaper! Of course, there needs to be a lender willing to lend, but at this point banks still seem to be willing lenders, as well as the many life insurance companies, pension funds, and debt funds that have been lending to commercial real estate over the past years. The CMBS market, the bundling of commercial real estate loans into investable securities, will be very quiet for the next 2–3 months, but it was only 14% of the commercial mortgage market to begin with, so it won’t materially affect the ability of borrowers to get a commercial real estate loan. Overall, the cost of debt will likely remain similar to what it was, where the lower interest rate will be canceled out by lower risk preference of lenders.
• Cost of equity: Equity providers, or buyers of real estate, include REITs, private equity funds, and institutional investors buying real estate directly. The latter are for example pension funds such as ADIA, GIC, PSP, etc. These pension funds differ in their risk profile and ability to allocate capital to real estate, but I expect most of them to be somewhat more careful in doing new deals. Of course, what is in the pipeline may still go through (as long-term investors, they buy through the cycle), but in a market with uncertainty, it is better to wait. In addition, public pension plans typically have a fixed allocation to real estate, and as the equity portfolio decreases in value (with the S&P500 down to 2017 levels), the allocation to real estate increases, which means a hard stop on new real estate deals. REITs won’t be net buyers either, as they need to raise equity for new acquisitions, which is expensive in the current market (their share price is down, so issuing new equity is not desirable, and many will be focused on remaining at low leverage). That leaves private equity funds. They have USD300 billion in capital to deploy, so most of them probably can’t wait for a downturn to happen — or at least, for some offloading of assets by owners that are forced to sell because of mortgage payment issues. The world is so flush with cash that once commercial real estate prices go down, many investors will want to get into real estate. That means the cost of equity won’t significantly go up in the near term.

So, is nothing happening to asset prices?

Of course not — even though cap rates may stay relatively stable, on increase just slightly, the net operating income of many properties, and the projections thereof, won’t be as rosy as it used to be. A decrease in NOI of 10% and a relative increase in the cap rate of 10% will lead to a 20% decrease in asset prices. In case a building is levered (that is, financed) at 70%, the loan to value ratio will likely break what is acceptable to the bank, potentially setting off a negative spiral of delinquencies, leading to lower asset prices, etc. But for now, that seems unlikely in a scenario where the COVID19 crisis is deep but short — banks will much rather keep the asset off their balance sheet, working with the borrower.

One last note on the construction market — currently construction projects are on hold in many cities, meaning that there will be a delay in new space coming on the market. That may provide some relief to markets with ample supply of space. Also, construction projects that were still on the drawing board will likely remain there for a while, leading to supply that will be lower than forecasted.

Stay healthy!

References

• Moody’s CRE webinar slides || recording
• RCA — Commercial Real Estate Moves Into Uncharted Territory
• Colony Capital/Barrack — Preventing CMBS market collapse
• CBRE Macro update March 2020

The Capitalization of Energy Efficiency: Evidence from the Housing Market

with Erdal Aydin and Dirk Brounen, Journal of Urban Economics (2020)

Download

Current policies addressing the carbon externality from energy consumption in the building stock often hinge on the assumption that markets efficiently capitalize the energy performance of assets, assuming perfect information. This paper uses different identification strategies to examine the capitalization of energy efficiency in the housing market, addressing methodological shortcomings in the existing literature that may lead to inaccurate estimates. Using an instrumental variable approach, we document that a ten percent increase in energy efficiency leads to an increase in the transaction price of about 2.2 percent for an average home in the residential housing market. We confirm these findings using a repeated sales analysis. Importantly, the results indicate that the extent of capitalization of energy efficiency is not significantly affected by the reduction of information asymmetry through the presence of an energy performance certificate (EPC). Using a regression discontinuity approach, we show that consumers do not capitalize the information that is provided by EPCs. The findings in this paper provide some evidence on the efficiency of the market in pricing home energy performance, indicating that the salience of this information may obviate the need for costly certification programs.

 

Building a Real Estate ETF, Bottom-Up

Last week, the investment management behemoth BNP Paribas launched a “green” real estate ETF—a mutual fund that invests in listed property companies (aka REITs), passively, while taking environmental considerations into account. This real estate index, which is based on the FTSE EPRA Nareit Green Index, is special for two reasons.

First, it is one of the first passive real estate index products that integrates so-called environmental, social, and governance (“ESG”) considerations. Real estate plays an important role in ESG-related issues. The sector consumes 81% of electricity in the U.S., emits 40% of carbon, and provides shelter for 90% of our time (only 10% of time is typically spent outdoors). The FTSE EPRA Nareit Green Index (and thus the BNP Paribas’ green real estate ETF) applies a conduct-based exclusion based on the United Nations Global Compact principles, and constituent weights are adjusted (tilted) based on two sustainable investment considerations—green building certification and energy usage.

Second, and perhaps even more groundbreaking, the ETF is based on data that maps the individual holdings in portfolios of listed property companies/REITs. Drawing on a geolocation database of over 15 million buildings from GeoPhy, circa 73,000 individual buildings with over 10 billion square feet combined floor space are identified. These cover real estate holdings for 93% of the constituents of the FTSE EPRA Nareit Developed Index, the most widely used real estate index in the institutional real estate space.

Using a bottom-up approach, exploiting asset-level data, is important. It allows for matching each asset with green certification data, such as certification by LEED, Green Star, and BREEAM. And, it provides the basis for detailed, building-by-building energy use, and carbon modeling. The data is then aggregated to create portfolio-level metrics that provide a timely, consistent, and highly-granular assessment of the sustainability performance of each property company across three key indicators:

1. Share of the total net leasable area covered by eligible green building certification
2. Average estimated energy use per square meter
3. Average estimated greenhouse gas emissions per square meter

These metrics are applied as “tilts” (or weights) to develop an innovative, sustainability-focused alternative to a “conventional” real estate index and ETF. The green index puts more weight on real estate portfolios demonstrating strong sustainability performance and reduces exposure to those portfolios with a less sustainable asset base. The graph below shows significant reductions in carbon emissions (-22 to -40% on a per-dollar basis) for the green real estate index.

Index level sustainability performance vs. benchmark. Source: FTSE Russell

 

Money talks when it comes to “green” financial products—including real estate ETFs. A simple backtest of two indices that focus on “greener” property companies shows excess returns of about 1% per year. While the results of the past are no guarantee for the future, the increasing regulatory and investor focus on the environmental performance of buildings may further reinforce the outperformance of REITs with a greener portfolio, with a high fraction of sustainable, low-carbon space.

 

Index level financial performance vs. benchmark. Source: FTSE Russell

 

A real estate portfolio reflects the aggregate performance of a collection of assets—information on each of those individual assets allows for the development of novel and innovative financial products. The BNP Paribas’ green real estate ETF is a leading example of a bottom-up approach to index construction—a similar approach in real estate can be taken for a “pure play” sector index, a climate resilience REIT index, etc. Each of these products will offer pension funds, insurance companies, endowments, and other investors the ability to make more targeted investments in real estate through a liquid product that is offered by REITs.

Stay tuned for these products to come to market, sooner rather than later! In the meantime, read more about the FTSE Green Index here.

Industrial Real Estate Is Red Hot. But Where to Invest?

The demise of retail real estate, mostly at the hands of e-commerce, has had one positive side-effect for the industry: it’s been a boon for owners and developers of warehousing space, and industrial real estate more broadly. Numbers speak louder than words: according to CBRE, the average cap rate for acquisitions of industrial space reached a record low of 6.3% in the first half of 2019 (as a comparison: office stood at 6.7%, neighborhood retail at 7.5%, multifamily at 5.2% and hotels at 8.3%), down from 7.5% in 2013.

In some markets, such as LA’s Inland Empire, cap rates are now consistently below 4%. That’s not much higher than what you would get on a virtually risk-free savings account. Public market investors have also taken notice: the stock price of Prologis, the largest industrial REIT in the U.S., is up 27% for the year (compared to 2.6% for the S&P) and up 121% over the past 5 years (compared to 52% for the S&P).

A wall of capital looking for opportunities

The attractiveness of industrial and warehouse assets is, of course, no state secret, and investors of all colors and stripes have piled into the sector. Real estate giant Blackstone has amassed 800 million sqft. of industrial space, as mentioned in this WSJ article. Prologis, another gorilla in the industrial space, just acquired Liberty Property Trust, for USD 10 billion. The “average” private equity investment manager has also significantly increased his or her allocation to real estate. Constituents in the MSCI PREA/ACOE Index (the ACOE Index includes the major commingled private equity real estate funds, such as those managed by JP Morgan and Morgan Stanley) increased their allocation to industrial real estate from a low of 12.5% in 2015 to 17% in Q2 2019.

As capital continues to flow into the real estate space (Preqin estimated the “war chest” or “dry powder” of private equity real estate funds at some USD 333 billion in March 2019), and industrial real estate remains the “flavor of the day” (or perhaps: the decade), many real estate investors and developers are looking for opportunities in the industrial real estate space. But equally, investors that developed or acquired industrial assets over the past years may consider capitalizing on the current craze by offloading some of their assets, or their full portfolio of assets.

That leads to the question: which markets will do well, with significant rental growth ahead, and which markets will see rental growth tapering off, or perhaps even decreasing?

Understanding industrial markets using (big) data

Forecasts of rental growth (or decreases in rental rates) are typically inaccurate (this is an interesting paper that studies the forecasting performance of real estate professionals). Today’s plethora of big data can help investors spot the causes of future rent change. For the forward-looking investor, it’s just a matter of sifting through those mountains of data, but that’s not exactly what an investor is looking to do.

Enter GeoPhy Value Drivers — a set of curated market and location attributes that help to quantify the demographics, freight outlook, and hyperlocal characteristics of the area surrounding a property. ValueDrivers come at four levels:

1. Macro or nationwide
2. Regional or metro area
3. (Sub)market
4. Neighborhood or location

We will look into a selection of these Value Drivers using an overlay of all REIT-owned U.S. assets with an “industrial” focus — assets owned by the likes of ProLogis, Duke Realty, W.P. Carey, First Industrial, etc. Given that all of these assets are in the U.S., macro isn’t necessarily worth discussing, as it refers to macroeconomic conditions, such as core inflation, the FED interest rate, stock market performance, and sentiment indicators such as consumer confidence. These factors mostly affect capitalization rates, for all property types, and across the country.

Comparing industrial properties, from Kansas to Carolina

In contrast to macroeconomic indicators, regional or metropolitan area indicators are highly relevant for industrial assets. Which metro areas will see demographic growth in the next 5–10 years? Which markets provide a deep pool of (affordable) labor — an increasingly important question in the current tight labor market?

One source of data that we uncovered at GeoPhy is the Freight Analysis Framework, developed by the Bureau of Transportation Statistics. The graphs below provide a snapshot of the Freight Analysis Framework data (an online, interactive version can be found here). There are some clear differences between areas — for example, the amount of freight in the Raleigh-Durham metro should decrease (clearly, the region is shifting to higher-value freight), whereas freight volume in the Kansas City metro should increase both in tonnage and in dollars. Although high level, this data provides a good first insight into a ranking of regions by freight flows and of growth therein.

Freight Analysis Framework and REIT assets

The Freight Analysis Framework graphs above underscore just how diffuse industrial investment opportunities are. Given the wide variety of metros that fit this initial criteria, additional analysis is clearly needed to assess a property in one metro relative to a seemingly similar property in another metro.

This is where an investment mandate or thesis becomes an important consideration. For purposes of illustration, we evaluate two different purposes:

1. Industrial properties that will benefit from the continued growth of e-commerce, so those that are in close proximity to last-mile markets, with high density of consumers, especially those with higher income; and
2. Industrial properties where light manufacturing or regional distribution takes place, requiring (light) industrial job skills and a deeper pool of affordable labor.

Zooming in: demographics and socio-economic indicators

Data at the metro area provides pretty good insight into demographics — both to understand access to a skilled and willing workforce, as well as access to a large catchment of potential consumers (most relevant for regional distribution centers, and critical for last-mile delivery, as laid out nicely by Prologis in this article). How many people live in an area? What’s the average household income? What’s the cost of housing?

We pick two industrial properties at two totally different places:

1. A 340,000 sqft. asset located in Greensboro, North Carolina, owned by Liberty Property Trust
2. A 314,000 sqft. asset in Olathe, Kansas, owned by Monmouth Real Estate Investment Corporation.

Both are larger facilities, both “multi-market” properties at key transportation hubs. Using Census ACS and Zillow data, we analyze the nearby area. It’s important to look beyond the immediate catchment or nearby area of a property. We measure every indicator both at the ZIP level, as well as within a region covered in a 30-minute and 60-minute drive, using GeoPhy Reach.

At first glance, Olathe, located just south of Kansas City, seems more populated, with higher incomes. The total population in the ZIP code is 80,000 people, (in 27,385 households), but within a 60-minute Reach, there are more than 2 million people (in 806,000 households). The median household income is USD 92,000 (relatively high compared to the U.S. average) — the aggregate household income within a 60-minute drive is some USD 64 billion. That’s great for assets focused on local distribution (there are many willing buyers for goods stored in distribution centers), but of course, for assets focused on regional and pan-regional distribution, different things matter (those facilities need people to work).

Greensboro seems to be better positioned here. Within 60 minutes, there are 1.6 million people. But, the labor market participation rate is relatively low, house prices are low (which implies higher affordability), and the population is not as highly educated (logistics facilities typically offer few high-skilled jobs). We also have data on hourly wages for different job types. For industrial/logistics, we’re specifically interested in jobs related to Production, Transportation, and Material Moving (PTMM). In Greensboro, hourly wages are at USD 16.65, decreasing slightly to USD 16 at a 30–60 minute driving distance. In Olathe, where the labor market is tighter, wages are about 10% higher.

GeoPhy Industrial Value Drivers

Other nearby points of interest: Amazon, airports, and ports

Using other sources of data, we evaluate the distance of a property to the following key points of interest that are relevant for tenants in (and thus owners of) industrial space:

• Airports, ports, rail terminals

• Amazon fulfillment centers (presumably Amazon has a superior location selection strategy)

• Nearest highway on-ramp

• Presence of public transit (bus stops matter for industrial facilities, at least for their employees)

• And more

The pictures below (online, interactive versions can be found here) show both Olathe and Greensboro are far inland and don’t have direct access to seaports. But the Greensboro asset is very close to an airport, whereas the Olathe asset is in close proximity to Amazon.

Amazon, Airports and Ports around Olathe

Amazon, Airports and Ports around Greensboro

A hyperlocal perspective: from fast food to financial services

A final layer of data that is often overlooked is where (hyperlocal) location data comes in: the micro level. Here, we investigate the presence of amenities for employees within walking and driving distance — a place to eat, to drink, or do some quick shopping after work. Of course, there are many other data layers available at the local level, such as the incidence of crime, but also more sophisticated data such as real-time mobile phone data to better understand local dynamics.

At the hyperlocal level, Kansas and the Carolinas (Olathe and Greensboro) are quite different. For example, there is a relatively high density of amenities in Greensboro, as opposed to the asset in Olathe. Whereas restaurants, shops, and other amenities are not typically associated with industrial real estate (much more so with multifamily and office properties), such amenities are increasingly important for the workforce. As the battle for talent shifts to all jobs, not just white-collar jobs, employers compete for labor, and the presence of amenities close to the job may be a competitive advantage, as access to amenities could increase employee morale and retention.

Amenities in Olathe

Amenities in Greensboro

Closing thoughts: data driving investment decisions

As e-commerce continues to become a more important part of retail sales, competition for industrial space won’t be abating anytime soon. The war for “last mile, last touch” locations is just starting, and it is in these locations that land and space are especially scarce. But whether it is for regional distribution centers or properties used for last-mile delivery, investors will find themselves increasingly in markets that they previously did not operate in. Local knowledge sourced through brokers is useful, but hard to scale and often hard to quantify.

Relevant data can help investors and lenders objectively assess the merit of locations, supporting location selection as well as underwriting decisions. Of course, the use of a property may require being in close proximity to an urban area, such as in the Olathe example above, or it may rather require the presence of a large workforce that may be available to work in the industrial facility. In the era where bricks-and-mortar retail is replaced by data-driven e-commerce platforms, using data for investment, lending, and location decisions for industrial and logistics real estate is the best way forward.

Environmental Performance of Commercial Real Estate: New Insights into Energy Efficiency Improvements

with Piet Eichholtz and Rogier Holtermans (Journal of Portfolio Management)

Download

This article provides new insights into the performance of commercial real estate, focusing on the environmental performance of institutional assets. We employ a proprietary dataset of energy consumption data that includes more than 26,000 buildings between 2009 and 2018. We document that, in our sample of commercial real estate, the median energy intensity decreased by more than 40% over the decade. Using a difference-in-difference analysis, we find that the adoption of environmental building certification (Leadership in Energy and Environmental Design) is associated with significantly lower energy consumption and that there is substantial variation in these effects, depending on certification level and program, and label tenure. Moreover, specific interventions aimed at improving the energy efficiency of buildings considerably reduce ex-post energy consumption, with effects varying based on local climatic conditions.

Chicago Is The Greenest City In Green Building Adoption Index For The Third Straight Year, As Green Building Certifications Reach New High Nationally

Chicago’s office market was named the greenest in the U.S. for the third year in a row as the green building trend continues to expand in the nation’s largest cities, according to the sixth annual Green Building Adoption Index by CBRE, Maastricht University and the University of Guelph. Researchers found green-certified office space across America’s 30 largest office markets has reached 42.2% up from 41.9% the year before, marking a new high.

At the same time, CBRE also released the inaugural Multifamily Green Building Adoption Index, which shows growth in this sector as well, though starting at a lower level than the office sector. 3.3% of multifamily apartment units in top 30 multifamily markets are green-certified.

Office Index

“Green” office buildings in the U.S. are defined as those that hold either an EPA ENERGY STAR® label, USGBC LEED certification or both. The 2019 Green Building Adoption Index shows that across the 30 largest U.S. office markets, about 4,879 buildings have now been certified as “green,” the highest total in the index’s history.

Chicago took the top spot for the third straight year, with 71.1 percent of its space being green certified. This was a slight increase from the previous year, when the Midwestern city recorded 69.8 percent. Second-place San Francisco made significant ground, increasing from 64 percent to 67.5 this year, marking the largest percentage gain, along with ninth place Seattle, year-over-year. Atlanta maintained the third spot with more than 59 percent of all space green certified, while Minneapolis moved up to the number four spot with 57 percent, passing Los Angeles, which now rounds out the top 5 at 56.6 percent.

“Green building continues to be a growing trend, as both tenants and owners seek the benefits of being associated with these properties,” said Spencer Levy, chairman of Americas Research for CBRE and senior economic advisor. “Long-term, these buildings offer real cost savings, making them appealing to owners and investors alike. These buildings are also more attractive to tenants, as many corporate users seek out these properties for their operational and social benefits. As the market has proven, its popularity only continues to grow.”

Inaugural Multifamily Index

The inaugural multi-family index from CBRE, Maastricht University and the University of Guelph, in partnership with the National Multifamily Housing Council, found that while still in the early stages, green certification is gaining momentum in this sector, with 3.3% of all multifamily apartment units in the top-30 markets now green certified.

Denver took the top spot with 7 percent of the market’s multifamily apartment units certified as “green”, followed by Washington DC/Suburban Maryland with 6.9 percent and Seattle at 6.5 percent.

Dr. Nils Kok, Associate Professor at Maastricht University, said “Tenants and investors are looking for high-quality space, to work and live in, or to allocate capital to. Quality has become synonymous with sustainable, green space, offering superior air quality and lighting, in addition to being efficient in its use of energy, water and other resources. These preferences are now a market reality in the office market, and are starting to take hold in the market for multifamily buildings.”

This is the sixth release of the annual Green Building Adoption Index. Based on a rigorous methodology, the index shows the growth of ENERGY STAR- and LEED-certified space for the 30 largest U.S. office markets, both in aggregate and in individual markets, since 2005. View the study’s findings HERE.

This is the inaugural U.S. Multifamily Green Building Adoption Index. Based on a rigorous methodology, the index shows totals for ENERGY STAR-, LEED-, and National Green Building Standard-certified space for the 30 largest U.S. multifamily markets. View the study’s findings HERE.

The Price of Innovation: An Analysis of the Marginal Cost of Green Buildings

with Andrea Chegut and Piet Eichholtz (Journal of Environmental Economics and Management)

Download

Energy efficiency plays an important role in reducing the carbon externality from buildings, but economic analyses of more efficient, green building have thus far ignored input costs. This paper finds that the average marginal cost of green-labeled construction projects is smaller than the value premiums documented in the literature. However, design fees, representing just a fraction of development costs but paid largely up-front, are significantly higher for green construction projects. These projects also take longer to complete. The results provide some insight into the market barriers and market failures that may explain the relatively slow adoption of otherwise economically rational green construction practices.

Getting High or Getting Low? The External Effects of Coffeeshops on House Prices

with Erdal Aydin, Piet Eichholtz and Mike Langen (October 2019)

Download

The legalization of cannabis is a hotly contested policy topic. While beneficial to some, cannabis dispensaries may create negative externalities for others. This paper studies the external effects of coffeeshops – Dutch cannabis sales facilities – on local house prices. We employ a difference-in-difference analysis and a repeat sales analysis around a change in regulation, leading to exogenous coffeeshop closings. We document that coffeeshop closings have negative effects on home values. Compared to homes nearby remaining coffeeshops, homes nearby closing coffeeshops decrease on average 1.6 to 7.8 percent in value. The findings are robust to sub-tests and unaffected by the subsequent use of coffeeshop location.

On the Value of Environmental Certification in the Commercial Real Estate Market

with Rogier Holtermans (Real Estate Economics)

Download

A significant part of the global carbon externality stems from the real estate sector. Environmental certification is often hailed as an effective means to resolve the information asymmetry that may prevent markets from effectively pricing the energy performance of buildings. This study analyzes the adoption and financial outcomes of environmentally certified commercial real estate over time. We document that nearly 40% of space in the 30 largest U.S. commercial real estate markets holds some kind of environmental certification in 2014, as compared to less than 5% in 2005. Tracking the rental growth of 26,212 office buildings, we measure the performance of environmentally certified real estate over time. We document that certified office buildings, on average, have slightly higher rental, occupancy and pricing levels, but do not outperform non-certified buildings in rental growth over the 2004–2013 period. Further performance attribution analysis indicates that local climate conditions, local energy prices and the extent of certification lead to significant heterogeneity in market pricing. On aggregate, these findings provide some evidence on the efficiency of the market in the adoption and capitalization of environmental characteristics in the commercial real estate market.

Predicting Commercial Real Estate Values? Use House Prices!

Cross-posted on Medium, joint with Ali Ayoub.

On September 7, 2017, Amazon announced that it started its search for a second headquarters, comparable in size to its very significant Seattle presence. The rest of that parable is history, at least for the casual consumer of daily news.

For investors in real estate, however, the rollercoaster of the Amazon search, selection, and deselection of an additional location for its headquarters had and continues to have material implications. After all, just the prospect of landing the headquarters of a company planning to employ 40,000 highly paid workers, let alone the creation of thousands of indirect jobs, makes mouths water. Think of the apartments and homes needed. Think of the office space required. The retail that all these hipster millennials need. Yoga studios, juice bars, … etc. Many markets on the shortlist announced January 18, 2018, saw heightened investor interest in anticipation of Amazon’s final choice. Of course, when the final word came with not one but two additional future headquarters — Long Island City (NY) and Arlington County (VA) — capital markets really started to rumble. Then when Long Island subsequently got nixed, earmarked capital immediately began to dissipate.

Amazon HQ2: Putting a value on a (great) prospect

There is a lot of speculation about the impact of corporate moves such as the Amazon example (but also: Google’s increasing presence in Manhattan, Facebook’s move to San Francisco, etc.). Understanding the impact of the looming arrival of the world’s largest company (by market cap) on the value of commercial real estate assets presents a significant challenge. After all, commercial real estate assets don’t trade frequently, and certainly not with sufficient numbers to measure market changes in pricing at the local level. (I’ll leave the technical details of index construction out, but ideally, you measure market trends by analyzing repeat sales, or multiple sales of the same building — RCA, for example, is using that technology for their indices.) To assess the appreciation or depreciation of commercial real estate, the industry, therefore, relies on manual appraisals, typically done once every 1–3 years for a given building. But, how does an appraiser incorporate the prospect of a company establishing a presence in an area?

Intuition can certainly give hints. Conservative estimates show that 40,000 people need 4 million square feet of office space, 30–35,000 apartments (even on an Amazon HQ wage, you can’t always afford a studio or home for yourself), and the average U.S. consumer has 23.5 sq.ft. of retail space at its disposal (although I suspect that Amazon employees live their shopping life predominantly online). That’s a lot of additional demand for space, and indeed, early market evidence from Crystal City show that some of it is already materializing! In addition, more investor capital will flow into the market, lowering return expectations (the “cap rate,” in real estate jargon) and increasing prices. But it’s easy to see that translating intuition into the valuation of commercial real estate is hard!

Using REITs to gauge market sentiment

One way to gauge the impact of Amazon on the local commercial real estate market is to look at the price of publicly traded REITs with exposure to either one or both Amazon locations. For example, JBG Smith, an office REIT, has about a third of its portfolio located in Arlington County (other REITs owning assets at that location include Simon Property Group, Equity Residential, Ashford Hospitality Trust, Vornado Realty Trust, and a few more). The maps below show REIT-owned assets both in Long Island City and in Crystal City.

The announcement by Amazon wasn’t necessarily the cleanest ‘event,’ as markets had some anticipation of location choice (a CEO that has a home in the area seems to be a reliable predictor of company HQ choice). But still, the stock price of JBG Smith outperformed the broader REIT index around the announcement of Amazon, and its stock rose further when Amazon decided not to go to NY after all (Schadenfreude, as the Germans call it).

 

REIT-owned assets in Arlington County (highlighted) and beyond.

 

REIT-owned assets in Long Island City, NY (highlighted) and beyond.

The housing market as a leading indicator for CRE values

The change in REIT pricing reflects investor perception of the change in portfolio asset value. However, it doesn’t tell us exactly or directly how the valuation of individual assets changed. Another (indirect) way to look at the impact of the Amazon HQ location choice on the commercial real estate market is to analyze housing prices. Compared to the commercial real estate market, the housing market is liquid and deep — an average of 14,000 homes and apartments sell every day! The leading homes sales and rental platform, Zillow, provides a detailed set of monthly home price and rent indices, available at the ZIP code level. After the announcement of Amazon to split the “new” HQ between Arlington and Long Island City, Zillow analyzed predicted price and rent growth. Now, a few months after the announcement, and with hindsight knowledge of the retraction out of Long Island City, we can look at actual data.

The figure below plots the development of the Zillow Home Value Index (based on Zillow’s Zestimate, standardized to 100 on August 1, 2018) and the Zillow Rent Index. Interestingly, housing prices in Long Island City rose in anticipation of the Amazon announcement, but they started to decline right after the Amazon announcement to locate in Long Island City, perhaps in anticipation of what was to come…? For rents, we see a reverse effect. Asking rents declined until just before Amazon made its announcement to move to Long Island City, at which point rents started to increase quite rapidly. Unfortunately, that growth began to decrease after the pivotal moment of the LIC pullout.

 

Using automated valuation models (AVMs) for CRE

While it may seem far fetched to relate house prices and rent developments to changes in commercial real estate markets, that’s precisely what a modern data-driven valuation does. It relates the price of commercial real estate assets to quantitative, observable fundamentals in the local market and in the macroeconomy. Of course, this plethora of information cannot filter into property valuation manually, it requires machine learning models that already power so many products and industries. Automated valuation models (AVMs) for commercial real estate are able to incorporate hundreds of variables (technically, the number of variables could be unlimited, but some adult supervision is helpful), using sources updated as frequently as daily. Think about the movement in the stock market and in interest rates. Both are inputs into the cost of capital, and thus the value of commercial real estate. Think about jobs, income levels, and income changes. Consider ‘hyperlocal’ metrics such as crime, events, amenities, and access to public transit.

 

Location features powering the GeoPhy AVM

AVMs, housing prices, and the effect of Amazon

The GeoPhy AVM includes a number of features that reflect levels of and changes in house prices — from local house price indices to permit data, and from local housing market rents to market velocity. The picture below shows how GeoPhy valuations of commercial real estate change based on a percentage change in house price-related features (note this is ceteris paribus, so everything else in the models stays constant).

Now, what would the impact of Amazon on Long Island City’s commercial real estate market have been? There are many factors that would have changed in the process, but looking at changes in housing prices alone, we estimate that commercial real estate values increased by approximately one percent in anticipation of, and subsequent to Amazon’s decision to locate in NY. We’re still in the process of bubble deflation, but we expect this effect to disappear rather quickly. For buy-and-hold investors, similar to those following the Amazon saga with nothing but bemusement, the Amazon flip-flop was thus merely a blip, and they likely haven’t even noticed the change in value of their assets.

 

The impact of changes in house prices on the value of commercial real estate (GeoPhy AVM)

But. . . the GeoPhy AVM indicates that real value was created in the Amazon location decision, and real value was eventually destroyed!

Environmental Performance and the Cost of Debt: Evidence from Commercial Mortgages and REIT Bonds

with Piet Eichholtz, Rogier Holtermans, and Erkan Yonder, working paper (Journal of Banking and Finance)

Download

The increasing societal focus on environmental issues leads to important questions about the relationship between corporate environmental (ESG) performance and firms’ cost of capital, but research on this topic remains scant. The real estate sector offers an ideal testing ground to investigate the relationship in two distinct manners, while specifically addressing concerns about endogeneity. We first investigate the spreads on commercial mortgages collateralized by real assets, some of which are environmentally certified. We then study spreads on corporate debt of property companies (REITs), both at issuance and while trading in the secondary market. The results show that loans on environmentally certified buildings command lower spreads than conventional, but otherwise comparable buildings, varying between 24 and 29 basis points, depending on the specification. At the corporate level, REITs with a higher fraction of environmentally certified buildings have lower bond spreads in the secondary market. These results are robust to different estimation strategies, and signal that environmental risk is efficiently priced in the real estate debt market.

Flash Boys in Flash(y) Buildings -- The Increasing Importance of “Fiber” in Commercial Real Estate

Also posted on Medium

In his NY Times bestseller “Flash Boys” Michael Lewis describes how hedge funds and other investors beat the market by being able to trade faster than competitors (perhaps helped by a bit of insider insight, but that’s an aside, and better described in another great read, Black Edge). The book starts with a detailed narrative on the digging of a trench for a fiber cable between Chicago and New Jersey, to reduce by milliseconds the time it takes for orders to reach the Chicago Mercantile Exchange. Equally impressive are Lewis’ insights into how investors buy buildings or locate servers in buildings closest to the NY Stock Exchange.

Based on Flash Boys, one could argue the old adage of the real estate sector “location location location” is as relevant as ever in today’s internet-based society. It’s just that the factors that make for great locations have changed. Beyond the ever-increasing importance of access to public transport and a 24/7 vibrant neighbourhood, access to fast internet — or “fiber” in industry jargon — is now among the top priorities of choice tenants. Mind you, today’s most desirable tenants are no longer just good-old financial services firms, banks, and household names in manufacturing. Facebook, Apple, Netflix, Google (the FANG stocks, or FAAMG stocks), as well as WeWork (currently the largest tenant in New York) and many of the other space-sharing companies, now stake a claim among tenants rapidly increasing their footprint in the office sector.

Fiber Accessibility As an Amenity

For tech companies, space-sharing companies, and banks (with trading floors) alike, fiber accessibility is paramount. Whether it is for cloud-based computing and data services, or for trading purposes, the speed of internet matters — a lot. An illustration in point is the well-known example of Google’s first NY office, located in Chelsea, bought in 2010 for a stunning USD1.9bln (in cash, mind you). As astutely described in this article “the appeal [of the building] probably lies in the fiber-optic cables transmitting high-speed data that lie under the former Port Authority building, primarily the “fiber highway” along Eighth Avenue/Hudson Street and Ninth Avenue that’s considered one of the most vital connection points to the world’s telecommunications networks.” More recently, Google added another building on Chelsea market to their portfolio, this time paying USD2.4bln (cash only, please) to Germany-based fund manager Jamestown.

Measuring “access to fiber” can be done in many ways — it is not a top secret where such cables are located. The map below (from Durairajan et al., 2015) shows the main fiber cables across the US. The other map (from our GeoPhy colleague Daynan Crull) shows the main fiber cables in NY specifically. A real estate developer, investor, or (prospective) tenant could measure a building’s distance to the fiber cable to get some basic understanding of latency. If such an amenity is desirable for a sufficiently large number of tenants, real estate prices may start to differentiate based on distance to fiber cables. Anecdotally, that seems to be the case (e.g., the Google example), and there is some emerging empirical evidence on the value of fiber for commercial office buildings.

The long-haul fiber-optic network in the US (Source: Durairajan et al., 2015).

Source: GeoPhy

A Nutrition Label to Measure “Connectivity”

But of course, the connectivity of a building is more than proximity to fiber access alone. A building may be situated close to fiber cables, but its infrastructure may not allow for consumption of high-speed internet (also known as a building’s throughput). Enter Wired Certification. Established by WiredScore in 2013, Wired Certification is akin to a nutrition label for commercial office buildings, assessing the presence of all components that make for a “connected” building. An analogy can be made to the LEED label, which measures the sustainability performance of buildings. While unknown to some, Wired Certification has actually taken the market by storm in just a short period. It provides a simple-to-interpret tool that not only enables landlords to identify marketable connectivity features to promote best-in-class building internet access, it also provides a means for tenants to easily identify those properties that fit their current and future connectivity needs. Wired Certification is now present in 6 countries, with a focus on commercial office properties.

Wired Certification across the US and Europe (Sources: WiredScore and GeoPhy)

For institutional real estate investors, such as pension funds and insurance companies (e.g., CalPERS in the US), the increasing importance of connectivity in buildings has likely gone unnoticed. Such investors mostly invest in real estate indirectly, through private equity real estate funds and publicly traded property companies (a.k.a. REITs, or Real Estate Investment Trusts). But those REITs and private equity fund managers with the awareness to incorporate “fiber” into property and asset management may well be better positioned in the market for tenants. That foresight potentially leads to outperformance at the operational level, which in turns leads to the ability to beat the market at the stock level.

How Connected Are REITs?

To understand how REITs across the globe are adopting “building connectivity” as a theme, we analyzed the diffusion of Wired Certification across the 321 equity REITs included in the FTSE EPRA/Nareit Developed Index. This index is the globally leading REIT index used by most of the largest active and passive REIT investors as the benchmark of choice. Each quarter, GeoPhy collects information on the asset holdings of each of the 320+ property companies, including detailed information about location, property size, age, quality, and if available, net operating income and valuation or transaction price. We then match this dataset with information on Wired Certification (WiredScore provided the data). The resulting constituent list shows the fraction of each REIT’s assets that is Wired certified, both equally weighted and value-weighted.

In total, 38 out of 321 of the REITs in the FTSE EPRA/Nareit Developed Index have one or more assets that are certified by WiredScore. Although mostly US-based, several of these companies are in the UK, France, and Japan. On average, 13% of each REIT portfolio is certified, measured by the number of assets. Measured by space (in square feet), 15.3% of each REIT portfolio has Wired Certification, with larger buildings more likely to be certified. These averages, however, mask some important variations. For example, while the Empire State Realty Trust (owner of, yes, the Empire State Building) has 82.5% of its portfolio rated for its superior connectivity — with other NY-based owners such as Paramount Group and SL Green Realty also ranking high. London-based property companies Derwent and Workspace Group have 49–56% of their floor space certified. (Download the full list here.)

Of course, not all buildings with great internet infrastructure are Wired certified. That means these numbers likely represent an understatement of adoption and focus on internet accessibility by institutional landlords. It’s worth noting the increasing importance of connectivity is not limited to that of office buildings. Retailers also steadily rely more on consistent in-store connectivity, while industrial warehouses have a strong dependence on the internet for order intake, order processing and communication with downstream distributors (warehouse behemoth Prologis is on our list as well, albeit with a single building. . .). Additionally, fast and reliable internet connectivity for tenants in multifamily apartment buildings has become almost as important as running water (for some, it’s probably even more critical).

Flash boys, speculative investors, trade on speed while institutional investors trade on knowledge of fundamentals. The former benefit from access to fiber. The latter would benefit from better understanding which REITs have assets with superior connectivity. After all, flash boys want to be in flashy buildings, and the new “location location location” may soon be determined by access to the fiber highway, rather than the physical highway.

STORM WATCH! These REITs and CMBS Deals Are Most Exposed To Hurricane Florence

As posted on Medium with Ali Ayoub

The hurricane season has barely started, and the first monster hurricane is already upon us — Hurricane Florence is rapidly approaching the East Coast, and is expected to lead to significant material damage.

Financial markets are pretty good bell-weathers on which industries will be hit hardest, with certain stocks sliding in advance of the storm making landfall. Indeed, Bloomberg reported earlier today on insurance stocks taking a battering, regional utility companies taking a hit, and firms with significant presence in the storm cone of Hurricane Florence (retail, banking, etc) going down.

One industry that is particularly prone to climate risks is commercial real estate. Earlier this year, we analyzed the exposure of the U.S. REIT sector to a variety of climate risks, including flood risk. But rather than an analysis based on hypothetical risk models (which short-term focused investors find hard to incorporate in conventional asset pricing models), the threat of Hurricane Florence provides a “clear and present danger” for investors in and lenders to the real estate sector. (Mr. President, are you reading this?)

To better understand the exposure of the commercial real estate sector to storm and flood risk from Hurricane Florence, we analyzed the assets owned by real estate investment trusts (REITs) and assets that are collateral for loans bundled into commercial mortgage backed securities (CMBS). For context: REITs own 42,924 assets across the U.S., representing 6.2 billion sq.ft. of space (the REIT universe is based on the U.S. universe of the FTSE EPRA Nareit Developed index, the main REIT index used by REIT ETFs and REIT investors). Since 2012 (the start of the CMBS 2.0 era), more than 24,000 properties and loans have been bundled into CMBS deals, with a total appraised value (for what it’s worth) of more than USD500 billion (note that one building can be securitized into multiple CMBS deals, and that appraised values are missing for about 13% of the properties/loans).

The National Ocean and Atmospheric Agency (NOAA) provides forecasts of the “storm cone” of Hurricane Florence as well as the area where storm surge is expected. Of course, these geographic boundaries are shifting on an on-going basis — we used the polygons as of September 12 at 8am ET. The maps below show the overlay of CMBS assets (left), REIT assets (right), and the NOAA-based storm path of Hurricane Florence, as well as storm surge areas.

The Florence storm cone and flood surge versus assets in CMBS (bottom) and in U.S. REITs (top) (Source: GeoPhy and NOAA)

Some major urban areas are included in the current area that is forecasted to be impacted by the storm, areas where almost all REITs own assets and where many CMBS loans have collateral. In total, 94 out of 130 REITs are expected to be affected by Hurricane Florence, with some 5,545 assets (545,235,430 sq.ft.) in the storm area. REITs with the highest exposure include Cousins Properties (NYSE: CUZ), with 67% of its portfolio in the hurricane zone, apartment giant Mid-America Apartment Communities (NYSE: MAA), with about a third of its portfolio in the storm cone, and Blackstone-backed Invitation Homes (NYSE: INVH), with more than a fifth of its portfolio exposed. From an absolute perspective, REITs with a significant exposure include Equity Lifestyle Properties (NYSE: ELS), Public Storage (NYSE: PSA) and Duke Realty (NYSE: DRE).

For CMBS investors, loan delinquency is expected to rise following natural disasters — tenants may default or walk away from flooded or otherwise destroyed properties. Given the limited focus of rating agencies on climate risk and resilience (other than some basic flood analysis), Hurricane Florence should be of particular interest to CMBS investors, as it likely goes unreflected in ratings, and unpriced by the market. Our analysis shows that in total, 2,900 properties and loans in CMBS deals are located squarely in the storm area, with quite a few CMBS deals that have an exposure of more than 20% of the portfolio. The figures below show which deals are most exposed to Hurricane Florence, both from an absolute and a relative perspective. (Note that measuring exposure by either sq.ft. or appraised value is challenging, as this information is not consistently available for properties and loans rolled into CMBS deals.)

While investors are attuned to daily news about interest rates, employment figures, and the latest on the continuing trade war sage, financial markets are less apt to reflect the pending impact that climate events may have on asset values. We believe that thus far, the street has failed to incorporate the clear and present danger of Hurricane Florence into the price of both REITs and CMBS deals that are (heavily) exposed. Time for a trade?

Green Building Certifications at All Time High in U.S. Largest Metros

Maastricht University and CBRE just released the 5th annual Green Building Adoption Index -- it's pretty interesting!

• Summary report
• Online mapping tool

Here's the press release:

 

LOS ANGELES--(BUSINESS WIRE)--The nation’s largest cities are getting even greener, according to the fifth annual U.S. Green Building Adoption Index by CBRE and Maastricht University. Researchers have found green certified office space across America’s 30 largest metros has reached 41 percent of market totals – the highest in the index’s history.

“Green” office buildings in the U.S. are defined as those that hold either an EPA ENERGY STAR® label, USGBC LEED certification or both. According to the report, 11.5 percent of all buildings surveyed are ENERGY STAR labeled, while 5.2 percent of buildings are LEED certified, both at all-time highs for the five-year study.

Chicago again claimed the top spot with nearly 70 percent of its space green certified. In addition to defending its title as the nation’s greenest city, Chicago saw a difference of nearly six percent with second-place San Francisco, the largest spread ever recorded in the Green Building Adoption Index. Atlanta maintained the third spot with more than 58 percent of all space green certified, while a surging Los Angeles claimed fourth – up from sixth last year. Minneapolis rounds out the top five with 55 percent of office space certified.

“From moving to 100 percent renewable energy in our public buildings, to supporting our private partners as they work to reduce emissions, Chicago is showcasing to the world the impact that cities can have on climate change for their residents and for people around the world,” said Chicago Mayor Rahm Emanuel. “This national recognition is a testament to the progress and success of our efforts to improve our environment while bettering communities across Chicago.”

Continued improvement in average energy efficiency for the nation’s commercial buildings also prompted the EPA to change the underlying calculations for ENERGY STAR scoring this year. This change is expected to lower average scores for office buildings by as much as 10 points next year. These changes may have a significant impact on next year’s Green Building Adoption Index rankings, particularly for markets whose ENERGY STAR certifications comprise the bulk of their green space.

“Green building certifications have become an important proxy for sustainable practices, recognized by all stakeholders. Any significant change to one of these major certification programs can have a significant impact on the buildings affected. We will be closely watching for the results,” said David Pogue, CBRE’s Senior Vice President, Global Client Care.

Green Buildings Certification Influencing Capital Markets

CBRE and Maastricht University researchers note that building certification has become a more recognized and important part of a building’s profile. As these programs reach maturity, the capital markets are increasingly incorporating these certificates into loan pricing and alternative financial instruments such as green bonds. And, according to additional research by Green Building Adoption Index co-author Rogier Holtermans, buildings certified by ENERGY STAR and/or LEED have been shown to transact for about 10.1 percent more than non-green certified buildings.

In fact, in 2018, for the first time in the four-year history of CBRE’s Investor Intentions Survey, more investors said sustainability is an important criteria in asset selection than said it was unimportant. This reflects a gradual trend of increasing investor interest in sustainability.

On the lending side, there have been significant advances to integrate green building certification into financing programs, and some lenders, like Freddie Mac and Fannie Mae, are adapting their rates based on the presence or absence of green building certification. Freddie and Fannie are providing pricing breaks in the range of 10-30 basis points to multifamily assets that are rated by one of eight different green rating schemes.

“For investors and lenders in the commercial real estate sector, green building certification affects their cost of capital. The rationale is that such buildings have a more attractive risk profile, and may be more resilient when economic headwinds arrive,” said Dr. Nils Kok, associate professor at Maastricht University.

This is the fifth release of the annual U.S. Green Building Adoption Index. Based on a rigorous methodology, the index shows the growth of ENERGY STAR- and LEED-certified space for the 30 largest U.S. office markets, both in aggregate and in individual markets, over the previous 10 years. A feature again this year is a geographic mapping platform that highlights the name, location and details of the specific green certification for each building in all 30 markets. View the study’s findings HERE.

 

 

After Amazon and Whole Foods, will Alibaba buy Trader Joe’s?

Cross-posted at Medium.

Over the past year, there have been quite a few headline-grabbing, wave-making deals where it has become clear that the “tech world” is increasingly advancing on “old world” real estate territory (with some notable “reverse-takeovers”). Think: Walmart buying Jet.com (2016), WeWork buying Lord and Taylor’s flagship store (2017), Walmart buying Flipkart (2018), etc. But none has created such a tsunami as Amazon buying Whole Foods.

Until last year, the disruption of the bricks-and-mortar retail sector was mostly visible in the non-food space, with notable bankruptcies of for example Borders, Sports Authority, Toys R’ Us, and sharply falling prices of retail real estate (this price-correction is not yet accurately reflected in real estate valuations, but the public market provides better evidence of what is still to come: retail REITs are down some 45 percent from their 2016 highs). The advance of tech into retail has dominated industry conferences and spurred significant lobbying against what is often perceived as unfair competition (with even the Tweeter-in-Chief lashing out against Amazon).

On June 16, 2017, big tech formally announced its presence in the grocery retail space, an industry that generates almost a trillion dollars in revenue per year. With Amazon buying Whole Foods, a high-end grocery that seduces taste buds while emptying wallets, online retail has now firmly established a foothold in physical U.S. retail territory. This unprecedented move excites the tech-savvy, scares retail investors, and has unleashed further speculation about the future of retail real estate (of course, there are still optimists out there).

The reasons for Amazon’s acquisition of Whole Foods are manifold, but buying direct access to America’s upper-middle class is certainly high on the list. After all, Whole Foods is known for being strategically located in areas where median income is high and unemployment is low. Whether you like it or not, this is the demographic that makes retailers salivate — not enough time, but plenty of disposable income. Indeed, real estate developers and investors are often watching Whole Foods (and Amazon) not just because of their potential threat to existing retail businesses (quick reminder: a decade ago, retailers worried about “Walmart coming to town,” how times have changed…), but also because of their aptitude in selecting the next store location. In case you’re curious, here are all U.S. locations of the more than 450 Whole Foods stores, and a close-up view of New York (click on the maps for a more detailed view):

Whole Foods locations across the US and in New York — Overlay with median household income (Census, 2016)

As shown by the simple overlay of of median household income on the map, the location of high-end grocery stores such as Whole Foods may provide a pretty good indicator of (hyper)local economic activity, neatly summarizing the demographic profile into one simple binary indicator — is there a Whole Foods nearby, yes or no. But Whole Foods is just one of many grocery stores. What about Stop & Shop, Aldi, Lidl, or Trader Joe’s? In a recent real estate return forecasting model, we investigated the prevalence of Trader Joe’s, and its ability to forecast returns. Unknown to most, Trader Joe’s is actually owned by Aldi, a German-based discount retailer better known for bare-bones retail space, putting fire to the feet of overpriced grocery stores in Europe. In 1960, the Aldi brothers divided their imperium into Aldi Nord and Aldi Süd. The Süd part of the business includes Aldi in the US, but Aldi Nord acquired Trader Joe’s in 1967. At that time, Trader Joe’s was pretty much a hippy store in California, known for having a good wine selection. But today, Trader Joe’s operates almost 500 stores across the US, often in areas similar to Whole Foods territory. Indeed, the two grocery stores seem to follow a location strategy that is quite similar — check out the distribution of Trader Joe’s stores across the US, relative to Whole Foods (click on the maps for a more detailed view):

  

Trader Joe’s and Whole Foods locations across the US and in the Bay Area — Overlay with unemployment rate (Census, 2016)

The map of Trader Joe’s and Whole Foods also provides an overlay of the unemployment rate, as a proxy for the local demographic profile (this map shows an overlay of education levels). Further comparisons of 2016 Census data in the graphs below show that the areas where Whole Foods and Trader Joe’s are located (measured by Census tract) are pretty much the same! Also note how dissimilar the profile is from the US average, with Trader Joe’s and Whole Foods located in areas that have, for example, median income that is higher than the national average by about 50 percent.

Now, that raises an interesting perspective. What if another big online retail platform would want to get foot on US soil, gaining exposure to the most desired demographic group that the US has to offer? An easy way in would be to acquire Trader Joe’s! Of course, that is easier said than done — Trader Joe’s is wholly owned by Aldi Nord, which is owned by three different trusts. That said, we can think of quite a few online retailers that would (want to) eat Trader Joe’s for breakfast (and ideally, Aldi for lunch). Perhaps Alibaba, with some 62 billion in revenue and a market cap of almost 500 billion? The war chest of 200 billion should be sufficient to provide for even the frothiest of German valuations. Perhaps the acquisition of Trader Joe’s by Alibaba will be the sticker shocker for retail in 2018?

Who Cares About Climate Risk? (The real estate sector should…)

This is a crosspost of my blog with Ali Ayoub on Medium.

When it comes to natural disasters, buildings, once constructed, are much like sitting ducks. But ducks can fly, and buildings cannot (as of yet). Climate events, including for example storms, heatwaves, and floods, thus pose a significant risk to buildings, whether commercial or residential. The recent sequence of superstorms (and subsequent flooding events) in major U.S. cities serves as a tangible reminder (think: New York, Houston, San Juan, PR, etc.). And it’s not just storms and flooding, but also cold spells, heat waves, drought, periods of extended precipitation, tidal flooding. Heat and flooding regularly account for the most weather-related deaths in the U.S., according to the National Weather Service. While such climate events already happen on a frequent basis, there is reason to believe that both the intensity and incidence will increase going forward. The New York City Panel on Climate Change, re-convened in the wake of Hurricane Sandy, projects an increase in the most intense hurricanes and increased precipitation from hurricanes.

For investors in real estate, be they shareholders of real estate investment trusts (REITs), direct investors in commercial real estate, or those investing through private equity firms, measuring exposure to climate risk often seems like a daunting task. However, the advent of (big) data has made climate risk analysis for real estate much more straightforward. On the one hand, maps of different types of climate risk are often publicly available. Although varying in detail and quality based on risk type and region, it is easy to access historical data on climate events, as well as forecasts of such events going forward (needless to say, a forecast is just that, and a high probability of an event occurring does not “guarantee” the event, think about earthquake risk in the San Francisco Bay Area). On the other hand, the location of real estate is fixed, and can be identified easily by a unique set of coordinates. Using the exact location of assets in an investment portfolio, investors can thus assess their exposure to flood risk, extreme temperatures, etc. with relative ease.

Using data collected by GeoPhy, we investigate all buildings held by 133 equity REITs with assets in the U.S. (some of these REITs are Canadian) as of Q1 2017. These portfolios, which represent just the U.S. holdings of these REITs, add up to a grand total of 36,641 buildings, covering almost 3.7 billion sq. ft. (3,709,107,064 sq. ft., to be precise). The maps below show the location of REIT assets and the overlay of two different climate risk layers. First, we use the well-known FEMA flood risk data — the Federal Emergency Management Agency (FEMA) uses their assessment of flood risk for federal insurance purposes. While often criticized for being inaccurate (either indicating “false positives” or “false negatives”), the FEMA flood risk data is used widely in the real estate market.

 

Flood risk (FEMA) and U.S. REIT assets (GeoPhy)

As a second climate risk layer, we use a forecast of total direct, financial climate damage as a percentage of county GDP. This data is based on recent research by The Climate Lab, published in the renowned Science journal. Using forecasts of changes in weather and climate (the medium IPCC scenario), this map shows the combined effect of these changes on agriculture, mortality, energy, low-risk labor, high-risk labor, coastal damages, property crime, and violent crime. Ultimately, this translates into a monetary effect on local GDP, as presented on the map.

 

Economic damage from climate change (The Climate Lab) and U.S. REIT assets

 

To get a better feel for how this affects real estate investors, we aggregate the data at the level of the REIT portfolio, both counting the number of buildings for each REIT portfolio that is exposed to flood risk and the broader measure of climate risk, as well as summing the total square footage of these buildings.

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. There is significant variation across REITs: Simon Property Group (SPG-N), the largest commercial real estate company in the world, has 85% of its portfolio in areas with low flood risk and 3% of its portfolio in areas with high flood risk, whereas 9% of assets in the Kilroy Realty Corporation (KRC) portfolio, one of the world’s “greenest” REITs, are exposed to high flood risk. The figures below below show the top-10 REITs by flood risk exposure, measured by asset count, and the top-10 REITs by flood risk exposure, measured by percentage of the portfolio.

 

As for climate risk, the data provides insight into the decrease in county GDP as a result of climate change — for each REIT, we calculate the exposure to such economic risk, by taking the average decrease in GDP across the counties where the REIT has assets. The figure below shows the top-10 and bottom-10 REITs by exposure to economic impact of climate risk.

Of course, “being exposed” to climate risk is not a big deal per se. It merely means that as a REIT, or as an investor in a REIT, you are more, or less, exposed to climate events, now and in the future. Depending on the extent of (private) insurance, a climate event, be it large or small, may not necessarily lead to material effects for the portfolio. But such thinking is short-sighted, which would not be prudent for an investor in a long-lived asset. Government insurance programs for climate events largely go unfunded. And insurance premiums can be adjusted annually. The average duration of a commercial real estate investment is 5–7 years, and often longer still. As the incidence and intensity of climate events increases, future buyers of an asset will start to take climate risk into consideration in underwriting and pricing of an asset — risk, or uncertainty, translates in higher return requirements, thus leading to a lower price for assets that are exposed.

Climate risk is, or should be, a non-partisan issue. Storms don’t recognize the political predisposition of an area, and neither does flooding. For (institutional) REIT investors, but also for investors in private equity real estate funds, or for direct investors in real estate, understanding exposure to any form of risk is paramount. The fiduciary duty of investors towards clients and trustees is the foundation of the capital market. Stewards of capital should carefully assess current and future risks. It’s time to add climate risk to the mix by using quantitative assessments of such risk, exploiting the insights that (big) data is increasingly bringing to the capital market.

The CBRE/Maastricht University International Green Building Adoption Index (2018)

Today marks the release of the inaugural CBRE/Maastricht University International Green Building Adoption Index -- an index that reflects the uptake of "green" building certification (such as LEED, BREEAM, Green Star and other) across 10 major international property markets, including markets such as London, Paris, Toronto and Sydney. This index is joint work with Rogier Holtermans (now at USC, soon at University of Guelph) and Dave Pogue of CBRE.

View the official press release or Download the report.

Here the (long) summary:

We have long understood that buildings, and especially commercial buildings, are at the forefront of many of society's most pressing issues. Water, waste, and significant energy use with the resultant carbon emissions, are each drawing the attention of a growing list of constituents and stakeholders. For example, governments have adopted ever-stricter building codes, comparable to fuel-efficiency standards for cars. Also, the European Union mandates the construction of zero-net energy projects by 2020 (by 2018 for public buildings). Occupiers are increasingly translating corporate carbon and Environmental, Social, and Governance (ESG) goals into requirements for the buildings they occupy, demanding efficient buildings and energy sourced from renewables. And finally, lenders are gradually starting to assess collateral on its energy efficiency, offering carrots such as reduced rates for more efficient buildings, and sticks for non-efficient buildings.

In the face of these issues, building owners have been progressively improving the environmental performance of their assets, but for those active in the commercial real estate market, it is challenging to assess the importance and diffusion of energy efficiency in the national or local market. How does this compare across markets? One way to measure the importance of energy efficiency in buildings is to assess the use of "green" building certification programs. Such certification programs have been in place, in various forms, for more than a decade across the global commercial property market. Although no green building certification program is the same, they all share basic characteristics, such as measuring energy performance, assessing a multitude of other dimensions of sustainability, and providing external certification through typically independent providers.

To discover how the market for "green" building has progressed over time and across markets, we developed a comprehensive, annual review, the U.S. Green Building Adoption Index, a collaborative effort between CBRE and Maastricht University, detailing the growth and distribution of "green building" certifications in the top 30 U.S. markets since 2005. In these annual reviews, published since 2014, we have measured the number and percentage of space in each market that has achieved a defined green building certification. In this report, we are expanding the U.S. Green Building Adoption Index to the global real estate market, seeking to measure the adoption of green certification programs across several international real estate markets. Information on market size (number of buildings and/or square footage of space) is provided by the local teams of CBRE, while the numerator of each index includes a wide variety of "green" and energy certification schemes, such as BOMA BESt, BREEAM, DGNB, HQE, LEED, NABERS, and Green Star (see Appendix A for an overview of schemes). This International Green Building Adoption Index (IGBAI) is similar in spirit to the U.S. Green Building Adoption Index described above, and initially covers 10 cities in Australia, Canada, and Europe. Each market is covered in detail in this report, including a detailed discussion of the methodology.

Key Findings

In the 10 markets covered by this report, we document that 18.6 percent of space is now certified as "green." This represents more than 227 million square feet of green space, out of a total of 1.2 billion square feet of office space reviewed. This is a significant increase from just 6.4 percent a decade ago, in 2007. Market-specific details are below:

• Australia
  • Melbourne: 29 percent of office space in the CBD was certified under the Green Star or NABERS program at the end of 2016, compared to just 1.4 percent at the end of 2006.
  • Sydney: 46 percent of space in the CBD was certified under the Green Star or NABERS program at the end of 2016, compared to just 0.8 percent at the end of 2006.

• Canada
  • Toronto: More than 50 percent of office space was certified under the BOMA BESt or the CAGBC LEED program at the end of 2016, compared to 15 percent at the end of 2006. Measured by number of buildings, the adoption of both programs increased from 2.5 percent at the end of 2006 to more than 20 percent at the end of 2016.
  • Vancouver: Almost 52 percent of office space was certified under the BOMA BESt or CAGBC LEED program at the end of 2016, compared to 29 percent at the end of 2005. In number of buildings, the adoption of BOMA BESt and CAGBC LEED increased from 6.7 percent at the end of 2005 to approximately 24 percent at the end of 2016.

• Europe
  • Amsterdam: BREEAM-NL is the dominant rating program in Amsterdam. At the end of 2016, almost 11 percent of office space was certified under the BREEAM program, compared to just 0.2 percent at the end of 2011. The Amsterdam office market included only 2 LEED certified buildings by the end of 2016.
  • Frankfurt: Two certification programs are used frequently in the Frankfurt office market: DGNB and LEED, with limited overlap. At the end of 2016, 13 percent of space was certified by LEED, compared to just 0.2 percent at the end of 2009. In comparison, at the end of 2016 5.1 percent of space was certified by DGNB, compared to 1.4 percent at the end of 2009.
  • London: BREEAM is the dominant building rating scheme in London. Despite a high number of BREEAM certified buildings, the adoption levels for London are relatively low. At the end of 2016, 9 percent of office space in London was BREEAM certified.
  • Paris: A variety of programs are used in the Paris office markets, although HQE is most prevalent. At the end of 2016, approximately 9 percent of office space was certified under HQE, BREEAM, or LEED, compared to just 0.1 percent at the end of 2007.
  • Stockholm: LEED is the dominant rating program in the Stockholm office market. At the end of 2016, almost 12 percent of space was LEED certified, compared to just 1.2 percent at the end of 2009. Only one building in the office market is certified by BRE.
  • Warsaw: Like Frankfurt, both BREEAM and LEED are frequently employed in the Warsaw office market, although again with limited overlap between both programs. At the end of 2016, 12 percent of office space was certified under the BREEAM program, compared to just 1.2 percent at the end of 2011.

• United States
  • New York: For comparison purposes, we include the 2016 data from the U.S. Green Building Adoption Index. In 2016, 20.2 percent of the Manhattan office market was certified by LEED, compared to just 0.3 percent in 2006.

Limitations

The numbers in the International Green Building Adoption Index come with some qualifications. This report includes certification data on office buildings only and other property types are excluded. We further exclude owner-occupied or government buildings. In line with the CBRE definition, we filter out all green-certified assets that are deemed "illiquid." Finally, CBRE typically covers just the central business district and parts of a city with significant office market activity. We only include green-certified assets within the CBRE market boundaries. It should be further noted that, unlike the U.S. markets reported on in our prior work, these global markets are not consistent in data or approach. Our ability to measure total stock per market varies and market boundaries are often indistinct, while the definition of “liquid space” tracked by CBRE varies across markets. Green certification programs often include many owner-occupied and government buildings, which are manually excluded from our measure of green stock per market. Some markets provide detailed information on building count and building square footage, while some markets only measure space, but not the number of buildings. Finally, address data is often inconsistent from development to project completion. As with the U.S. Green Building Adoption Index, many of these initial issues will be addressed and resolved in the coming years. We believe that this report provides some good first insights into what has become a global phenomenon: green building certification. 

Information Provision and Energy Consumption: Evidence from a Field Experiment

with Erdal Aydin and Dirk Brounen (Energy Economics)

Download

Energy consumption and the residential real estate market are closely related, leading to a multitude of policy interventions targeted to reduce the carbon externality from the housing market. Feedback provision regarding household energy consumption is considered a low-cost strategy for promoting energy conservation. Although various studies investigate the impact of information feedback on energy consumption, less is known about the heterogeneity of these responses. In this paper, we report the findings from a field experiment where participants are exposed to consumption feedback through the use of in-home displays during two discrete stages. The results show that information provision reduces electricity consumption by around 20%, on average, relative to a sample of non-treated households. Importantly, we also show that this average effect significantly differs based on the time of day and across the treatment group. Most of the feedback effect occurs during off-peak hours, and clusters among households that are older and that are most focused on energy conservation.

The DiPasqual/Wheaton Quadrant Model for Proptech

The long-lived nature of real estate, and real assets more broadly, massively exposes real estate investors to the emergence of new technologies, such as rideshare and homeshare platforms, and increased transparency through “big data.” 

This article discusses the implications of technology on real estate and was recently published in NAREIM Dialogues FALL 2017 (the whole magazine is worth reading). I start the article with a lay-of-the-land of real estate tech, nicely summarized through the DiPasquale/Wheaton Quadrant Model for commercial real estate:

As academic as the framework is, the workings of the real estate market can be boiled down to a combination of the construction market, the market for space (where landlords and tenants interact), and the market for assets (the capital market, where sellers, buyers, and providers of capital interact). As illustrated by the graph above, each part of the market has its own set of disruptive “tech” firms – I listed just a few names, but the list is virtually endless and grows every day. 

Check out more details in the article.

Finding the next Williamsburg — Site Selection Using “Big Data”

(From the @GeoPhy blog.)

For real estate developers and investors, finding “the next Williamsburg” or “the next Soho” is often considered the holy grail. But, how to identify what areas (may) gentrify? At the macro level, site selection is often done using data on demographic trends, including population, employment, and income growth. But once a city has been selected for capital allocation, Census data is not granular enough to be useful.

Enter big data. Because at the level of the city, there are a multitude of data layers that can be used for further differentiation, as detailed as an inch, as frequent as every second. Think about data on bars, restaurants, coffee shops, art galleries, (music) events, crime, the location and frequency of pictures uploaded onto social media, homesharing (e.g. listings on AirBnB), WiFi hotspots, public transport stops, rideshare pick-ups and drop-offs. And all the other data layers that Richard Florida wrote about in his “Rise of the Creative Class.”

These “modern” data layers, which can often be accessed through APIs, lead to unparalleled market intelligence that enables real estate investors, developers and lenders to make more informed, data-driven decision. As opposed to, or perhaps in addition to, “heard” on the street or gut feeling. But the trick is often to access and make sense of all these different layers of information, as most firms are not set up to ingest many different sources of primary data, but are rather used to consuming data in aggregated format (think: data on rent levels, price developments, etc.).

To illustrate how new, granular sources of data can be used by the real estate sector, GeoPhy developed a simple site selection tool, the “Grapevine Dashboard” (after all, we often hear about new, upcoming, cool areas through the proverbial grapevine). 

The Grapevine Dashboard pulls a vast real-time dataset of physical venues and one-off events in a city to provide a detailed view of arts, nightlife and other leisure activities. This includes the exact location of amenities like bars, cafes, art galleries, music concerts, food festivals and exhibition openings.

By utilizing proprietary methods to calculate locational proximity and distribution of such venues or events, we can then spatially sort and rank this data across entire cities. This produces views of the city that each tell a different story and enable the user to investigate and test certain assumptions and scenarios surrounding their property investment strategies. For example, which areas have the most independent art galleries? Where is “the next Williamsburg” or “the next Soho”? The picture below shows, for London, which areas have the greatest number of new bars, cafes and restaurants (in this case, those which have opened in the past two years). However, this view can also be filtered to look at a more specific subset of the data, such as restaurants or coffee shops that are not part of the major chains.

What’s hot and what’s not — bars, cafes and restaurants opened during the last two years

The data also allow us to look at less spatially fixed behaviour, such as events that might not take place in a traditional venue; which could be pop-up markets, outdoor cinemas or all-night warehouse raves. In doing so, we can access a view of the city that is rarely seen; and understand which neighbourhoods certain groups of people are likely to go to in order to spend their money and enjoy themselves. Which areas are the most popular for music? Which are the most popular for theatre?

One of the most powerful aspects of the Grapevine Dashboard is in the ability to chronologically analyze the data to reveal long-term neighbourhood trends. For example, the screenshot below shows the relative increase and decrease in overall numbers of new venue openings and events over the past two years. Here we can clearly see that despite the fact that Clapham is undoubtedly a “nice area” in parts, that it actually has fewer new venue openings or events than nearby Brixton. And neither area is as cool as Peckham, which despite being well-known as a newly “trendy” area, is still rapidly increasing in terms of new bar openings or arts events. This is especially important when the latter are known to greatly improve the market value and quality of life in an urban area. Therefore, the Grapevine Dashboard allows us to observe the important real-time trends that are changing the characteristics and market value of urban areas.

Measuring changes in local vibrancy — changes in art and nightlife events and venues (incl bars and restaurants)

The financial indicator for gentrification that we used in our analysis was ‘relative rental increase’, which we tracked over the last 8 years on a per bedroom basis. While correcting for macro-economic indicators such as interest rates and employment rates, we identified the leading indicators for that relative rent rise. Viewing the increase and decrease in an area’s popularity alongside rental price data — combining relative rental levels in a city with relative increase/decrease in local economic vibrancy — thus provided a “gentrification indicator.” Low rent, strong increase in economic activity, that’s what developers and investors should be looking for!

Gentrifying areas — low rents combined with a strong increase in “vibrancy”

According to the Grapevine Dashboard, London’s most happening neighbourhoods are:

1. Peckham

2. New Cross/Deptford

3. Stratford

And Grapevine’s predictions for the “next Soho” are:

1. Forest Hill

2. Seven Sisters / Tottenham Hale

3. Barking

Of course, macroeconomic data may shift some of the institutional focus away from London. But the concept of GeoPhy Grapevine can equally be applied in every market for every property type.

As the availability of data grows, investment decision making will increasingly be informed through objective analysis. And if it makes you feel better, you can always add a dash of gut feeling.

Check out the GeoPhy Grapevine Dashboard: https://grapevine.geophy.com/

 

 

Buildings and Health: All Buzz or a New Megatrend?

This article, joint with Paul Scialla (Delos) was just published in the PREA Quarterly.

The US spends about 18% of its GDP on health care. In 2016, that equaled $3.2 trillion, or $10,000 per person. No matter how the current political debate on health care, and ultimately, the regulation on health insurance, plays out, these costs are set to rise. Baby boomers are retiring, the US population is aging, and the incidence of chronic diseases, such as arthritis, heart conditions, and obesity, is soaring. Chronic disease drives US health care spending, with 5% of the people accounting for 50% of total health care spending. These structural trends will continue to create major liabilities for the government, businesses, and private individuals.

At the same time, the health and wellness industry, which is focused on disease prevention and general improvement of fitness, has just passed the $1 trillion revenue mark. The lion’s share of this trillion is made up of beauty and anti-aging products ($679 billion), followed by fitness and “mind and body” exercise ($390 billion) and healthy eating, nutrition, and weight loss ($277 billion). Clearly, healthy living is on people’s minds, and we are willing to (voluntarily) spend significant amounts of money on it.

What do both trends have to do with real estate? As it turns out, the real estate sector is at the nexus of the debate on both health-care costs and healthy living. The $11 trillion commercial real estate market provides the shelter where much of the population spends its time working, shopping, eating, sleeping, and relaxing. It has been asserted that, on average, Americans spend an astonishing 90% of their time indoors. “Indoors” thus has a significant effect on the air Americans breathe, the food they eat, and the (casual) exercise they exert during the day. And while “indoors” suggests protection against outdoor elements, concentrations of air pollutants, which may cause eye irritation, headaches, coughing, and chest tightness, can sometimes be higher inside than outside. Thus, people are trapped in buildings that directly influence their health, their lifestyles, and thereby the likelihood of incurring disease, both incidental and chronic. But that is just the pessimistic view, based on the moral hazard of the real estate sector. On the bright side, the commercial real estate sector has the opportunity to contribute a partial solution to the massive burden that health-care costs put on society through passive measures designed to prevent disease. Building owners can benefit from the health and well-being craze by offering better buildings that cater to the needs of an industry generating more than a trillion dollars in revenues. 

Read full article here.

Big Data in Real Estate? From Manual Appraisal to Automated Valuation

with Eija-Leena Koponen and Carmen Barbosa, Journal of Portfolio Management (Fall 2017)

Download

Real estate is the third-largest asset class for institutional investors, but determining the value of commercial real estate assets remains elusively hard. This paper provides a practical application of “big data,” employing a unique set of data on U.S. multifamily assets, in combination with sophisticated modeling techniques, to develop an automated, machine-based valuation model for the commercial real estate sector. We find strong evidence on the superiority of automated valuation models (AVM) over traditional appraisals – the absolute error of the automated model is 9 percent, which compares favourably against the accuracy of traditional appraisals, while the model can produce an instant value at every moment in time, at a very low cost. We also provide evidence on the importance of using “hyperlocal” information on the location of an asset. The model developed in this paper is directly applicable for real estate lenders and investors, and has important implications for the traditional appraisal industry.

National Green Building Adoption Index - 2017

It is an unsettled time for matters of energy efficiency and sustainability, at least from a policy perspective. A question we are hearing is how businesses will respond to these changing policy priorities – will their historical focus on energy efficiency, green certification, and renewable resources waver, or will they stay the course?

In the early 2000s, energy efficiency was for the committed few, and “green” building was a niche concept. But with the advent of strong tenant and investor interest in constructing, operating, and occupying better buildings, the concept of energy efficiency and sustainability in buildings has taken a firm hold. To quantitatively measure the growth and uptake of this phenomenon, Maastricht University and CBRE as part of our Real Green Research Challenge grant program developed the CBRE Green Building Adoption Index, working in close collaboration with USGBC and CBRE Research. Based on a rigorous methodology, the adoption index shows the growth of ENERGY STAR and/or LEED certified space for the 30 largest U.S. office markets, both in aggregate and for each individual market, since 2005. The headline statistic – the percentage of commercial office space that has been certified as “green” or “efficient” – now stands at 38 percent across 30 office markets in the U.S. That percentage grew from less than 5 percent in 2005. This long term and consistent increase in certified buildings is but one of the signs of continued and growing interest in energy efficiency and sustainability in the built environment.

Underlying the headline statistic, there are many trends, both across markets and across certification schemes. The fourth release of the annual Green Building Adoption Index shows some noteworthy findings:

• Measured by square footage, the amount of certified commercial space slightly increased from 37 percent in 2015 to 38 percent at the end of 2016The ENERGY STAR program expanded slightly in 2016, with 10.3 percent of all commercial office buildings in the largest markets now certified, up from 9.9 percent. This represents 31.7 percent of total commercial office space, up from 29.9 percent;
• At the end of 2016, LEED certifications represented 4.7 percent of the total number of commercial office buildings across the 30 largest U.S. office markets, up from 4.6 percent the year before;
• Large geographic variation in the adoption of LEED and ENERGY STAR certification remains. For both LEED and ENERGY STAR certification, the top-3 markets in terms of green building adoption by percentage of square footage are 1) Chicago, 2) San Francisco and 3) Atlanta, with Chicago taking the top position for the first time.

To expand this year’s research approach and attempt to understand the impact benchmarking laws have on the adoption of green building certification programs. an analysis was conducted in partnership with Institute for Market Transformation relating the adoption levels of ENERGY STAR and LEED to the enactment and implementation of energy benchmarking and transparency laws.

Since 2008, the adoption of energy benchmarking laws has rapidly advanced across U.S. cities, counties and states. In total, 23 cities, Montgomery County, Md., and the state of California have now enacted laws requiring large privately owned commercial buildings to annually measure and benchmark their energy consumption, as well as to publish the resulting scores.

Evidence from the 30 largest U.S. commercial real estate markets suggests that these benchmarking and transparency laws may contribute to increased adoption of environmental building certification. Nine out of the top 10 markets ranked in this year’s Green Building Adoption Index (GBAI) have implemented benchmarking ordinances, and some cities have collected multiple years of benchmarking data.

Specifically, a city having enacted a benchmarking ordinance is correlated with a 9 percent increase in ENERGY STAR and LEED-certified buildings, and a 21 percent increase in ENERGY STAR and LEED-certified square footage. Also several cities experienced an increase in the adoption of environmental building certification after the passage of benchmarking and transparency laws.

For future research, we are closely monitoring the development of certification and rating schemes that reflect emerging trends in the commercial real estate sector. Those trends include health and well-being, certified by WELL and FitWel, but also digital connectedness, certified by WiredScore. We aim to incorporate these and other schemes in future editions of the Green Building Adoption Index.

View the full Green Building Adoption Index  Report and interactive city rankings.

 

Data: it’s not how big it is, but what you do with it.

(From the GeoPhy blog)

“Big data” has quickly emerged from obscurity into a buzzword, rising from non-existent in 2011 Google Trends numbers, to peak popularity in 2016. Indeed, peak popularity of “big data” was last year. In 2017, the world no longer cares so much about how big data is, but rather, what you can do with it. And as I learned since I started at GeoPhy 3 months ago, the possibilities are endless. The goal of the GeoPhy blog is to give the real estate industry, and basically all other industries that use buildings or their surroundings (I’m still thinking of an industry that does not fit this description…), insight into some of the applications that boundless swaths of data provides. Because without application, data is like raw oil without the refinery.

When we talk about data on buildings and their environment, it all starts with the GeoPhy data lake that is filled with about 100 million buildings. Each building has a basic set of characteristics (or: features), such as size, year of construction and renovation, use types (that’s plural, as buildings can have multiple parts with different functions), etc. There are financial details, such as the rent roll, occupancy rate, the last sales price, liens on the building (i.e. a mortgage). And importantly, each building resides in a certain area. That area is different and unique for every building -- distance to amenities such as bars, restaurants, events, gyms, (public) transport, and the density of the “catchment,” measured by number of people of age cohorts, income cohorts, etc. At a more macro level, there are many more data layers: economics, demographics and risks, including jobs and job growth, income growth, inflation, flooding, population growth, etc. All of this is “raw” data, from thousands of different sources, both public, semi-public and private. These rivers of data flow into the data lake directly, through automated connections (APIs), are imported through spreadsheets, or are harvested from PDFs and webpages through natural language processing (NLP) and crawlers.

For many of GeoPhy’s users, there is already tremendous value in the raw data, but for others our refinery is needed. Our core information products coming out the data lake are standardized metrics that can be used in the evaluation of buildings and areas: quality, value, and risk. The QualityScore is a 0-100 measure that reflects that quality of an individual building and its surrounding area, relative to buildings in the same property type (each property type has a unique scoring algorithm). Under the quality umbrella, we also have a carbon footprint for each building in the data lake (see our recent blog on carbon footprinting), and a GreenScore that reflects the presence, depth and quality of sustainability characteristics. Value is based on the GeoPhy AVM, an automated valuation model that predicts a value for every building in the database. This is a bit like an appraiser assessing the value of a building, but rather than walking around each of the 105 million buildings and making subjective judgements, we use the power of data in combination with smart, modern machine-learning modeling techniques. The RiskScore reflects the extent to which an asset and its area are exposed to climate risks, such as flooding (see our flood risk dashboard developed for Rijkswaterstaat, the Dutch agency responsible for 2,700km of dykes), extreme weather events, etc.

Now, for clients to consume this data, we would love to simply feed them information on the buildings and areas that they’re interested in, whether it is for the evaluation of a new location for a retail store, a logistics facility for the distribution of your packages from Amazon (etc), investment in an office building, development of student housing, etc. That feed would take the form of an API, and we would be done. But the reality is that “consuming an API” is not standard practice yet, and many clients, both companies and governments, do not have the in-house capability to ingest data through an API, and neither the visualization and/or analytical capacity that is needed to ultimately use the information. That’s where GeoPhy turned from data company into part-data, part-software company -- we developed a series of dashboard that deliver the data in a user-friendly format. The GeoPhy Dashboard to access information on individual buildings, the Alpha platform to access portfolios of buildings, and the Metropolis tool to access data layers such as catchment, proximity to public transport, flood risk, etc. And of course, it does not end there: we also perform data analysis, explaining the effect of airport proximity on office rents, the effect of the government as a tenant on property values, the effects of bars/events/arts venues of rental growth, the effect of Brexit on the London office market, etc.

Whether it is a QualityScore or the automated valuation of real estate, all examples of application of data in combination with analytics is a story in itself. Don’t despair -- these stories will come to you, one by one, week by week. So, stay tuned, and recall, next time you read about “big data” -- it’s not how big (data) is, but what you do with it.

Read more on geophy.com/blog

Carbon reduction in real estate: paradigm shift or just hot air?

(my colleague Ali Ayoub at GeoPhy has done all the hard work for this blog, all credits to him!)

It should not come as news that the real estate sector is a large user of energy, with significant carbon emissions as a result. Some quick stats: 60% of EU and 73% US electricity consumption is in commercial and residential buildings, and 38% of total US carbon emissions stem from buildings.

Real estate owners, occupiers, and investors are increasingly setting targets to reduce the carbon emissions from their real estate holdings. They do so for many reasons, including cost reduction (“doing well”), environmental stewardship (“doing good”), and environmental regulation that is increasingly targeted towards buildings (e.g. mandatory disclosure in many US cities, minimum energy performance requirements for commercial buildings in the UK and the Netherlands, etc). Examples abound:

• Unibail-Rodamco (Europe’s largest listed property company) announced a target to reduce carbon emissions by 50% from 2016 to 2030;
• PGGM Investments (in the top-10 of largest pension funds in the world) requires its investments to reduce carbon emissions by 50% between 2015 and 2020 (!).
• Etc. (there are many many more example to list, these are some of the recently announced, highly publicized targets).

Now, the carbon footprint of a building is the product of its energy consumption and the carbon intensity of the grid that supplies the the building’s energy. That is an important notion: unlike the energy consumption, which purely depends on the building and its location (i.e. weather), carbon footprint is heavily influenced by the electricity grid’s carbon intensity, which in turn is determined by country or state energy policies. The carbon footprint of an energy efficient building can thus be relatively high if it is connected to a grid that uses electricity mainly generated from coal combustion. On the other hand, if a building’s electricity is generated from hydropower, its carbon footprint will be relatively minimal, even though the building can be a significant user of energy.

To put carbon emission targets into proper perspective, it is therefore important to understand the carbon intensity of the grid. Note that owners and/or occupiers can always decide to buy carbon offsets (a cheap trick), or to procure renewable energy more directly (see for example, this article  about “Amazon Brings on Five New Solar Projects to Power Its Cloud”). Abstracting from such idiosyncratic decisions by individual building owners and occupiers, the average carbon intensity of a statewide or national grid, as well as the development of such intensity over time, provides important insight into the ability to reduce carbon emissions in building portfolios not from actual building improvements, but rather from “improvements” in electricity generation.

GeoPhy has collected detailed information on the current and historical carbon intensity of the grid in more than 54 countries. This data serves as input into the GeoPhy Carbon Model, where the carbon emissions of more than 105 million buildings are analyzed and tracked over time. To understand the feasibility of carbon targets, and the role of the grid in achieving such targets, we recently did an analysis of 32 countries, where the electricity grid’s carbon intensity is calculated by using the country’s electricity mix and applying each electricity source’s carbon intensity to that mix.

The result is a timeline of each country’s electricity grid carbon intensity in gCO2eq/kWh from 1967 until 2014, with an additional forecast for the 2015-2020 period. This forecast is based on the EU Reference Scenario 2016 and the International Energy Outlook 2016. In the table below, we show the carbon intensity of the electricity grid at 5 points in time (2020, 2014, 2004, 1994 and 1984), ranking the 32 countries from highest carbon intensity to lowest carbon intensity (note that we included the US national average here, masking variation across states).

Source: 1984-2914 data from Worldbank. 2020 predictions from EU Reference Scenario 2016 and the International Energy Outlook 2016. * indicates that 2020 predictions are based on statistical modeling, in the absence of publicly available forecasts.

According to the analysis, the countries with the highest grid carbon intensity are characterized by high dependency on coal as the main source of electricity generation. This includes Australia (in 2014, 83% of the electricity was generated from coal and natural gas), Poland (86%), Israel (98%), and Japan (73%).

The five snapshots of time in the table show significant variation in carbon intensity over time, with more detailed time series graphs for each country providing the year-by-year trend (download country-by-country data here). For example, the figure below shows that the carbon intensity of Japan’s grid was showing a decline until 2011, when the Fukushima nuclear disaster occurred. Nuclear electricity generation was mostly phased out by 2012, and the grid’s carbon intensity has since been rising again, due to reliance on natural gas as the main electricity fuel source.

Countries with the lowest carbon grid intensity in the analysis are Iceland, Norway, Switzerland and Sweden, where the main electricity generation sources are either hydropower (96% of Norway’s electricity generation) or a combination of the lower intensity sources (renewables and nuclear energy).

Countries showing impressive reduction in the carbon intensity of their grid include France, where the grid’s intensity fell from 603gCO2eq/kWh in the late 1970s to 51gCO2eq/kWh in 2014. This decline is mostly driven by the increase in nuclear energy. Another country showing a steady decline in grid carbon intensity is Germany (see figure below), where the decreased dependence on coal from 77% in 1967 to 45% in 2014 and embracing renewable electricity generation, resulted in cutting the grid’s carbon emissions by 40%.

Looking at predictions until 2020, the average carbon intensity of the grid is expected to decrease by 7%. For the most progressive countries, this is as high as 48% (UK and Denmark), whereas other countries are actually expected to increase their carbon emissions per kWh of electricity produced (e.g. Austria, Israel, Italy). Note also that these predictions do not include uncertainties such as economic shocks, disasters such as Fukushima, as well as the implications of intermittency stemming from the renewable energy flooding the grid.

Both the historical numbers and the carbon intensity forecast provide some important lessons for real estate investors, companies and governments setting reduction targets -- the “greening” of the grid should not be an excuse for inaction, but it will get many companies and real estate investors a long way to reaching their carbon reduction goals! One way to more directly measure the achievements of firms would be to measure energy intensity rather than carbon intensity -- this reflect real energy consumption of the building, rather than procurement of renewable energy, buying carbon offsets, or changing carbon intensity of the grid. An interesting example is a recent announcement by TH Real Estate (a large investment manager), which aims to reduce its energy intensity in the real estate portfolio by 30% from 2015 to 2030.

Clean Electricity, Dirty Electricity: The Effect on Local House Prices

with Piet Eichholtz and Mike Langen, Working Paper (February 2017)

Download

We study the external effects of large-scale conventional and renewable electric power generation facilities on local house prices. We compare coal, gas, biomass and wind power, combining information on all power plants and wind turbines in the Netherlands with house price data from 2.3 million housing transactions, covering a period of 30 years. Using a hedonic model and a difference-in-difference model to explain price effects, we document that homes located in close proximity to conventional power plants and wind turbines on average sell at discounts, ranging from -0.9 percent to -2.8 percent. However, there is significant heterogeneity in the documented effect, depending on generation type and model specification. We find positive opening effects for coal plants and negative effects for wind turbines. These external effects on the local housing market are important to consider, especially when considering the current policy focus on the expansion of renewable energy production.

On the Value of Environmental Certification in the Commercial Real Estate Market

with Rogier Holtermans, Real Estate Economics (2018)

Download

A significant part of the global carbon externality stems from the real estate sector. Environmental certification is often hailed as an effective means to resolve the information asymmetry that may prevent markets from effectively pricing the energy performance of buildings. This study analyzes the adoption and financial outcomes of environmentally certified commercial real estate over time. We document that nearly 40 percent of space in the 30 largest U.S. commercial real estate markets holds some kind of environmental certification in 2014, as compared to less than 5 percent in 2005. Tracking the rental growth of 26,212 office buildings, we measure the performance of environmentally certified real estate over time. We document that certified office buildings, on average, have slightly higher rental, occupancy and pricing levels, but do not outperform non-certified buildings in rental growth over the 2004-2013 period. Further performance attribution analysis indicates that local climate conditions, local energy prices and the extent of certification lead to significant heterogeneity in market pricing. On aggregate, these findings provide some evidence on the efficiency of the market in the adoption and capitalization of environmental characteristics in the commercial real estate market.

GeoPhy establishes presence in North American market and launches Alpha dashboard

Today, the following press release went out:

London, January 12, 2017  - GeoPhy, the independent global platform for real estate intelligence with offices in Amsterdam and London, today announces the opening of a New York office as part of its continued global expansion. Nils Kok, a well-known Dutch economist and real estate data expert, joins GeoPhy as its first Chief Economist and will head up the North American business.

Nils Kok, the highest ranking Dutch economist at Maastricht University and rated 8th among economists in the Netherlands in 2015, will be responsible for developing GeoPhy’s business in North America, engaging with banks, pension funds and other real estate investors and lenders. He is the founder of GRESB where he worked with over 60 leading institutional investors to assess the sustainability performance of more than 1,000 property companies and portfolio managers. In addition Nils will have a global role, using the vast amounts of property data which the GeoPhy platform holds to produce new tools for investors in commercial real estate.

GeoPhy today also announces the launch of Alpha, a real-time, interactive dashboard for real estate reporting, granular analysis and portfolio management. Alpha provides institutional investors with enhanced visibility of their portfolios and instant insight for better decision making. This includes information on asset value, location and asset quality assessment, and sustainability, drawn from a universe of more than 10,000 global private real estate funds and listed property companies.

Nils Kok, Chief Economist, GeoPhy, said: “The global commercial real estate industry is currently valued at USD13 trillion of which the US and Canadian markets represent approximately 40 percent. The continued low yields on equity and fixed income investment has led to more capital flowing into commercial property, while at the same time real estate investors are increasingly investing in assets outside their domestic market, in places where they lack local knowledge. Reliable data to enable real estate investors and lenders to make accurate decisions has hitherto been elusive.”

He continued: “I’m thrilled to take the chance to lead the growth of GeoPhy in the US and Canada, where the property investment sector is ripe for disruption, and the opportunity for unparalleled insight through the GeoPhy database is deeply exciting.”

Teun van den Dries, CEO, GeoPhy, commented: “If 2016 was the year of big data, 2017 is the year to actually start using it and for the commercial real estate sector to harness the potential of the massive amounts of data that have become available. Nils Kok is an acknowledged expert in this field and there is no-one better to sustain our growth as we expand across North America. We have already mapped over USD1.8 trillion of assets using our Alpha dashboard and we look forward to its rapid adoption for portfolio management.”

GRESB in 2016: A Year of Progress

As it goes, the end of the year always puts us into a mode of reflection. As I look back on GRESB’s history, I think about 2009, when we released the first ESG assessment for real estate companies and funds, backed by a handful of engaged institutional investors and leading industry associations. That year, 198 companies and funds reported on their ESG policies and performance, with less than 20% disclosing energy consumption data. Over the past seven years, much has happened – GRESB has established itself as the leading ESG benchmark in the real estate space, and branched out to real estate debt and infrastructure, to truly reflect its ambition to assess the global built environment for the world’s largest capital providers – from buildings to cities, from water utilities to renewables. Membership now stands at 62 Investor and Bank members, 120 Fund Manager & Company members and 70 Partners, including many of the leading industry associations, service providers, and solution providers.

With GRESB now solidly established in the market for institutional real asset investments, the time has come hand over the reins – GRESB is in a new phase, and it is ready for new leadership. Over the last 12 months, the team doubled in size, now standing at 20 people strong, prepared to take on what’s ahead. With the support of Mahesh Ramanujam, president & CEO of GRESB’s parent Green Business Certification Inc. (GBCI), and the appointment of my co-founder and long-term colleague Sander Paul van Tongeren as the new Managing Director, I’m confident that GRESB will remain the only industry-driven organization committed to assessing the ESG performance of real assets globally – with sustainable real assets as the end goal. (Also see the press release that went out late December.)

I’m leaving GRESB, looking back on the year 2016 that has been very successful indeed: The inaugural GRESB Infrastructure assessment, operating both at the fund and at the asset level, has answered a growing need in the marketplace, as reflected in the large number of reporting funds and assets: 185 in total, of which more than 50 are funds. At the same time, GRESB Real Estate and GRESB Real Estate Debt continue to see increased market coverage, with 759 property companies and funds], and 18 banks and alternative lenders reporting. The 759 companies and funds alone represent some 66,000 individual assets, housing hundreds of thousands of corporate tenants with millions of employees. The health and satisfaction of those employees is critical to what GRESB attempts to achieve: more efficient, more sustainable buildings, with healthier, more productive employees, and ultimately, better performing assets for investors.

To reflect the increasing importance of health and well-being and the role of buildings therein, we added a Health and Well-being Module to the GRESB Real Estate assessment. Nearly 200 companies and funds completed this new module, showing the attention that developers, owners and managers increasingly pay to this new megatrend. The GRESB Events on Health and Well-being, held in 6 cities, attracted more than 400 engaged attendees. The GRESB Results events, held recently in 12 markets, attracted an audience of nearly 1,100 people. In addition, we trained almost 200 leading real estate professionals in 2016 on the topic of ESG in real estate.

Our vision of “Sustainable Real Assets” can only be reached with true market transformation. We are therefore pleased to see so many initiatives in the market supporting this vision, and GRESB continues to seek alignment and collaboration where possible. This includes close relationships with building certification schemes, including BREEAM, Green Star and LEED, alignment with DJSI, GRI, PRI, and SASB, and alignment with many of our data partners that work with the real estate industry on a daily basis. And of course alignment with best practice reporting standards as promoted by ANREV, EPRA and INREV and other industry bodies.

Our mission “Enhance and protect shareholder value by assessing and empowering sustainably practices in the real asset sector” echoes the need for reliable data and insights. GRESB remains unique as a benchmark for ESG performance of real assets on a relative and absolute level for both investors and managers. The quality and granularity of GRESB data continues to improve, as more and more reporting companies and funds provide information on individual assets within portfolios. In addition, many companies are seeking external assurance of data.

Deeper understanding of the GRESB data increasingly allows the market to understand what is really needed to improve ESG performance. We recently introduced a new series of Sustainability Insights, which will present snapshots of GRESB data, providing a deep dive into trends and key topics around ESG in real asset investments. The series also includes additional resources – blogs, innovation case studies and interviews – all of which can be found on the GRESB website.

I know that 2017 will continue to see prolonged success for GRESB. The trajectory we are on is impressive – with Sander Paul and Mahesh at the helm, the organization will continue to expand and globalize the GRESB Real Estate, Debt and Infrastructure assessments, providing high quality, insightful ESG data, engagement and services, from asset to portfolio performance.

Have a great holiday and a productive and healthy new year – I’m looking forward to seeing the continued advancement and transformation of the ESG performance of real estate portfolios and infrastructure assets globally.

Study Finds San Francisco the Nation’s Greenest City

Today marks the release of the 3rd Green Building Adoption Index, an initiative by CBRE and Maastricht University (my colleague Rogier Holtermans, now at USC, and myself). Here's the visualization of the report:

And the press release:

Institutional owners of office buildings continued to pursue green building certifications in the 30 largest U.S. markets during 2015. Continuing an upward trend over the past decade, green certifications are now held by 11.8 percent of all surveyed buildings, representing 40.2 percent of all office space. Both figures are slightly above last year’s results, according to the third annual Green Building Adoption Index study by CBRE Group, Inc. and Maastricht University. “Green” office buildings in the U.S. are defined as those that hold either an EPA ENERGY STAR label, USGBC LEED certification or both.

After placing second on the Green Building Adoption Index the two prior years, the San Francisco market claimed the top spot with 73.7 percent of its space qualified as green certified. Chicago claimed the second spot, narrowly trailing the leader at 72.3 percent and Minneapolis fell from the top into third spot at 60.6 percent. Houston, Atlanta and Los Angeles all also achieved more than 50 percent green certification in their office markets.

“While the rate of growth in ‘green’ buildings has slowed modestly, our latest study underscores that in most major markets, sustainable office space has become the ‘new normal,’” said David Pogue, CBRE’s Global Director of Corporate Responsibility.

The overall results of the study do show that the while the uptake of green building practices in the 30 largest U.S. cities continues to be significant, the rate of adoption is slowing. In 2014 the total sq. ft. of green office space in the top 30 markets was 39.3 percent compared to the latest rate of 40.2 percent.

“This likely reflects the fact that only a certain fraction of the building stock can obtain a green or energy-efficiency certification,” said Dr. Nils Kok, associate professor in Finance and Real Estate, Maastricht University (NL). “Additionally, we believe that some buildings that were previously certified did not renew their certification in 2015. This does not necessarily mean that the energy use of these buildings has changed, but that some owners and managers may choose not to spend the time or expense to reapply for certification every year.”

A new feature of the 2015 study is a geographic mapping platform that highlights the name, location and details of the specific green certification for each building in all 30 markets.

Executed in close collaboration with the U.S. Green Building Council (USGBC) and CBRE Research, this is the third release of the annual Green Building Adoption Index. Based on a rigorous methodology, the Index shows the growth of ENERGY STAR- and LEED-certified space for the 30 largest U.S. office markets, both in aggregate and in individual markets, over the previous 10 years.

View the study’s findings HERE.

Climate Change And The Massive Need for Infrastructure Investment – A Balancing Act

Infrastructure is the foundation and connective tissue of society. In its broadest sense, it covers everything above and below surface (including both land and water). That’s buildings; energy generation (renewable and conventional) and transmission; road, rail and the various modes of transport using it; transport hubs like ports and airports; clean and dirty water; etc. So, rather than thinking about a building, we should think about a building in its urban grid, whether that is a precinct or neighborhood, a city, a state, a country, a continent, or the entire world.

With urbanization continuing (it is expected that by 2050, two-thirds of the then-9.5 billion people live in cities) and the global middle class rising, the world is facing a significant need for the services provided by infrastructure: energy, water, mobility, and much more. In fact, there is a massive need for infrastructure investment, estimated at USD89 trillion until 2030. But it’s not just new investments: McKinsey estimates that there is a backlog of USD15-20 trillion in maintenance backlog (the average airport terminal is witness to that). At the same time, humanity is facing the biggest challenge of its time in climate change and its potentially devastating consequences.

Infrastructure stands central in this challenge. Its often fixed structures will be directly affected by sea rise and extreme weather events; the emissions from infrastructure represent an important part of global carbon emissions; but, infrastructure also offers part of the solution, through renewable, green energy generation and savings from energy efficiency projects. So, while society needs (much) more infrastructure, the next generation of infrastructure must deliver needed services and protect human health and the environment.

The global capital market has an important role to play in guiding this balancing act by establishing clear performance expectations for new infrastructure investments and engaging with existing infrastructure investments, to improve the environmental, social, and governance (ESG) performance of the urban infrastructure over time. This role naturally aligns with the capital market’s fiduciary duty: as infrastructure capital commitments can span decades, understanding long-term risk is critical for prudent investment. The global capital market is also vital in funneling private capital into clean energy investment, such as wind, solar, and hydro projects. Such investments are increasingly profitable, independent of energy subsidies, and can replace investments in traditional energy generation (the clean energy arm of RWE, Innogy, provides an example of how energy generation companies may profit from renewable energy investments).

To make informed investment decisions, institutional investors need data. Today, GRESB released the inaugural GRESB Infrastructure Report, presents the aggregated data of the first globally applicable, investor-focused assessment of environmental, social, and governance (ESG) management and performance for infrastructure assets and funds. The initiative has been inspired and guided by 10 leading institutional investors. The GRESB Infrastructure assessment has been embraced by almost 200 infrastructure assets and funds in its first year, spanning 53 countries and 6 continents. The new assessment provides unprecedented transparency for investors to make more informed decisions, and infrastructure companies and funds to improve their ESG performance. This new information will accelerate a critical market transformation by recognizing and rewarding infrastructure funds and assets that demonstrably contribute to a low-carbon, resilient society.

Read the 2016 GRESB Infrastructure Report here.

What Obama, the Real Estate Sector, and 130 Investors Have In Common

While a typical summer is characterized by a lack of real news, leading the press to cover anything that’s even remotely newsworthy—or not – (we have a word for it in Dutch, “cucumber time”), the past two month have yielded enough stories to keep the average journalist busy: the Olympics, flooding in Louisiana, the ongoing civil war in Syria, fallout from Brexit, terrorist attacks across Europe, and the list goes on. So, you’re forgiven if you happened to have missed three newsworthy events that happened this past week:

1. A group of 130 investors, controlling USD 13 trillion in assets, called on the 20 largest economies (the G20) to ratify the Paris climate agreement, to accelerate investment in clean energy, to implement strong carbon pricing, and force disclosure of climate-related financial risk.
2. Real estate became the 11th sector under the Global Industry Classification Standard – the leading classification system for stock exchange-listed equities worldwide. Real estate was previously part of the “financials” sector, but it has been decided that the world’s largest asset class should indeed stand on its own.
3. And most recently, President Obama and President Xi Jinping (China) jointly ratified the Paris climate change agreement at the start of the G20 meeting in China (the cost of which reportedly exceeded that of the Rio Olympics).

While each of these events is important, they risk being overshadowed by the latest tabloid-worthy news. Taken together, however, they represent a significant turning point in how the world will deal with global warming going forward. After all, legally-binding emissions reduction commitments from the world’s two largest economies – together representing 38% of global emissions – will have major implications for public policy to reduce carbon emissions from energy generation, automobiles, manufacturing and the real estate sector. But, as we know so well in the post-Volkswagen era, regulation only gets us so far.

Thus, commitment from 130 of the world’s largest investors is welcome news. After all, money talks, especially when it is USD13 trillion. Their request to the G20 can provide immediate impact for companies connected to financial markets (i.e., almost all). They ask for more focus on and clarity about the implementation of the Paris climate change agreement. Most importantly, they want action from national governments and transparency from investments—to see government follow through on its commitments and put money to work in companies that provide solutions to this global challenge.

Finally, the recognition of real estate as a standalone sector may also bring more attention to the role that buildings can play in slowing down what many have called the most pressing issue of the 21st century – climate change. More visibility to investors will likely lead to more scrutiny about environmental, social, and governance performance, as real estate is asked to step-up to practices and performance expected from other asset classes. Attention from engaged, responsible investors will provide opportunities for recognition and constructive feedback that can motivate the sector to realize its potential to address the global challenge of climate change.

Buildings and a Low-Carbon Economy

While many countries have focused on energy supply as a solution to a low-carbon society, phasing out fossil-fuel-fired power plants and subsidizing the transition to clean energy, using less is another important part of the solution. Indeed, the 130 investors referenced above called for “strong regulations that encourage energy efficiency.” The recent Clean Power Plan proposed by the United States Environmental Protection Agency (EPA) allows for investment in [building] energy efficiency as a substitute for cutting carbon emissions from actual power generation. Across the ocean, the European Union aims for a 20 percent reduction in energy consumption by 2020, based solely on “cost effective” measures that are paid back through reductions in energy bills. And China has included energy efficiency as a cornerstone of its current five-year plan, with the ambition to retrofit four million square feet of non-residential space.

Buildings are thus increasingly the focus of both regulators and investors, though regulators are really second to the party. The property sector itself has had an aggressive head start with a 25-year history of voluntary action to define and recognize leadership on energy efficiency and, more broadly, sustainability through standardized certification schemes. BREEAM, used predominantly in Europe, is the oldest building sustainability label and was first developed by a UK-based organization in 1999. LEED followed, becoming the green building label of choice in North America and many emerging economies, along with other schemes like Green Star (Australia), HQE (France), CASBEE (Japan) and HK BEAM (Hong Kong), which have also been around for at least a decade. Complementing these voluntary schemes, building codes have been around in most countries since the 1973 oil crisis, recently coupled with building energy disclosure programs in Europe (energy performance certificates, EPCs), Australia (NABERS), and the U.S. (EPA Energy Star). Taken together, these tools and initiatives have already institutionalized high performance green building practice.

The Role of the “Invisible Hand” in Driving Market Transformation

However, all these initiatives are not enough to address the scope of the global climate challenge. They are not big enough, fast enough, or far reaching deep enough to achieve the necessary emissions reduction or prepare society for inevitable climate change. The sector still consumes 81% of electricity in the U.S. and is responsible for about 40% of carbon emissions globally. For real market transformation to happen, we need something more radical. Or perhaps a concept that’s as old as Adam Smith’s “invisible hand” (first coined in 1759) – the capital market. The capital market is able to weed out lemons, or bad investments, and to let money flow to those investments that are most attractive. With current regulation, but also the ever-more-visible materialization of changes in climate (e.g. flooding, drought, torrential downpour, but also smog, heat waves, etc), investors should be wary of buildings exposed to these issues. And vice versa, investors should be attracted to buildings that have a more favorable carbon-risk profile, with less exposure to climate-change-related risks.

There are signs that the capital market is indeed starting to find its way into the acronym-heavy world of energy efficient, sustainable, or “green” real estate. Bloomberg last week reported that “property investors are obsessed with the A/C in your office.” There is emerging academic evidence that buildings with more favorable energy efficiency and sustainability characteristics perform better in the marketplace. And, like the 130 investors calling for clarity regarding the policy and market implications of the Paris agreement, there are 60 investors that are calling upon the real estate sector, upon GICS Code 60 to provide transparency in the sustainability performance of companies and the operational performance of underlying assets. These 60 investors are united in their belief that GRESB provides practical global framework to measure the sustainability of real assets.

A Global Language for ESG in Real Estate

GRESB provides a global language to give insight into the energy and sustainability issues that are material and specific to the real estate industry (GRESB separately analyzes the infrastructure sector). The GRESB Real Estate Assessment includes critical performance indicators – energy consumption, carbon emissions, water consumption, waste management – as well as on- and off-site renewable energy generation. And the use of green building certificates. Given that the performance of a portfolio of assets is so heavily dependent on the company managing the assets, the incorporation of sustainability issues in the acquisition, management, and disposition of assets is also measured. And of course, how the company interacts with its tenants, its surroundings, and its supply chain.

Today, investors using GRESB data represent USD7.6 trillion in assets. Some of these investors have called on the real estate sector since 2009, and this year we have the opportunity to look at the impressive results of their long-term engagement. Companies and funds participating in GRESB have significantly improved their performance since 2009. On average, companies and funds improve each year they participate with those participating the longest having the largest gains in ESG performance.

Real Estate Reducing Footprint

But of course, the interest is not just in the number of companies disclosing, but also in the energy and sustainability performance of the portfolios and underlying assets. This year marks a milestone for GRESB with the release of the new GRESB Rating. The goal is to make sustainability simpler and more actionable for investors. The GRESB Rating digests thousands of data points to provide a categorical indicator describing the relative sustainability performance of companies and funds around the world. This data reduction inevitably sacrifices some details, so GRESB continues to provide high-level Scorecards and detailed Benchmark reports for investors interested in getting into the details.

Overall the new GRESB data translates into some early indication of real market transformation: the 2016 data shows a reduction in energy consumption of 1.2% from 2014 to 2015, or almost 1,000GWh. That’s the equivalent of 74,000 U.S. homes. Carbon emissions went down by 2%, or 427 kilo tonnes of CO2. That’s the same as taking 90,000 cars of the road (not those efficient Japanese cars, but proper gas guzzlers). Water consumption decreased by 1.9% - about 1,200 Olympic pools (even for Michael Phelps that’s a long time swimming). And 2% less waste went to landfill, the equivalent of 15,000 truckloads. 

Warning signs

These numbers are encouraging, but should also be a warning sign. The numbers are encouraging because the market transformation taking place in the global real estate sector began long before a global climate agreement and corresponding climate policy had been put into place, driven by the capital market, the apparent business opportunities in reducing resource consumption, and perhaps by the animal spirits unleashed by bringing high-level transparency in the sustainability performance of companies and funds to the C-suite.

The numbers are also a warning. Progress is nowhere near the level required to realize global climate goals and the sector may (or may not) be ready to meet rising expectations. As the global real estate sector will get more attention from investors following its recognition as a stand-alone, mature industry, and from policy-hungry politicians searching for an outlet for their carbon-reduction aspirations pledged under the Paris agreement, they will quickly and inevitably be attracted to the building-sector’s abundance of cost-effective emissions reduction opportunities. In turn, investors will reward those best positioned to help address near-future sustainability and climate change challenges. But they can only do so based on objective information. Investors, companies, and other participants in the real estate market need to be able to differentiate leaders from laggards. In today’s business environments, answers to these questions must also be clear and simple. We think that preparing for tomorrow starts with a simple question: What is your GRESB rating?

ESG, Real Estate, and the Six Stages of Grief

Last week I spent a couple of days in sunny Vermont, with our great IT partner Greenriver. Together with the GRESB Data Analytics team, they’ve been working hard on building out the GRESB Portal for the 2016 data collection on real estate, debt and infrastructure. One of the exciting developments is that GRESB is slowly moving from manual entry of information to seamless data flows between many different data management platforms and our Portal. Good old Excel uploads also work, as well as semi-automatic data flow from the EPA Energy Star Portfolio Manager platform to GRESB. More on all of this very soon.

With my snow boots and down jacket still on, I then flew to Miami for the NAREIM Executive Officer Spring meeting – a powerful group of >60 investment managers convening to talk and think. In addition to hearing Alexandra Villoch, the CEO of the Miami Herald, talk about what change means to a business (the Herald has seen a 90% drop in traditional revenue streams, and has successfully used the remainder of this income to seed-fund new initiatives, such as an online platform, apps, etc.), see 3 teams of smart students present in the MIT Case Competition for the transformation of the Port of Miami, I spoke about the role of ESG in real estate.

I’ve been beating this drum repeatedly, but given the time of the year, with ESG reporting season almost upon us, I feel that reiterating the “why, what and how” of energy efficiency, sustainability, and real estate, is useful for a broad set of stakeholders. So, here’s the outline of my talk:

“I’m excited to discuss then important topic of natural resources and real estate. Here’s how these two come together:

We spend 90% of our time in buildings – homes, offices, shops, restaurants, gym, etc.

• This results in:
  • Buildings consuming 14% of potable water
  • Buildings representing 41% of US energy consumption
  • Buildings and their occupants using 81% of all electricity generated in the US

These issues are real and relevant for real estate owners through policies affecting buildings (stick/demand push)

• Some of these policies relate to the negative externality that is brought by energy generation – carbon emissions
• While politically sensitive, I still want to digress for 30 seconds and talk about the indirect implications of these carbon emissions for building owners:
  • Climate change [Governor Rick Scott will get me arrested….climate change does not exist in Florida]
  • Tidal flooding in Miami Beach (and…30% of Miami will be flooded by 2100)
  • Extreme weather events (drought or extreme precipitation)
  • California drought – reduction targets of 25% in 2015 alone
• Ambitions to reduce energy consumption – in California by 50% in 2030
• Construct “zero net energy” buildings by 2030 (in Europe by 2020)
• Mandatory disclosure of building energy consumption in the majority of major metro’s across the country
  • Important role for certification and information provision
  • These certifications are used as carrots and as sticks (the UK has outlawed transactions of buildings rated inefficient – an EPC of F/G.)

That’s the policy-oriented view, but at the same time, consumer preferences have started to change (carrot/demand pull)

• Many tenants now demand, or prefer, LEED-certified “green” buildings. This includes the GSA (350 million sq.ft.), state and city governments, but also large blue chip tenants, as well as retailers and private individuals in multi-family homes
• The diffusion of “green” certification is not trivial. Recent CBRE research shows that about 5% of buildings, but 20% of commercial office space now has been certified by LEED
  • As much as 38% in Chicago and 40% in San Francisco (Miami at 22%)
• Buildings are increasingly seen as part of the broader CSR commitment of corporates
  • Focus on energy (retailer H&M, logistics company DHL, but also Facebook in renewable energy requirements for data centers)
  • Focus on buildings as a tool for productivity, as a tool to attract and retain talent – the new rage is about buildings as the key to health and well-being (if you think energy efficiency is scary, there is a whole new wave coming. Come to the GRESB Events on Health and Well-being!).

All of this may start to affect cash flows – rents, occupancy rates, operating costs, prices, and thus returns and risk for investors and lenders

• There is a growing body of academic literature that shows correlations between energy efficiency, sustainability and financial performance
  • US (2007, 2010) office markets
  • Single-family homes (California/Netherlands)

I’d like to elaborate some more on this based on recent research that I did with Avis Devine of Guelph, using data from Bentall Kennedy (download the paper here)

• Data – 10 years of monthly leasing data on all commercial office buildings in the U.S. and Canada (300 buildings spanning 58 million sq.ft.)
• Detailed information on rental rates, rent-free periods (or other allowances), occupancy rates, tenant satisfaction, energy consumption. 236,000 month/lease observations.
• Can’t show you the scary-looking formula here, but we then ran a series of analyses to investigate the impact of green building certification (including LEED, Energy Star, but also BOMA BESt, a Canadian scheme) on these performance measurements. We extensively controlled for age, size and quality of the buildings

Results

• Rents – strong effect of Walk Score, small but measurable effect of LEED certification (3.7%), as well as Energy Star certification (2.7%). In Canada, results were stronger for LEED (10.2%), but no effects of BOMA.
• Rent concessions (including rent credits, free rents, TI allowances, etc) – on average rent concessions are 11% of the rent (!), but for certified buildings, these concessions are “just” 7%
• Occupancy rates – over the 2003-2014 period, going through the recession, LEED certified buildings were able to hold on to occupants a little better (4% higher occupancy rate), the results for Canada are again slightly higher, at 8.5%.
• On the “why” of occupancy rates, we digged into lease renewal – for every lease, we track its renewal over time. We had this data for the Canadian part of the sample only, but the results indicated that, controlling for building characteristics, both LEED and BOMA BESt increased the likelihood of lease renewal, by about 3.4%.
• One step deeper still, we then looked at tenant satisfaction scores, based on bi-annual tenant satisfaction surveys. The results, available for Canada only, show that tenants are on average quite satisfied, scoring 5.2 out of 7. Green-certified buildings have satisfaction scores that are 1/3 of a point, or 6% higher.
• Finally, we looked at energy and water consumption – first of all, the collection and standardization of data was quite a challenge, and good data was available for a smaller number of buildings only. Results show that LEED-certified buildings consume less energy, about 14% in the U.S., mostly driven by LEED for New Construction, and about 28% in the Canada, mostly determined by existing building certification.

Lot of numbers, but Bentall Kennedy consolidated all economic effects into a building valuation model – check it out here.

So, if you believe these results, energy efficiency and sustainability factors should be taken into account in the investment process.

We talked about what tenants desires and policy requires, but another important stakeholder is the capital provider – how do investors and lenders incorporate some of this information into their considerations?

• On the debt side, Fannie Mae offers a pricing break for green-certified multifamily developments. And there is an emerging fixed income product called “green bonds,” where issuers raise capital through a regular general obligation bond, with proceeds used for purposes such as green building or energy efficiency programs (e.g. Vornado, Digital, Regency)
• On the equity side, over 50 LPs, including many of the largest national and foreign providers of capital, are using data collected by GRESB to better understand what investment managers and REITs are doing to improve their efficiency and broader sustainability performance.

GRESB was started in 2009 by a group of European LP’s, with significant holdings here in the U.S.

• Filling a niche – desire for portfolio-level measure of energy efficiency and sustainability practices
• On the listed equity side there are metrics such as those developed by MSCI and FTSE, etc.
• Complements asset-level schemes such as LEED and Energy Star, focusing on the management and operations of real estate portfolios.
• Includes policy practices, integration of sustainability into acquisition process, active measurement and improvement of energy efficiency and sustainability of assets, but also the interaction with tenants, the community, and importantly, suppliers.
• GRESB runs an annual assessment on about 50 indicators, and after the data has gone through a rigorous validation process, the data is scored, with each company or fund receiving a GRESB Score, which is compared against peers in the same property type and region. In this way, ESG is made measurable.
• You have the numbers in front of you, but at this point GRESB has rated over 1,000 private equity real estate funds and REITs, covering, for example, all of the ODCE universe, 55% of the U.S. REIT market. GRESB works closely with NAREIT and PREA, and its counterparts in Europe and Asia.

The GRESB data is now available to about 60 LP’s and their fiduciaries, including some of the larger fiduciary advisors. The big question is always “what investors want” with all this data (see my previous blog on this topic). Are they really looking at those sustainability policies and tenant satisfaction surveys?

• For most of the investors, the simple answer is “no.” Most investors are in the education stage, understanding, perhaps like you, what sustainability means for their business. In that stage, there is often the desire to at least signal to GP’s or partners that this is a topic that is increasingly important. Reporting to GRESB, ticking the box, is then what matters.
• But education will soon turn into awareness, at which point investors feel the desire to get an objective measure of the ESG performance of their investments. Like for financials, measuring ESG performance in a quantitative way allows for a simple, straightforward understanding of where GP’s or partners are at. At this stage, the data empowers investors that are otherwise uninformed. Creating transparency in the sustainability performance of the real estate sector.
• The third stage includes investor requirements around performance and active engagement to reach those goals. That’s where an increasing number of more forward-looking investors and advisors are now. And perhaps the Europeans set the stage here – PGGM requires a 50 percent carbon reduction in 5 years. APG requires investments to outperform their peers in the GRESB peer group (see another blog post on this topic).

But before we lose ourselves in what investors want, let’s go back to why energy efficiency and sustainability is a topic for real estate investment managers in the first place

• Policy makers currently perceive buildings as “the problem”. However, I see buildings as the solution.
• Buildings offer an unprecedented opportunity to resolve major societal problems, and those that do that best will reap the benefits
  • Reduce cost
  • Reduce risk
  • Increase returns

So, in the same way that you may ask about the position an sophistication of investors on the topic of sustainability and energy efficiency, I’d like to ask you: where does your organization stand on this topic?

My colleague Dan Winters, GRESB’s Head of North America, often refers to the “five stages of grief” when it comes to GRESB and property companies/fund managers:

• Denial (I’m ignoring GRESB)
• Anger (I’m so over GRESB, I hate GRESB!)
• Bargaining (Why does this not count towards my GRESB Score?)
• Depression (I will be fired if you don’t fix this for me…)
• Acceptance (Alright, let’s do this!)

I would like to add one more stage:

• Embracing (Wow – integrating ESG leads to a better business!)

Because those companies and fund managers that are truly embedding and integrating ESG into their business are ultimately be best positioned for the inevitable change that the future will bring.”

Is California More Energy Efficient than the Rest of the Nation? Evidence from Commercial Real Estate

with Matthew Kahn and Peng Liu, NBER Working Paper

Download

California’s per-capita electricity consumption is 50 percent lower than national per-capita consumption. Mild climate, deindustrialization, and its demographics explain part of this differential. California energy efficiency policy is often claimed to be another key factor. A challenge in judging this claim is the heterogeneity of the real estate capital stock. Residential homes differ along a large number of physical attributes. We access a proprietary dataset from a large hotel chain that allows us to evaluate the environmental performance of comparable commercial real estate across the United States. Controlling for climate conditions and geographic location, we document that California’s commercial real estate stock is the most energy efficient at a point in time but this differential is quantitatively small. However, over the years 2007 to 2013, California’s hotels achieved much greater energy efficiency progress than hotels in other states.

What Investors Really Want…

…is high returns at low risk (volatility). Sure, that’s the starting point and so-called fiduciary duty of pension funds, insurance companies, and the investment managers that invest their capital. But increasingly, investors also want the companies and funds that they invest in to show what these investments do when it comes to environmental, social and governance (ESG) issues. 

Last week I moderated two panels in two related, but quite different orbits. Not just because the REITWorld conference took place in the Wynn in Las Vegas and the Greenbuild conference in the Washington Convention Center, but also because the Greenbuild crowd is so deeply engaged when it comes to sustainability, and sometimes so disconnected when it comes to finance, and vice versa for the NAREIT crowd. However, it seems like these two worlds are slowly coming together, which should be good news to those REITs and fund managers that have embraced sustainability, and worrisome to those real estate investment managers that are still of the view that “sustainability is not for me.”

The amount of capital that has an interest in ESG data on REITs and property funds is significant. During the equity panel of the Greenbuild GRESB Investor Track, CBRE Clarion Securities, a USD22 billion REIT investor, alluded to their engagement with publicly traded property companies on ESG issues. It’s still in its infancy, and the conversation is mostly focused on those REITs that do not yet report on sustainability (through GRESB). But having actionable sustainability data on all equity REITs is the goal. Another panelist, the Townsend Group, is predominantly focused on private equity funds, with a scary USD170 billion in assets under advisement, all in real estate (read: Townsend advises clients on where to allocate their capital). Townsend already has clients that will not invest in funds that refuse to disclose their sustainability performance (again, GRESB is the measurement), but that represents the minority of investors. A dozen of Townsend clients are actively asking for the ESG performance and profile of their fund investments, and Townsend reports to those clients based on GRESB’s Portfolio Analysis Tool. And increasingly, Townsend is looking for more granular data – think: asset-level information on consumption, green certification, etc. There are also pension funds that have direct investments in real estate. The third panelist, Oxford Properties (with a portfolio value of USD34 billion) is such example, fully owned by OMERS, a large Canadian pension plan. Interestingly, Oxford sees the current market conditions, where real estate has become pricey (in my view overpriced) as another reason to deploy capital in its large portfolio of existing assets, increasing the net operating income (NOI) at returns that exceed cap rates on new acquisitions. Oxford Properties is an owner of prime office, retail, multifamily space, and sees strong demand for their “green” assets. An example in case is a recent LEED Platinum development in Torono for EY (aka Ernst & Young), where the war on talent (and the quest for productivity) drives demand for better buildings. The average age of EY employees in Canada is…28 years! These youngsters do not want to work in Park Avenue-style cubicle space deprived of natural light. (And rightly so.)

The REITWorld panel was themed “Sustainability in REIT Investments: Where Are We? And What’s the Investor Point of View?” Again, an impressive lineup. Dutch pension fund PGGM Investments, a >200 billion investor with over USD20 billion in real estate (both REITs and private funds) is moving to set actual targets for its investment (see also my recent blog) – 50% carbon reduction in 5 years is the goal. The pension fund, driven by its 2.5 million trustees that are healthcare workers, does not shy away from difficult discussions with its investments if no or limited progress is made. The second panelist, Cohen & Steers, is truly the gorilla in the REIT room, with USD53 billion in assets under management, all of it invested in “liquid real assets,” of which the largest chunk is REITs. Initially driven by clients, but increasingly by the realization that ESG and good management are strongly correlated, Cohen & Steers has expanded its definition of governance to include “environment” and “social,” allowing for these factors to influence the growth rate and discount rate in their REIT valuation models. Small changes to these variables can have considerable effect on pricing, and thus on overweight or underweight decisions by the firm. With all sophistication came the honest conclusion that Cohen & Steers should still do more to engage with REITs on the topic of ESG. Interestingly, Wellington Management, the third panelist, has engagement as a core part of its strategy. Wellington manages almost USD1 trillion (!) in assets under management, of which “a couple of billion” is invested in REITs. As a preparation for the panel, Wellington had asked a number of REIT management teams about their views on “how climate change may affect the portfolio, and what to do about that.” In all but one case, the response was an awkward silence. Work to be done – Wellington’s view is that ESG will affect pricing of REITs, and the ability of REITs to raise capital.

I often get the question from REITs and fund managers what investors want when it comes to sustainability. And why they never hear from investors directly. The panels this week provided some part of the answer: investors expect their real estate investments to actively develop and implement a sound ESG strategy. That’s simply part of good business, so don’t expect a pat on the back for running a proper sustainability program. However, for those that don’t, expect more and more questions. And for all: be prepared for the bar to be raised; business as usual won’t do a couple of years down the road. In the meantime, put that ESG slide in the quarterly investor briefings, and prep your fund-raising and management team for the ESG questions in case they come. Nobody wants to look a (potential) investor in the eye, laugh sheepishly, and answer that sustainability is something that the company is not actively considering.

What’s in a (reduction) target?

Last week, PGGM Investments, a EUR190 billion Dutch pension fund, announced that over the next 5 years, it is seeking a 50% reduction in carbon emissions from its investments in real estate – both listed property companies and private equity real estate funds. This is the world upside down: typically corporates make announcements for energy reductions or carbon neutrality – recently Coca Cola pledged to reduce the carbon footprint of “drinks in hand” by 25% in 2020, and Google and Walmart have announced to target powering their operations for 100% by renewable energy. PGGM’s goals are laudable, but I’d like to provide some context: 

Targets (and precedent)

The real estate sector is responsible for 81% of electricity consumption in North America and Europe, and figures are comparable for other developed markets that shifted from manufacturing to an economy focused on the service sector. While these numbers are high, and are leading to regulatory and investor scrutiny, the numbers do not necessarily mean that the built environment is hopelessly wasteful. After all, the energy and electricity are inputs for economic production – the energy is used to run buildings and appliances, in the same way that manufacturing facilities use energy to produce widgets. So, while we know that buildings use a lot of energy, we do not necessarily know how efficient or productive the sector is as a whole. Consequently, it is difficult to understand the levels of reduction that the sector can achieve while increasing economic output.  

Let’s be clear, this should not be an excuse for inaction: I fundamentally believe that the real estate sector can dramatically improve its efficiency. The McKinsey curve may be overly optimistic about the profitability of many energy efficiency opportunities in the real estate sector (even though current interest rates brings the cost of capital very close to the social cost of capital used in the McKinsey calculations), but the fruit of energy efficiency is ripe and still hanging low, and opportunities for energy savings in buildings are abound.

Interestingly, the state of California recently passed legislation with a target to reduce the energy consumption of buildings, by 50%, over a period of 15 years (by 2030). In other words: slashing consumption is on the minds of both investors and regulators. But, PGGM’s goal of 50% reduction is no small feat, let alone in 5 years. For some perspective, the 2015 GRESB data provide interesting stats for energy reduction targets:

• 348 out of 707 property companies and funds have long-term energy reduction targets;
• The average reduction target is a 15% decrease in energy consumption over a period of 6 years;
• 10 companies and funds have reduction targets of 50%(or more), over an average period of 11 years;
• Short-term reduction targets (for one year) are in place for 282 companies and funds, with an average reduction target of 5 percent.

 For carbon emissions:

• 288 out of 707 property companies and funds have long-term carbon reduction targets;
• The average reduction target is a 21% decrease in carbon emissions over a period of 7 years;
• 37 companies and funds have reduction targets of 50%(or more), over an average period of 13 years;
• Short-term reduction targets (for one year) are in place for 247 companies and funds, with an average reduction target of 7 percent.

And here are some illustrative examples of reduction achievements by property companies and funds (based on public statements on websites and on GRESB data):

• 35% portfolio-wide reduction in energy intensity and 46% reduction in emissions intensity, over the 2005-2015 period – The GPT Group (Australia)
• 30% portfolio-wide reduction in energy use, over the 2003-2013 period – Simon Property Group (U.S.)
• 65% reduction in landlord energy use, and 50% reduction in building energy use – Case study by British Land (one building, U.K.)
• 49% reduction in portfolio-wide energy use – Case study by Triodos Vastgoedfonds (Netherlands)
• 23% reduction in energy intensity and 56% reduction in carbon emissions intensity, both in the portfolio of managed shopping centers, over the 2006-2012 period – Unibail Rodamo (France)
• 60% reduction in carbon emissions of the portfolio, over the 2006-2015 period – Hermes Real Estate (U.K.)    

Carbon emissions versus energy consumption

Reduction targets are often set for carbon emissions, not energy consumption. I prefer energy reduction targets to carbon reduction targets.

First, carbon emissions ultimately reflect the choices that a property company or fund makes regarding energy efficiency, energy procurement, renewable energy, and scope of reporting/coverage. For example, a property company or fund can simply procure “green” energy, with that reduce its carbon emissions and pass the (slightly higher) energy bill on to its tenants. There are quite some examples of property companies and funds that pursue procurement of green energy, ranking from the Local Government Super real estate fund that procures green energy only, to the Dutch funds managed by CBRE Global Investors, that procure green energy for landlord-managed areas. Of course, reduction through energy efficiency improvements or through the use of on-site renewables is much harder.

Second, carbon intensities are difficult to compare across jurisdictions, due to differences in the energy mix – carbon simply matters less in the hydro-rich Nordics or nuclear-powered France. So, the information content in company-specific carbon intensities is low.

Third, energy reductions have direct financial implications, whereas the relevance of carbon emissions can be important or irrelevant for property companies and funds. This depends on factors such as:

• Carbon pricing (even in the presence of a carbon trading scheme, financial implications are limited – for example, at a cost of USD32 per ton of carbon dioxide, this would translate into 32ct/sq.ft. for a firm like Walmart);
• Composition of the energy mix (mostly, percentage of the energy generation through fossil fuel sources);
• “Softer” factors like corporate CSR strategy and stakeholder pressure.

This is a complex trade-off frontier: energy cost and emissions are complementary issues. Energy costs have a complex price structure. Emissions are the environmental externality from energy consumption.

Measurement 

To measure the 50% carbon reduction targets imposed on property companies and fund managers, PGGM will rely on predicted measures of consumption for those buildings for which it currently does not have data. Measuring building energy consumption and carbon emissions used to be hard, and perhaps even expensive. However, times have changed, technologies have evolved, smart meters have been rolled out, utilities are becoming more open and able to share data, and simple data management systems can be procured at a (very) low cost. However, some property companies and funds still struggle with systematically collecting non-financial data – 28% of the 707 property and companies and funds reporting to GRESB in 2015 did not report any data. And of course, the scope of reporting is often limited to landlord-obtained energy data.

 This leads to the question on how to get more data and more accurate data on the complete portfolio of investor’s real estate allocations. There are two ways: more pressure on property companies and funds to start collecting data, or relying on (gu)estimates. My strong view is that the first option is desirable. After all, building energy consumption estimates are inaccurate – the correlation between European building energy labels and real consumption is 0.65 at a maximum. The role of building occupants, building management, and an owner’s vision, determine how a building really performs. In order to make improvements reflected in savings on the meter over time, we need to measure real consumption, standardized by relevant metrics. Let’s not forget that an empty building performs best on a kWh/sq.ft. basis, and that increasing consumption in an industrial facility is not necessarily a reflection of economic inefficiency.

 One more thing: now that we have the Volkswagen experience still fresh on our minds (memory is short, and in six months this will have been forgotten...), it is important to rethink how to properly enforce legislation requiring perhaps irrationally large reductions in emissions, and in the same vein, the realism of investors requiring such reductions. Wall Street famously finds ways around legislation, the automobile industry seems to be pretty capable at circumventing legislation, and so, perhaps, are many other industries, including the real estate sector.

 So…

Let’s set aggressive but realistic targets, pushing property companies and funds to invest in energy efficiency solutions that are now often disregarded “because the payback period is 5 years.” Let’s make those targets long-term enough so the market can do its work, innovating itself out of the energy and carbon challenge. Some may not agree, but I’m hoping that more investors will make clear to the real estate sector what they want, while monitoring and engaging along the way. GRESB is already providing the tools for such engagement, with many more solutions to come in 2016. I’m optimistic that the real estate sector can reduce its consumption and emissions by 50% over the next decade – buildings as the solution, that’s the mantra!

Green Certification and Building Performance: Implications for Tangibles and Intangibles

with Avis Devine, Journal of Portfolio Management

Download

Commercial buildings represent a significant share of global energy consumption. In the general absence of regulation, voluntary labeling and green building certification schemes have been introduced to reflect this externality to building owners and tenants. The implications of such schemes have previously been documented to affect building financial performance. However, existing studies mostly focus on the U.S. market, and more importantly, generally include a limited set of performance metrics only. Using a rich, proprietary dataset from one of the largest building owners/managers in North America, this study is the first to investigate the effects of green building certification on non-financial metrics, such as tenant satisfaction, incentives, and lease renewal. The empirical results show that buildings certified through voluntary labeling schemes generally have a higher probability of lease renewal, lower incentives, and more satisfied tenants. We then study the effects of green building certification on financial metrics, such as rents and occupancy levels. The findings for the U.S. sample unambiguously confirm previously documented results – LEED and ENERGY STAR certified buildings command a small rent premium and have a lower vacancy risk. For Canada, effects for LEED-certified buildings are consistent with U.S. results. The results show that the national green building scheme (BOMA BESt) is not priced in, these buildings still offer greater overall stability versus non-certified buildings through increased releasing rates, lower incentives and substantially higher tenant satisfaction levels. The findings in this study provide an important contribution to the understanding of underlying value drivers in more efficient, sustainable buildings, and provide some first evidence for the international validity of otherwise mostly U.S.-based studies on the financial performance of green buildings. Press release

Energy Efficiency and Household Behavior: The Rebound Effect in the Residential Sector

with Erdal Aydin and Dirk Brounen, RAND Journal of Economics

Download

Policies designed to reduce energy consumption in the residential sector through energy efficiency measures are typically based upon engineering calculations, which may differ significantly from outcomes observed in practice. A widely acknowledged explanation for this gap between expected and the realized energy savings is household behavior, as energy efficiency gains alter the perceived cost of comfort and thereby generate shifts in consumption patterns -- a "rebound effect". This paper adds to the ongoing discussion about the method of identification and the magnitude of this effect, by examining the elasticity of energy consumption with respect to a predicted measure of thermal efficiency, using a sample of 560,000 dwellings and their occupants in the Netherlands. We document significant deviations between engineering predictions and the actual energy consumption of households: our results show a rebound effect of 26.7 percent among homeowners, and 41.3 percent among tenants. There is significant heterogeneity in the rebound effect across households, determined by household wealth and income, and the actual energy use intensity (EUI). The effects are largest among the lower income and wealth cohorts, and among households that tend to use more energy than the average household

Real Estate 2.0: Tesla-like buildings, used “Uber-style”

Warning: this is a loooong blog! A shorter version can be read on Greenbiz.

While the financial industry is still reeling from and reflecting on last week’s stock market gyrations, wondering whether China’s growth will (finally) go below 7%, and whether the Fed will be deterred from (finally) raising interest rates from their current rock-bottom level, it is tempting to forget about lingering long-term issues, such as the impact of extreme weather events that take place increasingly frequently, the slow rise of sea levels that threaten economies and entire societies, and the impact of changing demographics (i.e. aging populations) and health trends such as obesity and chronic diseases on our healthcare systems. It’s short-termism versus long-term thinking in its purest form. And it’s human. After all, clients and investors evaluate the performance of the financial industry on a yearly, quarterly or even more frequent basis, and as the saying goes, in the long run…we’re all dead.

But even amidst the current turmoil, there seems to be a sea of change in investment beliefs that is becoming ever more prominent, and ever more articulate. The belief that for long-term investors, long-term trends can have real implications for capital values and income returns. Whether it is the current drought in western North America and in Australia, flooding in Chinese cities, or the rise of renewable energy, some of the “long-term” trends are starting to become real, happening every day, at many different places in the world.

While long-term trends affect all industries, they are particularly relevant for the real estate sector, where assets are long-lived and…typically cannot be moved to another place. Buildings are basically sitting ducks, waiting for urban form and consumer preferences to change. In the real estate sector, attention to non-financial information that may affect financial performance has traditionally focused on governance – deal terms, fees, alignment, transparency, and reputation. But over the past ten years, buildings have become a focal point in the debate about broader, global sustainability issues. In the face of climate risk and resilience, buildings are a big problem, consuming over 40% of energy globally. In the face of water scarcity, buildings are a big problem, both as significant consumers of water and for example as the cause of drainage flooding. In the face of rapidly increasing healthcare costs, buildings are again a big part of the problem, with people on average spending 90% of time indoors, subject to often-suboptimal workplace quality that lacks any stimulus to move.

These issues all have regulatory relevance, and in many regions, countries and jurisdictions, building-specific regulation is introduced to address the impact of buildings on energy, water and health. Such regulation ranges from general sustainability disclosure requirements on stock exchanges to energy performance disclosure requirements at the asset level, and from mandatory water savings in buildings to mandatory improvement of underperforming buildings. For investors in real estate, this nascent growth of regulation adds to the real implications of environmental and social trends on the buildings that they own and manage, as well as the changing preferences of their consumers (or: tenants, in real estate language). Think for example about the changing role of the workplace, from place to work to place to meet, with flexible seating arrangement and more attention to desirable common areas. Think about the evolution of retail, from places to buy to places to experience. And of course, the “überization” of the real estate sector through platforms such as AirBnB and (perhaps not so well-known) WeArePopUp.

It is an interesting analogy to compare the real estate industry with the automobile industry. Fuel economy standards are common practice in the automobile industry, increasing in both Europe and Japan from 37MPG in 2002 to 50MPG in 2015 – that’s a 30% increase in efficiency over a bit more than a decade. In the U.S. and Canada, fuel economy requirements increased from 25MPG in 2009 to 35MPG in 2015 – a 40% increase in 6 years. Regulation is paired with increasing consumer awareness through standardized information provision, such as energy labels and MPG stickers. What’s more, the industry has innovated to mass-produce hybrid and electric-powered vehicles, ranging from the now-common Prius to the highly desirable Tesla. These innovations have not just led to more efficient cars, but also to a new generation of vehicles that no longer requires a dealer network, does not need the same level of maintenance, and can be updated and checked remotely, uprooting a century-old industry. Given that the average buildings lasts for at least 30-50 years, buildings are less sensitive to such rapid technological development, but one needs just a little imagination to envision how a new generation of Tesla-style buildings, used “Uber-style,” could similarly uproot the real estate industry.

Ultimately, it is the capital market that will both benefit and suffer from regulations, environmental and social changes, and societal trends. As in any business, for investors to understand and act upon new information, they need just that – data. Information transparency enables better investment, empowering decision makers to manage risk and find superior returns. Smarter investment will reward innovation, ultimately driving market transformation. The buzzword to measure the ability of companies to respond to long-term trends is “ESG” or sustainability performance – encompassing environmental, social and governance factors. In fact, those companies that better understand the implications of ESG trends on their business can be better positioned to generate higher, more stable returns in the short run, as ESG management is very often a useful proxy for superior management. It turns out that very few poorly run companies can effectively manage complex issues like energy, water, waste, and health.

Comparable to cars, there is a plethora of “nutrition labels” available for individual buildings and assets – globally there are over 200 energy and sustainability labels that provide market participants with information about the energy performance of an asset, and often much more than that. Leading labels such as BREEAM, Green Star and LEED include factors such as climate change resilience, water efficiency, location relative to public transport and other factors into their assessment. But buildings are often part of larger portfolios, owned and managed by developers, listed property companies (REITs) or private equity funds. Many investors, such as pension funds, mutual funds, bank insurance companies, endowments, etc., never touch individual properties, preferring to invest indirectly through property companies and funds. GRESB provides these investors with a systematic, annual assessment of portfolio ESG performance – a “nutrition label” for real estate companies and funds, comparable to what Morningstar provides on the financial performance of thousands of mutual funds, or to what Moody’s and S&P provide on the credit score of tens of thousands of countries, companies, and financial products. Or, back to the automobile analogy: the rating that the Consumer Reports provides to Teslas, and virtually every other car.

The GRESB ESG “label” enables large investors to be smart shoppers. But rather than spending USD30, 000 on a car, institutional investors are allocating tens of millions, sometimes billions of dollars to real estate. Today, most of these decisions are made without regard to health, safety, energy, water, etc. – not with malice, just ignorance. This means that there is a significant opportunity for investors just by asking for basic information and by beginning to consider the most important issues. Over time, the market will respond to their interests. Their attention will help drive performance. Over the past six years, GRESB has assessed and evaluated the sustainability performance of nearly 1,000 companies and funds operating in the commercial real estate sector. Perhaps that's not the thousands of Morningstar ratings, but consider that the real estate sector is still much less institutionalized (or: securitized) than most other sectors, and globally there are “just” 330 property companies in the main real estate index (the FTSE EPRA/NAREIT index), on aggregate representing USD 1.2 trillion. On the private equity side of the commercial real estate sector, numbers are much harder to come by (it is “private” after all), but estimates put the size of the sector at about USD 750 billion, and there is much more commercial real estate owned directly by sovereign wealth funds, pension funds, and corporates.

In 2015, 707 unique property companies and funds have been rated by GRESB, representing USD 2.3 trillion in commercial real estate and some 61,000 assets. The data is summarized in the 2015 GRESB Report, which provides new insights showing that the global real estate sector is increasingly integrating environmental, social and governance considerations into corporate policies and business strategy. Critically, the data also shows that policy and strategy are backed by actual implementation of energy and water efficiency programs, and demonstrable improvements in sustainability performance. On aggregate, the sector reported huge energy consumption of 109TWh in 2014, but it notably reduced its consumption by 2.87% since 2013. That’s the equivalent of taking 105,000 U.S. cars off the road. Greenhouse gas emissions decreased by a similar amount: 3.04% or 533,000 metric tons, the equivalent of nearly 50,000 U.S. homes. While these percentage reductions may feel small, they are beyond what policy makers and climate negotiators are typically aiming for when setting long-term reductions goals (such goals are a hot topic in advance of the Paris climate negotiations). Water consumption in the commercial real estate sector also decreased significantly, by almost 2% or 6.6 million cubic meters, the equivalent of nearly 3,000 Olympic-sized swimming pools. There is also a significant uptake in renewable energy with on-site renewable energy generation increasing to 445GWh in 2015 from 296GWh in 2014, equivalent to a quarter million barrels of oil.

The global sustainability performance of the real estate sector also improved across other areas of environmental, social, and governance performance. Trends in GRESB data show that sustainability goals and ESG disclosure are now firmly part of mainstream business practices: 93% of property companies and funds incorporate sustainability into business objectives. With extreme weather events and shifting weather patterns threatening economies and the built environment, 54% of all property companies and funds have policies in place that consider climate risks. In addition, the real estate sector increasingly recognizes the health, safety and well-being of occupants, the community, and the supply chain as sources of both risk and opportunity.

GRESB considers all this information and much more, churning the numbers through comparative calculations, and ultimately producing a single measure of overall ESG performance. This simple number has power. It provides a measure of something that was once invisible, a company or fund’s overall effort and success in addressing critical global challenges associated with environmental, social, and governance issues. In the hands of a savvy investor, this score can nudge risk ratings up or down; affect discount or growth rates; inform a choice on investment manager or operator; or simply assist real estate investor in better understanding the sustainability risks and opportunities intrinsic to the portfolios they invest in.

This score also allows us to take the pulse of the real estate industry. In 2015, we found that this pulse is strong and steady. It seems that our patient has been working out a bit. The average GRESB Score improved to 56, a significant boost compared to 46 in 2014. Another vital sign, the number of GRESB “Green Stars”, also improved, with over 350 companies and funds receiving this mark of distinction based on their combination of superior management and on-the-ground action.

Notwithstanding the outsized role of the property industry in the current debate on resilience, climate change and public health, the 2015 GRESB data, representing a significant part of the industry, suggests that the commercial real estate sector is “getting to grips” with sustainability as a business consideration, not just as a mere afterthought.

Analogous to the automobile industry, the commercial real estate sector has the capital, power, and innovative capacity to provide solutions to the problem of which it is an inextricable part. Regulation and changing consumer preferences will spur the need for these solutions. Our collective capital, managed by pension funds, insurance companies, banks and other financial institutions will be an important part of the transformation to a more efficient, more sustainable built environment. Not for reasons of philanthropy, but for reasons that the financial industry understands best: improving returns and reducing risk, both in the short term AND in the long term.

Read more about the GRESB and the 2015 data in the GRESB Report.

The 2015 Green Building Adoption Index

Yes...the 2nd edition of the CBRE/Maastricht University Green Building Adoption Index is out!

Here's the press release:

Owners of small buildings have an opportunity to differentiate themselves by implementing energy-efficient practices, due to a significant gap between large and small office buildings in achieving sustainability certification, according to a new study by CBRE Group, Inc. and Maastricht University. 

The 2015 Green Building Adoption Index, a joint project of CBRE and Maastricht, found that 62.1 percent of office buildings in the U.S. greater than 500,000 square feet are considered “green” (holding either an EPA ENERGY STAR label, U.S. Green Building Council (USGBC) full-building LEED certification or both). In contrast, only 4.5 percent of all U.S. office buildings less than 100,000 square feet qualified as green. 

 

“Our 2015 study confirmed that green building adoption has been primarily a big building, first-tier city phenomenon,” said David Pogue, CBRE’s global director of corporate responsibility. “It would appear that many smaller buildings in the majority of large markets still have an opportunity to be ‘best in class’ among their peer set by achieving these certifications.”  

 

Minneapolis led the city ranking for the second consecutive year, with 70.4 percent of all office space currently qualified as green, down from 77.0 percent in 2014. San Francisco, again in second place, significantly closed the gap and now boasts a 70.0 percent green market, up from 67.2 percent in 2014. Chicago, at 63.4 percent, was third, while Atlanta (57.8 percent) and Houston (52.9 percent) swapped positions at fourth and fifth. The top 10 cities on the 2014 list all retained a place on the 2015 list. 

 

The overall results of the study show that the uptake of green building practices in the 30 largest U.S. cities continues to be significant, but that the growth is slowing. At the end of the fourth quarter of 2014, 13.1 percent of the commercial building stock had an ENERGY STAR label, LEED certification, or both, compared to 13.8 percent at the end of 2013. Measured by size, the amount of certified commercial space also decreased from 39.3 percent in 2013 to 38.7 percent at the end of 2014.

 

“This decrease does not imply that buildings are starting to perform worse than before. Rather, it reflects the fact that only a certain fraction of the building stock can obtain a green or energy-efficiency certification,” said Dr. Nils Kok, associate professor in Finance and Real Estate, Maastricht University (NL). “Additionally, it appears that some of the buildings that were previously certified did not renew their certification in 2014. This does not necessarily mean that the energy use of these buildings has changed, but that some owners and managers choose not to spend the time or expense to reapply for certification every year.”

   

Executed in close collaboration with the USGBC and CBRE Research, this is the second release of the annual Green Building Adoption Index. Based on a rigorous methodology, the Index shows the growth of ENERGY STAR- and LEED-certified space for the 30 largest U.S. office markets, both in aggregate and in individual markets, over the previous 10 years.