Climate Alpha at the ULI Fall Meeting

Early this November, Climate Alpha travelled to Los Angeles for the Urban Land Institute’s (ULI) Fall Meeting to engage in productive discussions about the future of real estate and connect with industry leaders and innovators from across the globe. For the first time in ULI history, programming geared towards climate mitigation, adaptation, and resilience, seemed at par with other leading industry themes. According to the ULI Randall Lewis Center for Sustainability’s “Not So Secret Guide” – the ultimate resource for sustainability programming, there were almost 30 sustainability focused events during this year’s meeting. Climate Alpha had the privilege of participating in many of these sustainability programs and are sharing our key takeaways.

1. Climate Volatility Poses Greater Risks but Short Hold Periods Impede Meaningful Progress

Record-breaking heat, droughts, and wildfires, all exacerbated by climate change, present a unique set of challenges to the real estate industry. As the number of billion-dollar climate events significantly rises, owners and operators are experiencing higher operating expenses, in the form of more costly property insurance, energy maintenance, and damage repair. Despite higher costs and greater risk, the industry has done little to mitigate or adapt to climate change. According to the ULI/PwC Emerging Trends report, which was presented during ULI’s opening remarks, “a critical industry problem is that most market participants have a decision time horizon that is much shorter than needed to address physical risks due to climate change.” Therefore, the disconnect between the decision time horizon for property investments and climate change’s timeline allows real estate owners and operators to ignore climate risks. However, one key trend missing from the discussion is that the time between billion-dollar climate occurrences continues to shorten, which will inevitably infringe upon the average holding period for real estate investors.

2. Insurance is the New Variable that can Break Deals

During a panel discussion Mary Ludgin, Global Head of Investments Research at Heitman, shared that she believes insurance will be the vector that will change people’s mind about where they should invest. Historically, insurance has not been a concern for CRE owners, accounting for only approximately 3% of rent, but rising costs and declining availability is forcing the industry to rethink their insurance approach. Insurance premiums have risen for 22 consecutive quarters with some properties experiencing a quadrupling of insurance costs over the last year. Moreover, major carriers have dropped out of California, Florida, and Texas creating concerns for investor int these markets looking for a mortgage. The general sentiment was that the property insurance market is not going to get better any time soon, and that real estate owners should prepare for another challenging year ahead.

3. Mixed Feelings about Top Markets in the Sun Belt The Sun Belt continues to attract households, firms and investors eager to enjoy fewer regulations and lower taxes, and more sunshine. However, the top markets tended to be in the Southeast and Southwest, which are also susceptible to extreme heat and other climate stressors, highlighting that climate risks do not yet rank highly for many individuals/households. The top 5 overall real estate markets, presented by PwC, included Nashville, Phoenix, Dallas-Fort Worth, Atlanta and Austin. The top 5 markets for homebuilding prospects weren’t much different, including Austin, San Antonio, Washington, D.C., Atlanta and Dallas-Fort Worth.

Sara Queen, head of Equity Strategy for MetLife’s Investment Management Real Estate group, said that the top markets are not surprising, but it really depends on what assets you’re buying in each of those markets. Sara continues by underscoring the importance of being more selective about location and asset characteristics in slower growth environment.

Similarly, Andrew Yoon, COO & Managing Partner at BGO, shared those sentiments, elaborating that investors must be very detailed oriented in today’s market. It’s necessary to have boots on the ground to dissect why one corner is better than the next. However, Mary Ludgin (Heitman) paints a very different picture, indicating that top markets should sometimes serve as a sell signal. More specifically, she expressed concerns over the Nashville market, due to the significant greenlighting of development deals that could potentially lead to a supply glut.

4. Climate Forward Strategies, from Hardening to Community Resilience

One session featured best practices for incorporating water-saving, heat-mitigating, and fire-wise measures into real estate projects, which help mitigate physical risk and enhance asset value. A case study presented about the challenges Ranch Mission Viejo, a master planned community in south Orange County, CA put into perspective some of the challenges related to obtaining insurance in an area that has been flagged for high fire risk.

Another session discussed the alignment of private, philanthropic, and public partnerships to address immediate and long-term risk mitigation. The launch of community disaster resilience zones (CDRZ) by a bipartisan Congress and led by the White House with FEMA has put in place a new resilience framework for co-strengthening locations that are most at risk (high disaster vulnerability) and most in need (high social vulnerability). This framework will deploy over $1 trillion in alternative financing and resources.

5. Investment Advice on how to Incorporate Climate into Strategy During one session, the panelists were asked how they are advising their clients in terms of how to consider climate risk from an investment perspective and the following feedback was provided:

• Diversify your portfolio to make certain you don’t have unwitting climate risk exposure.

• Sensitize your cashflows for increasing insurance rates.

• Sensitize your cashflows for tenant pullback. More specifically, Mary Ludgin (Heitman) believes there will be reversal of migration patterns more towards Minnesota and away from the Sun Belt as the planet warms and acute weather events get more severe.

• Pay attention to the regulatory environment as municipalities are trying figure out how to pay for the mitigation needed for climate change and it will likely fall on the shoulders of the CRE industry.

We look forward to continuing these conversations at the ULI Spring meeting in April 2024, which will primarily focus on Resilience.