Archives for July 2021

Introduction

Environmental, social, and governance (ESG) has reached a tipping point. In a 2019 McKinsey survey, 57% of CEO respondents said they believe ESG programs create long-term value, and 83% say they expect ESG programs to contribute more shareholder value than they do today.¹ But what other signs are forming today in the real estate, finance, and corporate sectors?

For the first time in history, a court ordered a private company, Royal Dutch Shell PLC, to slash its greenhouse gas emissions by 45% by 2030 from 2019 levels.² In a record-high vote on an environmentally oriented shareholder proposal that was opposed by management, a whopping 81.2% of investors of DuPont supported a resolution asking the company to report on spills of plastic pellets that are released into the environment—the highest vote ever for a shareholder resolution on environmental issues.³

In 2020, ESG funds more than doubled net new money intakes, capturing $51.1 billion.⁴ The growth in ESG in recent years is fueled by multiple drivers, including consumer shifts, regulatory requirements, trillions of dollars of wealth transferring to Gen Z and Millennials committed to philanthropic living (not giving), a blurring of work and societal expectations, and a full sprint to attract and retain top talent. PwC’s 24^th Annual Global CEO Survey found that 30% of CEOs are concerned how climate change will threaten their organization’s growth (up from 24% last year)—a growing aspect of the ESG puzzle.⁵ Investor and market demand for ESG in real estate spans the globe with the key questions being what is material, where are we vulnerable, and which strategies will cost-effectively mitigate risks. Transformative, enterprise-wide ESG programs in all sectors of real estate can be one of the best ways to reduce carbon emissions, accrete value, and demonstrate reputational value. Many Private Equity and real estate firms have set bold ESG commitments, but perhaps one of the most watched organizations is the Blackstone Group. Committing to “reduce carbon emissions by 15% across all new investments where we control energy usage” and “a new target of at least one-third diverse representation on portfolio company boards for new control investments, starting in the U.S. and Europe, and a Career Pathways program designed to create employment opportunities and career mobility for people from underserved communities at Blackstone’s portfolio companies,” Blackstone is leading the way.^6, 7 Organizations are setting aggressive ESG targets that will need adept implementation and regular reporting on progress. Rating agencies and voluntary reporting frameworks are increasingly providing transparency and serving as watchdogs. GRESB, a leading ESG performance framework for real estate, found: “Participation in the 2020 Assessment grew by 22% to cover 1,200+ portfolios worth more than USD $4.8 trillion AUM…This increase in participation, coming despite the challenges of the COVID-19 crisis, shows an industry responding decisively to the accelerating investor demand for comparable ESG data…” ⁸

Decarbonization

Unprecedented numbers of companies are conducting greenhouse gas inventories, making commitments to carbon neutrality, emissions reduction goals, or becoming net zero by a set date. There has been a 5x growth in carbon targets between 2016 and 2020, with nearly 30% of Fortune 500 companies possessing a goal. Commercial real estate organizations with carbon reduction frameworks are active in numerous industry frameworks, such as CDP (413 represented), Science Based Targets (72 represented), and TCFD (72 represented). The Net Zero Asset Managers Initiative (87 signatories), and RE 100 (over 300 total organizations) also feature sizeable representation from the industry. Nearly 25% of the Department of Energy’s Better Buildings Challenge partners signed onto Better Buildings’ Low Carbon Pilot and will use the partnership as an opportunity to make tactical progress towards decarbonizing their portfolio. Driven by stakeholder demand, these commitments present challenges for organizations around funding and implementing the commitments at scale, but also opportunities for collaboration with others and the prospect of lasting change.

Climate Risk and Insurance

Climate change brings with it both physical and financial risk to assets. According to Deloitte:⁹

• “A majority of U.S. state insurance regulators expect all types of insurance companies’ climate change risks to increase over the medium to long term—including physical risks, liability risks, and transition risks.
• More than half of the regulators surveyed also indicated that climate change was likely to have a high impact or an extremely high impact on coverage availability and underwriting assumptions.”

With those factors in mind regulators are looking to new processes for due diligence, underwriting, value at risk analysis, and implications for allocations. Though moving at a slower pace than in the U.S., the EU is seeing similar response from banks. Costs are going up for two reasons: catastrophic loss from more frequent and intense storms, water damage, and floods; and the values at risk have grown exponentially in value over time.

Alternative Financing

The demand for progress towards ESG initiatives is encouraging capital markets and financiers to deploy an increasing diversity of financial products to support these goals. Alternative financing options such as green bonds, energy-as-a-service (EaaS), property-assessed clean energy (PACE), and energy savings performance contracts (ESPCs) are gaining traction in commercial real estate.^{10, 11, 12, 13} For example, the commercial PACE market has grown by about 10x since 2015, and Guidehouse estimates that energy-as-a-service will become a $27.2 billion global market by 2029.^14, 15

Many of these specialized financial products are designed not just to provide access to capital, but to shift the complexity of ESG project implementation from the customer to the service provider. Financiers are offering more streamlined and sophisticated services that can support deployment of ESG projects across large building portfolios—in part, a response to the growing demand for decarbonization at scale.

Social Issues

Workforce development, Diversity, Equity, and Inclusion (DEI) initiatives, and the importance of health and wellness in commercial real estate are setting new expectations for building operations and how to engage stakeholders such as tenants, residents, employees, and the communities in which real estate invests. Now more than ever the spotlight is on commercial real estate and its response to the issues that surfaced in 2020. The Urban Land Institute issued a survey earlier this year, and of those who implemented building health and wellness measures (pre-COVID and during COVID), respondents on average implemented 6 out of the 9 Space Layout measures, 5 out of the 7 Occupancy Control measures, and 3 out of the 10 Equipment measures, with over half stating they will keep the Equipment measures in place permanently such as upgrades to HVAC equipment.

Regulation, Compliance, and Policies

But it is the fast-paced changes in the regulatory landscape that will likely drive the most change over the next few years. European Climate Law enshrines the EU’s commitment to reaching climate neutrality by 2050 and the intermediate target of reducing net greenhouse gas emissions by at least 55% by 2030, compared to 1990 levels.¹⁶ There are several regulatory bodies governing ESG initiatives and reporting in Europe, with two of the largest being SFDR and the EU Taxonomy.¹⁷ SFDR introduced new ESG transparency and disclosure requirements, mandating all financial market participants (FMPs) to evaluate and disclose ESG data at entity, service and product level. The purpose of SFDR is to provide a unified ESG disclosure methodology that maintains transparency, inform investors, and prevent greenwashing in the financial market. Likewise, the EU green taxonomy requires financial participants in scope for SFDR to back up claims on environmental characteristics (e.g., ESG or sustainable funds) associated with their products, and report the percentage of their turnover, capital expenditures, and operational expenditures aligned with the EU taxonomy.

In the U.S., President Biden’s decision to re-join the Paris Climate Accord signaled a fundamental shift in the underlying demand from government and capital sources. The Biden White House Executive Order on Climate-Related Financial Risk firmly pushed climate and carbon risks to the forefront of legislative and regulatory agendas.  The Executive Order builds on a recent series of regulatory warnings stating “variability and imprecision of industry ESG definitions and terms can create confusion among investors.”¹⁸ On April 9, 2021, the United States Securities and Exchange Commission (SEC) issued a risk warning cautioning firms that their ESG statements will be more heavily scrutinized. And, earlier this year, Federal Reserve Governor Lael Brainard cautioned firms that fail to “manage climate-related risks could face outsized losses.”

According to the G7 Finance Ministers and Central Bank Governors’ Communique, “We support moving towards mandatory climate-related financial disclosures that provide consistent and decision-useful information for market participants and that are based on the Task Force on Climate-related Financial Disclosures (TCFD) framework, in line with domestic regulatory frameworks.”¹⁹

Globally, government stimulus had reached “$15 trillion and counting” by early May, according to Reuters. And the Carbon Brief identified that the stimuli “range from monetary policy, such as central banks lowering base rates or purchasing loans via “quantitative easing” (QE), through to fiscal policy via government spending to pay peoples’ wages, investment in specific programs or giving loans to distressed companies.”^{20, 21, 22, 23} This further confirms that ESG has reached a tipping point, and now the expertise, creativity, and innovation that the real estate and finance industries are well known for need to be applied to assessing risk and deploying strategies to mitigate those risks while creating value for investors, occupants, and the capital markets that serve them. •

Source: “From Materiality to Risk Mitigation: ESG at A Tipping Point for Real Estate“

Technology once again makes our Top Ten list but under different conditions and with more short-term implications. Constant themes like artificial intelligence (Al), machine learning (ML), the Internet of Things (IoT) and cybersecurity remain part of the landscape.  They have moved from “new” to “how we do things now.” This year the news is not about new tech, but about our acceptance of it. Lockdown-driven changes in our work, in the economy, in social structures and in our personal behavior have pushed our reluctance aside. The acceleration and adoption of technology during the pandemic has impacted everything and real estate is no exception.

The question remains: what will stick? Real estate is long-lived and capital intensive. This article examines lasting and ephemeral change, and what it means for real estate.

How Is This Wave Different?

Change is hard, and technology change is especially so. It’s perceived as painful, expensive and risky. As such, adoption was driven by obvious rewards, like more customers or lower cost, and competitive pressure. The events of 2021 removed many typical hurdles to adoption by creating new pressures—”If I’m not online, I’m out of business” or “If I can’t do curbside, I can’t sell” or “I don’t want to work at home, but the office is closed.”

At the same time, new opportunities arose that led to record-obliterating capital investment. “If we can make online work, we can take over this entire market, forever.” “We never liked handing out menus anyway, and they’ve all got phones. Less printing, faster turnover.”

Behavioral changes such as reduced consumption and more online time forced reluctant users to learn modern tech behaviors like collaborative online work and, in doing things for themselves, resolving tech issues. Even the most office-bound “please start my PowerPoint” users were forced to self-sufficiency, or to a level of skill that permitted online support. Concerns about looking like a clown on a Zoom session led to trainings and visits to “YouTube University” to learn long-avoided techniques.

Big Trends

The result? We’ve adopted more tech in fourteen months than would normally happen in five years.  So, which are the biggest changes?

We’re adopting faster. We’re adopting the same stuff as before, but more rapidly.

• Remote work: We saw a 2.5-3x increase during pandemic and a 2.7x increase in teleconferencing.¹
• Shopping: Amazon profit more than tripled in Q1 2021 over Q1 2020.²
• Productivity Gains: Goods and services production as of May 2021 are at pre-pandemic levels, but with 8.2 million fewer workers.
• Tech Spending: Business spending on equipment rose 16.7% annualized in Q1 2021, double the rate of the overall economy.
• Cloud adoption: In a panic to put quarantined workers back in play, even the most reluctant companies found that the shortest path to work in remote worlds has been cloud migration.

We’re more open-minded and adopting challenging new ideas.

• Cyborg work: Robot/human collaboration as seen in Amazon warehouses, where humans select from robot-stocked bins, and in self-checkout lanes. Amazon plans to add 75,000 more employees (to the 500,000 added since 2019) in fulfillment and logistics, driven in part by the 200,000 robots throughout its warehouses.
• Telemedicine: Patient visits via phone or webcam – 43% of health centers used telemedicine in 2019, compared to 95% during the Pandemic.
• Getting nearly everything delivered: Grocery delivery service Instacart recorded its first monthly profit in April 2020, up from monthly losses of $25 million in 2019. lt also added 300,000 shoppers in the first half of 2020, a threefold increase.
• Do-it-yourself medicine: Emerging test-yourself-at-home technologies for hearing (e.g., Lively) and vision (e.g., Eyeque) reflect new levels of acquiescence.

We care about different stuff. Shutdowns, shortages, interruptions and fear, combined with new opportunities, changes in demand, and changes in employment, have shifted our priorities in a big way.

• Reliability is now sexy: We’ve watched critical systems fail or flounder, including the postal service, the IRS, unemployment systems, the Suez Canal, and on-time delivery for the holidays. In response, corporations are shifting funding toward systems that create resilience and mitigate risk.
• Data visualization is mainstream: Once the darling of the e-suite, real-time graphing with drill-downs, custom filters, and ever-improving analysis, all tied to curated data sources, are relied upon by the general public in its effort to evaluate COVID risk, find vaccination services, and learn which businesses are still open.
• Availability over quality: Retail bankruptcies, restaurant staffing problems, panic buying and shifts in open hours mean that we no longer hold out for the best choice. We’ll take the one that’s in stock right now, thank you. This is reflected in housing prices, in car rental, and even in willingness to buy off-brand toilet paper.
• Let’s put some things out of their misery: The newly trained populace is moving away from time-honored staples like regional malls, toll booths, cash, and sales meetings. Land-line phone use is collapsing under the depth of a robocall flood.
• We’ve learned what we never liked: Waiting in line, waiting in lobbies, getting bad advice from salespeople, all-hands meetings, commuting, and flying everywhere for everything. When they all got scary, we learned how not to do them. And many will never return.
• We do things in the off hours: Eliminating commutes and in-person shopping shifts both work and shopping to different hours. Whole Foods and others hire for 4-6 AM and twilight shifts. Newly cloud-enabled companies depart from standard office hours.   Formerly office-based companies shift to workflow tools and delivery-based management, rather than face-to-face time.

What’s It Mean for the Real Estate Sector?

Lasting impact requires the creation of value. Mere response to a pandemic-driven anomaly is insufficient to make permanent shifts. Value creation will be driven by three things: risk management, generating trust, and increasing utilization.

The pandemic was a stress test, revealing vulnerabilities, appetites, and new and increased risks. We have been awakened to some familiar but nascent areas of importance, namely cybersecurity, supply chain and price instability. None of these are new concepts, but in a span of months if not weeks in some cases, we saw high profile hacks, shortages of resources like microchips, lumber and labor, and rising prices across the board.

• Cybersecurity: The opportunity created by pandemic-driven disruption was not lost on criminals.  Specific to real estate, an analysis of 1,000 sites revealed that 47% of building systems were exposed to the open Internet, 49% had valid user credentials for former staff and contractors, and 81% did not have current backups. This was not pandemic driven, but criminals exploited such weaknesses to drive up the volume of attacks.
• Supply chain: The Suez Canal blockage was the most visible example of a supply chain built for speed and economy, with less resilience than we supposed. Changes in demand for computer chips, rental cars, lumber, metal, and even toilet paper triggered cascading effects in many markets as our inability to respond to these changes was revealed.
• Price instability: Home prices, lumber prices, metal prices, and the labor cost and availability became hard to predict, and they continue to affect the availability of cars, houses, buildings, food and equipment.
• Shutdown containment: Precise, detailed records of who was where, and when, can be the difference between shutting down an entire building, and identifying a small pocket of risk. ISO-certified manufacturers have long been aware of the value of data to minimize the impact of errors. The same applies to controlling infections.

In the absence of personal meetings, hands-on work, and retail browsing, technology has filled the void to create trust in key areas and finding new ways to build trust.

• Environmental and lite safety information: Fearful employees and customers need information from previously invisible systems concerning overall indoor air quality (IAQ), air exchange rates, water quality and safety, building occupancy, cleanliness, and touchless controls. This will further accelerate the IoT as new sensors, systems and analytics will be required to get the data, react manually and with Al, and communicate the data through dashboards, apps and digital signage.
• Productivity measures: Office managers moved to automated systems to measure productivity of offsite employees. Most studies reveal solid productivity so far during the remote work pendulum swing, but with possible reductions in innovation.
• Career management: HR and training teams face concerns from now-remote workers about their paths to promotion absent face time. This is counterbalanced by concerns about safety. Companies rush to adopt tools that measure effectiveness and show a path to promotion from one’s laptop and kitchen table.
• Privacy: Social media exploitation of data, HIPAA and vaccine cards, smart speakers listening and tailoring advertisements, and endless tracking by smartphones and apps have led to a backlash. Meanwhile employers and educators install camera and tracking software to assure that users are really studying or working. This brings on political reactions such as General Data Protection Regulation (GDPR) in the EU and early legislation in Florida which allows citizens to sue social media for censorship.

The accelerated upgrade of connectivity, security, and hosted processes mean that utilization is being maximized and any place is now a potential workplace. This creates new pools of vacancy and pools of availability enabled by technology.

• New vacancy: Permanent assignments for underutilized workplaces were already old-fashioned and will cease to be acceptable. Fifty percent utilization was one thing, but 20% or lower will drive new waves of space assignments and un-assignments. This calls for tech to assign spaces, monitor cleaning, occupancy and life safety, and possibly the utilization of reservation systems for other resources such as parking even in suburban surface lots. Passive monitoring through cameras is replacing check-in systems as a means of identifying safe and available space.
• Newly suitable space: Think of it as part-time adaptive reuse. Emerging online catalogs of available workspaces, such as www.workfrom.com, identify coffee shops, hotel lobbies, restaurants, bars, and coworking spaces with excess capacity, good internet and parking.
• Newly usable retail hours: Whole Foods leads in hiring early-bird and twilight “shoppers” to pick and pack orders as early as 4 AM, before stores unlock their doors. This reduces daytime traffic and increases volume.
• Putting the customer to work: Self-check-out, self-diagnosis, and self-reporting all drive workload and space need to the customer. If a phone app provides the menu, the payment, and status checking, retailers and restaurants can increase customer turnover in the same space.

What Tech Changes Will Persist?

Tech has moved to the front of the line. It now defines competitiveness in all classes of property. Yet not everything we embraced in the pandemic will remain front of mind.

Among changes we expect to endure are the following:

• System controls that permit shutdowns and decommissioning quickly, without damage;
• IoT-based systems that provide real-time information on safety matters to occupants, and not just to facility managers;
• Documented security of building systems, and their ability to withstand hackers, ransomware, and other malfeasance that interrupts operations;
• De-emphasis on investment in sexy features in favor of those that build resilience for occupiers;
• Sensors to identify real-time occupancy and to identify available space without making a reservation;
• Corporate portfolio management that includes non-traditional “you could work here” spaces in hotels, cafes, and other unusual spaces; and
• Demonstrated readiness for the next pandemic.

Pandemic-driven uncertainty is fading; we’re off the diving board and in the water. When we stop panicking, decision drivers change—from survival-based questions to those driven by optimization, by inflection points, and by moments where change can happen. Lease expirations, construction projects, mergers and dispositions will all include an aspect of tech-based pandemic response.

Other articles based on the Top Ten Issues will cover non-tech aspects of the “new normal”—mobility, cultural change, and shifts in how we make, deliver, and consume goods and services. At every shift toward this new normal, the big jump in tech adoption will shape the decision and enable that change. •

Source: “Pushed Off the Diving Board: Accelerated Tech Adoption in the Golden Age of the Late Adopter“

The spike in activity wrought by the COVID-19 pandemic is one example of a misleading indicator.

The exponential growth in e-commerce sales is a “misleading signal” for the industrial market, says Real Capital Analytics’ Jim Costello–and savvy investors should watch out for the inevitable slowdown.

“The thing about exponential trends is that they only match into the future for some time, then everything starts to fall apart,” Costello writes in a recent post.  “Before the pandemic, that sort of breakdown in the pattern of growth for e-commerce activity was already underway… Fundamentally, e-commerce growth should slow at some point to a pace more like that set by disposable personal income as it starts to capture a greater share of total consumer spending. The uncertainty here is exactly when the slowing begins.”

From 2003 to 2016—before e-commerce drove nearly every facet of consumer purchasing behavior—industrial deal volume represented just 15% of investment in the so-called “big four” (office, retail, apartment, and industrial). During that period, Costello maintains, “industrial sector was long viewed as sleepy and slow-moving, and few investors saw exciting opportunities within such a low volatility sector.”  In 2003, less than 2% of all consumer purchasing happened online, but that figure began growing by about 50 basis points per year until 2014, when it began to pick up major steam.

By 2016, investor interest in the sector also began to climb, and by Q1 2021 industrial investment accounted for 26% of all CRE investment activity in the US. RCA’s Costello predicts that e-commerce sales will likely reach 20% market share by 2024.

Another misleading signal: the spike in activity wrought by the COVID-19 pandemic. During the worst part of the pandemic, online sales accounted for 15.7% of all sales, which would have put e-commerce sales at 16% of total by the end of next year, Costello says. Essentially, we’d see two years of growth in e-commerce’s market share in a single quarter.

But “any investor who set their expectations for the industrial sector moving forward based on that one spike is likely to be disappointed,” Costello says, calling the spike a “temporary shock that was “not indicative of the future trend.” He notes that as brick and mortar distribution channels begin their post-COVID bounceback, e-commerce activity has declined to 13.6% share as of the first quarter.

“Make no mistake, there is a lot to like about the industrial sector,” he says. “All of the performance characteristics that made the sector boring in the past are now en vogue. Stable yield with low capex relative to the NOI … what’s not to like? Still, if one is undertaking an investment strategy that will only work if there is continual exponential growth in e-commerce activity, one might be disappointed as that industry matures.”

Source: “Some E-Commerce Drivers For Industrial Are ‘Misleading‘”