Archives for August 2022

Government regulators around the world are increasingly passing laws, rules, and ordinances regarding the performance and disclosure of real estate assets according to environmental, social, and governance (ESG) criteria. These requirements are forcing real estate investors to measure and report – and in some cases publicly disclose – their assets’ energy and water use, waste, carbon emissions, and climate change risks. It is these fast-paced developments in the regulatory landscape that will likely support the adoption of policies and practices toward low-carbon economy change over the next few years.  These requirements are also instigating much innovation in the design, development, and construction of new buildings as well as renovation of existing stock with long lifespans ahead of them.   Regulators are taking this stance because they are being demanded by the marketplace and the next generation of consumers and politicians to address climate change.

In the real estate industry, ESG risk assessment and mitigation initiatives are becoming essential components of real estate investment. In 2021, the U.S. Securities and Exchange Commission (SEC) acknowledged the growing demand by investors for ESG and climate-related disclosures. In March 2021, the SEC launched an ESG Enforcement Task Force to identify material omissions or inaccuracies in issuers’ disclosure of climate risks¹ and in April issued a risk warning to caution investment advisers, registered investment companies, and private funds that their ESG statements will be more heavily scrutinized.²

The SEC proposed sweeping requirements in March 2022 that would require public U.S. companies to begin disclosing greenhouse gas (GHG) emissions and climate-related risks as early as 2024 for calendar year 2023 operations. If adopted, public companies would need to disclose both physical climate-related risks, such as sea level rise, and transition risks, such as increased insurance costs or decreased asset values. For example, if determined to be material real estate investors would be required to provide a list of any properties by zip code with identified physical risks and the percentage of buildings or properties located in flood hazard areas. All effected companies would be required to report Scope 1 and Scope 2 GHG emissions from owned operations and purchased electricity. One of the most controversial proposed requirements include larger portfolios to report material Scope 3 emissions, such as tenant electricity consumption. If not satisfied with the disclosures, investors and the SEC would be able to challenge what a company deems material.³

More extensive requirements are in place and being expanded in Europe and the UK.  The UK government’s Green Finance Strategy set an expectation that all listed issuers  and asset managers will begin reporting emissions and climate risks in alignment with the Task Force on Climate-Related Financial Disclosures (TCFD) by 2022.⁴ On the continent, European Climate Law has codified the EU’s commitment to reaching climate neutrality by 2050 and the intermediate target of reducing net greenhouse gas emissions at least 55% by 2030 compared to 1990 levels.⁵ Two of the largest regulatory bodies governing ESG initiatives and reporting in Europe are the Sustainable Finance Disclosure Regulation (SFDR) and the EU Taxonomy.⁶ SFDR introduced new ESG transparency and disclosure requirements for European financial market participants, mandating that all Financial Market Participants (FMPs) evaluate and disclose ESG data at entity, service, and product level. Likewise, the EU Taxonomy requires financial participants in scope for SFDR to back up claims on environmental characteristics associated with their products, and report the percentage of their turnover, capital expenditures, and operational expenditures aligned with the EU Taxonomy.

In addition, cities and municipalities around the world are implementing local ordinances requiring the benchmarking and reporting of commercial buildings’ energy use, including over 30 cities and four states in the U.S.[7] Several cities have also passed laws mandating GHG emissions reductions from large commercial buildings within their borders, such as New York City’s Local Law 97 and similar laws in Denver, Boston, and Washington D.C. Building owners who do not comply face significant fines in the coming years.

While the “E” in ESG gets the most attention, we must remember that ESG stands for environmental, social, and governance.  Increased stakeholder recognition of the importance of social factors like diversity, as well as health and wellness, in commercial real estate are setting new expectations from investors, employees, and the communities in which real estate operates. Both the SDFR and the SEC have expressed interest in disclosures on social topics, and they may be added to ESG disclosure regulations within the next few years.  The “G,” Governance, comes into play by holding companies accountable for their actions.  ESG is hardly a new concept, and it may be number Ten in this survey, but one could say that it is embedded in or greatly impacts each of the other issues.  Like all the Top Ten Issues, it is very present and will continue to make its mark on the real estate industry.

Source: “ESG Requirements Forcing Change“

Economic prospects have worsened, and the outlook is becoming increasingly uncertain. Numerous headwinds have emerged–rising inflation, persistent labor shortages, continued supply-chain challenges, the war in Ukraine and risks of a Fed policy mistake. The economic outlook for 2022 and 2023 have been revised down sharply and recession risks are rising fast.

View the full presentation provided by Cushman & Wakefield here.

Source: “Where Do U.S. Property Values Go From Here?“

We are in a new era of cybersecurity risks in commercial real estate, driven by decades of technological advances that impact all buildings’ physical and environmental functionality. There are material risks for investors, owners, operators, and occupants. Risks include insurance gaps relating to nation-state attacks and for-profit ransomware, as well as from ill-equipped building managers and contractors.

Insurance carriers and brokers increasingly deny cybersecurity insurance coverage. When you can get a policy, the premiums skyrocket, and there are gaps and exclusions in existing policies. Often, cybersecurity incidents in building control systems are not addressed in property and casualty (P&C), general liability, and cyber riders and can result in litigation as well as the aforementioned exclusionary language emerging notably in P&C. Directors and Officers (D&O) insurance is now rising in importance with some cybersecurity lawsuits against individuals and recent SEC Cybersecurity disclosure proposals.¹

This is not a so-called smart building or Internet of Things (IoT) problem, which continues to add to risks, but rather a 40-year build-up as our main systems (e.g., HVAC, elevator, lighting, access control, parking) have all required computers, networks, and Internet connections since the 1980s. These IT elements are necessary to provide building-wide control between devices and floors as well as remote maintenance and updates. Notwithstanding those multiple decades of technology inundation, there have never been suitable technology or cybersecurity skill sets in the entire CRE value chain from design to development and management. Therefore, the problem is systemic and pervasive throughout the entire industry, which is unfortunately now on full display in a global era of cybersecurity awareness.

More recently, there has been a steadily intensifying cybersecurity theme from state actors such as Russia (publicly) and Iran (in secret documents) and for-profit hackers that all target critical infrastructure in the West. This is not only power plants and dams but also commercial real estate and all non-single-family use types. In one specific instance, Russian malware was recently discovered in REIT HVAC systems only one week after the U.S. government warned of the malware by name and country of origin.² Iranian documents mention specific system and manufacturers of HVAC, lighting, and metering systems when stating their malicious intentions for commercial real estate.³ These real estate targets include corporate office properties, banks, schools, hospitals, public venues, and more. The Boston Children’s Hospital HVAC contractor was ransomed by international hackers and created intense concerns.⁴

Consequences can include life safety issues, equipment replacement, unmitigated access to corporate networks, full-building downtime, and significant brand damage. We are entering the perfect storm from the confluence of decades of tech buildup, lack of skill sets, cultural ignorance, savvy bad actors, and a dependency on commercial real estate as critical infrastructure. This impacts all stakeholders but can be influenced most broadly by investors and owners as their policies and requirements can be mandated downstream to asset managers and property managers for assessments, policy enforcement, and active monitoring.

Source: “Cybersecurity Interruptions“

While once institutional allocations were weighted towards retail and office, they have responded to long-term structural shifts and refocused on industrial, multifamily and data centers.

Institutional investors have shifted with the times and honed in on the sectors that have outperformed the broader commercial real estate market in recent years, with multifamily, industrial and data centers topping the list of investor preference according to the results of the first WMRE Institutional Investor Survey (brought to you by Yardi).

Survey results show that institutions are most likely to prefer investing in multifamily (67 percent) and industrial (47 percent), followed by data centers (36 percent).

“Since the GFC, multifamily and industrial have had tremendous demographic tailwinds, and COVID added after-burners,” says Jeff Adler, vice president, Matrix at Yardi. That sentiment also is reflected in sales data. Multifamily assets represented about 41 percent of all property transactions with $154.6 billion in sales during the first half of 2022, while industrial had the second highest volume at $74.6 billion, according to MSCI Real Assets.

Although office and retail have traditionally been considered part of the four major food groups for institutional investors, both office and retail rated low by respondents at 14 percent and 12 percent, respectively. The general premise driving demand for office was that people needed to go to one central physical location to do work, notes Adler. “COVID blew that apart. We’re still in the early innings of trying to figure out how to put all of that back together, and it’s not going to be the same as it was,” he says.

However, it is noteworthy that within the office world, there are two niches that are absolutely out-performing general office—life sciences and medical office, notes Adler. Life sciences rated favorably among one-third of respondents and medical office at nearly one-fourth. The challenge for institutions is that it can be difficult to access life sciences as it’s a very small segment of the overall office stock. Medical office also is performing well with strong demand drivers due to the baby boomer population that likely will have more demand for medical services as they get older. Although retail rated low in the survey, grocery-anchored centers continue to perform well, while the mall sector is working to reinvent itself and it does show signs of stabilizing, notes Adler.

Views on preferred property types also might reflect the evolution occurring within real estate portfolios. Traditionally, 1.0 executions were overweight in office and retail, whereas 2.0 executions have a greater emphasis on logistics and residential. According to says Bernie McNamara, head of Client Solutions at CBRE Investment Management, the focus for many institutions is currently on 3.0 portfolio strategies that focus on increasing allocations to logistics and residential as well as other growth sectors, such as self-storage and seniors housing.

When asked to select the top three investment vehicles institutional investors are most interested in, survey respondents rated direct investment in multitenant commercial and multifamily real estate assets the highest at 54 percent, followed closely by private equity real estate funds at 49 percent. Private placements with real estate investment managers and public REITs also rated favorably among 27 percent and 25 percent of respondents. Those vehicles least in favor were real estate mutual funds at 8 percent and CMBS at 7 percent.

Institutions typically view funds as an efficient way to get diversified access and exposure to certain sectors and subsectors, and then use direct investments where they have more control as a complement to those fund strategies, notes McNamara. In terms of other formats that are on the rise, more investors are taking an “all of the above” approach that helps them to reach target allocations, he says. For example, that might include deploying capital into public REITs. There also can be both tactical and strategic reasons why investors are embracing different vehicles, such as using public REITs to get access to growth sectors that might be harder to access at scale through direct investment, such as life sciences or SFR, he says.

Source: “Institutions Have Shifted to Multifamily, Industrial and Data Centers in Their Real Estate Allocations“