Assessing Climate Risk: Canadian real estate

THE NEXT DISRUPTION

COVID-19 Offers an Instructive Exercise for Climate Change Upheaval

By Barbara Carss

CANADIAN COMMERCIAL real estate assets are comparatively less exposed to the dire physical threats that extreme weather poses or has already served up in other global regions.

Industry insiders suggest that could make the COVID-19 pandemic an even more instructive trial run for the ancillary risks the sector is likely to face due to climate change. Brewing calamities will bring economic and social upheaval far beyond their meteorological track, and a growing pool of investors is looking for evidence that asset and property managers are prepared to respond.

“2020 was a year that saw ESG (environmental, social, governance) reporting move to centre stage. In the same way that, 15 years ago, discussion around LEED certification really morphed from ‘Should we do it?’ to ‘It’s the new norm’ so, too, will ESG reporting become a permanent component of our industry,” observed Paul Morassutti, Vice Chair, Valuation and Advisory services, with CBRE Canada, during the online release of the firm’s 2021 Market Outlook. “Let’s talk about how climate risk could impact underwriting and even capital flows. Every institutional investor pays very close attention to

the reversionary value and their ability to exit in 10 years, 20 years or 30 years. It [climate risk] will absolutely be on everyone’s radar by then, which means it should probably be on ours now.”

Turning to those institutional investors, MSCI analysis estimates that 6% of the value of the Canada Property Index, or nearly $9.5 billion worth of directly held assets, is vulnerable to the physical forces of climate change or the related stresses of an imperative transition to a lowcarbon economy. Speaking during the virtual results presentation of the index’s 2020 investment returns (see story, page 6), Bryan Reid, Executive Director of Real Estate Research with MSCI, outlined how the index currently scores on two separate risk matrices.

These matrices gauge: the potential for on-site physical damage tied to the occurrence of an extreme climatic event; and the economic costs and regulatory constraints that could come into play to meet emission reduction targets and other required responses to a climate crisis. Results are then combined to tally the total value at risk.

Overall, Canada’s global latitude and roster of inland cities serve it well. Across the entire index of 2,356 assets predominantly dispersed in nine major urban centres, the vast share of value at risk — nearly 5% of the index’s capital value — is attributable to transition factors.

HALIFAX MOST EXPOSED Assets located in Halifax stand out for a higher degree of physical risk, equating to nearly 10% of asset value exposed to the possibility of coastal flooding and/or tropical storms, while Vancouver ranks as the next most vulnerable host city with just less than 5% of value at risk to coastal flooding. In contrast, assets in Toronto are most insulated, with 4.43% of value deemed at risk and less than 0.5% of value at physical risk.

“The physical risk for Canada is pretty low relative to some other countries. When we run other countries through this model, what we tend to see is that increased coastal flooding, fluvial flooding and tropical storm risk are the highest drivers of physical value at risk,” Reid reported. “In terms of extreme heat, the potential temperature rises aren’t as high [in Canada] as in some of the other more southerly locations so the costs associated with cooling buildings is not as high as what we might see in places like Phoenix. In fact, the lower prevalence of extreme cold days [with climate change] is also likely to offset a little bit and reduce the running costs of some of the assets as well.”

Reid characterizes the physical risk analysis as a “high-level snapshot” and notes that additional risks may emerge that will need to be weighed. Morassutti leans to an upside interpretation.

“If you look at any list of the global cities that are most vulnerable to either coastal flooding or warming, you’ll see many familiar places: New York; London; Miami; Boston; Phoenix; Hong Kong; Shanghai; Tokyo; but no Canadian cities,” he reiterated. “That is not to say that we will not be impacted. We will, but the effects of climate change will not be felt evenly. That may result in a recalibration of how global capital views those markets, and that may very well be to the benefit of major Canadian markets.”

However, pointing to other trends outside Canada, Colin Lynch, Head of Global Real Estate Investments with TD Asset Management, reminded investors, owners and managers that transition risks could arise with little advance notice.

“In 2019 and 2020, we’ve seen governments make regulations in reaction to a lot of social pressure around real estate, and that is something that we all have to be cognizant of going forward,” he reflected during a panel discussion on the Canada Property Index investment results.

FOCUS ON TRANSITION ADVISED ESG is steadily gaining traction as a means to steer investors and guide asset and property managers on both physical and transition risks. Also contributing to the panel discussion, Deborah Ng, Head of Responsible Investment and Director, Total Fund Management, with the Ontario Teachers’ Pension Plan Board, maintained that both groups have already successfully subscribed to ESG benchmarking and reporting so the next steps are simply to stretch those applications further.

She identifies net-zero carbon emission as the logical goal post for quantifying transition risks, while urging more contingency planning around physical risks.

“Real estate made a link between sustainability and managing energy and water use very early on because it was a value driver; because it attracted and retained tenants and actually resulted in the ability to command better rents. There is a lot of empirical evidence to support that,” Ng asserted. “The gaps are in thinking about transition — how are properties preparing themselves for potential regulations to be net-zero or potential pressures from tenants so the tenants themselves can achieve their net-zero goals? — and thinking through physical risks and how they impact property, whether that’s flooding or increased heat that’s going to require more HVAC.”

Ontario Teachers’ and its real estate arm, Cadillac Fairview Corporation, use hazard assessment modelling for the latter exercise to derive 10-, 20- and 30-year projections of the gamut of extreme climatic events that could potentially engulf each asset. Meanwhile, Ng warns that investors and property/ asset managers will likely have to respond to regulatory dictates and absorb transition costs sooner still.

“COVID was disruptive for sure, but netzero and the transition to a low-carbon economy is going to be incredibly disruptive for real estate. Looking forward, there needs to be a lot more understanding from real estate managers of embracing technology. How do you harness technologies — smart metering, battery storage, deep lake cooling — to make buildings more sustainable?” she said.

Ng frames ESG as an increasingly critical tool to both support investment decisions and hold asset managers accountable.

“We’ve seen a lot of disclosures — what’s being tracked? what’s being monitored? what’s being targeted? Now, there’s going to be a lot more focus on performance, and how that performance compares relative to peer groups or relative to this low-carbon or net-zero trend mission that is underway,” she submitted.

“Despite the fact that investors are having to deal with a lot of short-term challenges now as a result of COVID, they really haven’t lost any focus on the longterm climate risk. In fact, I’d say that over the last year we’ve even seen increased interest in profiling and understanding climate risk,” Reid concurred. “There isn’t a trade-off between near-term and long-term risks. Risk management is definitely getting a lot more scrutiny across the board.” zz

TECH TO THE RESCUE

As facility managers observed World FM Day on May 12, the predominant topic of conversation in the industry remained the effects and implications of the pandemic. Having spent most of 2020 adapting to changing safety protocols, the implications for facility design, construction, and maintenance are still top-of-mind.

For the most part, repair maintenance activities have carried on throughout all the pivoting, adapting, shutdowns, lockdowns, and “new normals”, having been deemed essential and, therefore, exempt from some of even the strictest lockdown situations across the country. They faced the outbreak directly, with all the modifi cations to safety protocols that involved.

Now, as vaccines roll out and local and regional economies start to emerge from hiding, such companies provide useful examples to look to for reinvented approaches to safety, project delivery, coordination, and customer service.

What has changed? Neil Winters, service manager at Flynn Group of Companies, had a front-row seat to some of those changing processes and their impact on facility management and repair and maintenance services.

“It’s a little different now,” he understates.

Indeed, most companies not involved in food preparation and delivery, handwashing previously received virtually no procedural attention, and soldiering through a cough or cold was a badge of honour. Last year, we all suddenly received refresher training on how to wash our hands,

and it now seems like the phrase “social distancing” has always been with us. Facility management and its associated trades have seen their share of changes.

For repair and maintenance crews at Flynn Group of Companies, interacting with customers has indeed become “a little different”.

“Some of the in-person things changed,” Winters says. “We used to make a point of meeting the customer, shaking hands, giving our business card. It was part of our customer service process. Now there’s access protocols. The only time we go inside the [customer’s] building now is for essential leak investigation. And that only happens after we’ve made contact with the customer over the phone and we’ve decided we really need to get inside to have a look. So we’re asking a lot more questions when the call fi rst comes in, and we’re deciding some of those things before we even arrive.”

Technology to the rescue Years ago, Flynn began developing its own mobile technology to meet the needs of their customers and employees. Founded in 1978, Flynn is now the leading contractor in North America for the total building envelope.

Their suite of apps, built and maintained by an in-house development team, includes a service call request app, and a “coaching” app that pairs experienced tradespeople with rookies during their fi rst months on the job.

“We’ve always pushed communication,” Winters says. “We have the Flynn service app, where you receive the service call, make contact with the customer, document the work, take photos, and sent a report to the customer all from the app.” The original intent was to drive performance and develop people, but during the pandemic, the technology has paid off in new ways.

“All the things we did before that really set us apart, well, now it just looks like common sense. Of course you would send photos from your phone, and of course [the customer] would want to tap to schedule a repair.”

Like many companies with pre-existing processes and technology well-suited to the new reality and customer

www.FlynnCompanies.com

expectations, Flynn has been able to adapt faster and easier.

“These are things that now are going to be expected,” adds Winters.

What’s next Some things from the pre-pandemic world won’t change. “There’s so much for facility managers to worry about. Furniture, fl ooring, HVAC systems, cleaning, to name a few. Honestly, when they call a company like Flynn, they’re doing it because they know we’ve got our safety culture, the right processes in place, and the right trained people.” They can keep their focus on the long-term health of the building.”

Flynn’s Service department tagline, “We have you covered, coast to coast,” refl ects the company’s national coverage and all-hours response capability. This past year, it may also have refl ected a certain peace of mind, as, like many other companies across North America, Flynn was well-equipped to meet a challenge few saw coming.