In this episode, Neal Bawa presents how climate change could greatly affect the real estate space.
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Joe Fairless: Welcome to another special episode of The Best Real Estate Investing Advice Ever Show where we are sharing the top sessions from the Best Ever Conference 2021. This year, the Best Ever Conference is back in person, February 24th through 26th. Come join us in Denver, Colorado. You’ll hear all the new keynote speakers, you’ll meet some new business partners, you’ll learn some insights from the presentations and from the people you meet, that you can apply to your business today. Here is an example of a session from last year that is still relevant today and will be beneficial for you.
Neal Bawa: You’ve heard about climate change. Maybe you’re a believer in its destructive impact or maybe you don’t believe in it. In fact, there’s anecdotal evidence that over 50% of the real estate community in the US doesn’t believe that the climate is changing. Or maybe they think that the climate is changing but that humans have nothing to do with the change, or they reckon that climate change has nothing to do with real estate. After all, if it doesn’t affect our daily real estate hustle, then maybe it’s not worth worrying about. Right? Well, unfortunately, wrong, completely, unequivocally wrong. In this 18-minute talk, I’m going to prove to you beyond any shadow of a doubt that if you’re buying apartments, your livelihood and your investors’ profits are going to be impacted by climate change.
When I use that word “impacted”, I am sugarcoating it bigly. I am going to make the case that in fact, the impact on real estate is the greatest of any industry in the world. So get out your pain meds because this one’s not going to be a walk in the park, unfortunately. Now, I’m not going to waste your time arguing that climate change is real, or that we should be doing more to stop climate change from happening, or that it represents an existential threat to humanity. No, sir. I am going to show you why you absolutely need to worry, regardless of your beliefs, about climate change. Alright, let’s get started.
Our story starts with a credit rating and risk analysis company named Moody’s. Now, many of you remember that this particular company was partially to blame for the 2008 real estate crisis. Remember, Moody’s gave A ratings to mortgage-backed securities that were filled with toxic single-family loans that were in default. That crashed the real estate market, it kick-started the Great Recession. As you can imagine, Moody’s was then beaten black and blue by Wall Street for doing such a horrific job of rating the mortgages. So the big dude at Moody’s said “Never again, never again will we be caught with our pants down like this.” So what did they do? They revamped their credit rating system. To do that, they started looking at future risks to investors. When they did that, their research told them that everyone was ignoring the biggest risk to real estate investors, the impact of climate change.
Moody’s research indicated that only one company in the US knew how to evaluate the impact of destructive climate change on real estate, a little-known company named Four Twenty Seven. This company was already working with the world’s largest investors, asset managers, commercial banks, and government agencies, people whose job it is to look 10 years into the future. So Moody’s went out, they bought this company Four Twenty Seven, and they started learning more about climate risk to real estate and also other types of businesses. And what they discovered was absolutely mind-boggling.
Four Twenty Seven was tracking extreme climate events in the US, stuff on the screen like flooding, extreme heat, wildfires, droughts, hurricanes, typhoons, tidal flooding. They started tracking the losses from each of these different events, and they looked at the dollar numbers. And they were massive, people; over $80 billion a year lost.
They started reading headlines like some of the headlines on the page and investigating if anyone in the US was paying attention. No one, absolutely no one was. Unless people were talking about these rapidly skyrocketing losses, then we’re talking about the real estate market crash in 2006. In the gray box on the page, you can see that one lone CEO, Chris Hartswan, is talking about how assets in the US are priced in it completely irresponsible way given what we know about climate change. So Moody’s said, “We have to fix this or investors are going to lose trillions of dollars.” So they took the six-step Four Twenty Seven models shown on the left, and they started applying them to the United States for all kinds of real estate. The results were, again, stunning. As you can see from the page, 104 million people with hurricane risk, 169 million people living in areas running out of water, 92 million living in areas that are facing either extreme heat or extreme rainfall. And as they track these disasters, they realize that these disasters were like the Coronavirus in one key respect – they were on an exponential growth path.
Remember how the US had 20 Coronavirus cases in early March and two months later we had millions. Exponential curve. These events were on a very strong exponential curve, so they started extrapolating, figuring out the risk into the future five, 10, 15 years, so they could rate real estate risks in all of these areas. As you can see from the comment at the bottom of the screen, Miami Dade County has already lost nearly half a billion dollars in value in a 10-year time because of reduced real estate values. But look at the future projection of value on the page – not half a billion, not one billion, but 35-billion-dollar decline in real estate value. And South-East Florida is just one example.
Neal Bawa: We all remember when Hurricane Sandy smashed into New York, turning the New York Public Library into a large swimming pool, turning Wall Street into a waterpark. We’ve chosen to forget the colossal damage of 65 billion dollars from just that one little hurricane. Try to remember pictures of Manhattan with submerged cars and overturned trucks, no power, no heat for weeks, for millions of people. New York is now moving forward to building a seawall that will cost about 200 billion dollars. We hear that they plan to raise that money by massively increasing taxes on New Yorkers, including massive increases in property taxes. How’s that going to affect your investments in New York or Miami when massive tax hikes are used to build these sea walls?
Or maybe instead of jogging your memory about what happened in New York, maybe you just want to read in any newspaper or online site in America today. Texans are dying because of a record cold snap where parts of Texas had zero degrees Fahrenheit. Millions are without power and gas. The governor says that every single source of power in the most power-rich state in the US is compromised because of climate change. A Texan is dying every hour from freezing cold in what used to be one of the warmest states in the country. Republican politicians are screaming about reforming Texas’s power grid to bring it into the 21st century. The cost? Tens of billions of dollars. Where will that money come from? Well, there’s no state income tax, so it’s likely that the money will come from property taxes, which are already one of the highest in the countries. Well, how will that affect your Texas investments, I wonder?
And then there’s California. Boy, California, California, California… Earlier this year –I live in California by the way– I felt like Elon Musk had transported me to Mars or to some dystopian future. The sky was deep red, there was thick gray ash falling everywhere, every door was shut, and not because of COVID, but because a significant portion of the entire state was on fire. In fact, in California, the six largest wildfires in history were all in 2020. Imagine the top six quarterbacks of all time – Brady, Manning, Montana Favre, Elway – all breaking their throwing records in the same year. How ridiculously bizarre would that be? Well, only about as bizarre as California’s wildfire season in 2020. Do you get my point? 10,000 homes and commercial buildings burned down, tens of billions in losses in it, and inevitably, huge insurance hikes. By one conservative estimate, the wildfires will double again from their 2020 level in just five years, and could quadruple in just 11 years. I wonder what the impact to California’s cap rates would be when it quadruples.
And it’s not just the damage from the wildfires. California, Oregon, Washington, they’re the three states that have the largest number of ski resorts at risk. Ski resorts have super expensive real estate. But imagine that you’re an investor in real estate in a West Coast ski resort, let’s say Soda Springs in California. And you start noticing that the ski season starts a day later on average each year and ends a day earlier on average each year. So you get curious and you start researching future predictions about Soda Springs, California. And you discover, to your shock, that projection shows that Soda Springs won’t even be a ski resort in the future. And while that’s going to take decades, within the next 10 to 15 years, the ski season would become so short, that ski operators could not make money; they’d be forced to shut shop. Would you then think today about moving your investments somewhere else? And if everyone did it, wouldn’t some of those fancy ski resorts look like abandoned mining towns in 10 to 20 years? Think about it.
But hey, Neal, these impacts are years in the future. Five years, 10 years away, who gives a s**t? We will worry about it 10 years from now, right? Well, wrong again. Because of Moody’s, these guys started to plug their future projections of climate-related losses into their ratings in the last few years and built risk scorecards like the one on the screen. When they did that, the insurance industry started to wake up and smell the risk. The insurance industry started to hike insurance premiums left and right. Insurance was going up 10% every year, 2018, 2019, 2020, 10%, 10%, 10%. Then the apartment industry took notice; they started screaming at insurance companies crying foul. This huge hue and cry have started to force these insurance industries to move away from a one-size-fits-all insurance model.
More and more insurers are now saying, “Look, if Miami is going to get flooded every year, we can’t penalize Oklahoma apartments. If Northern California is going to be on fire every year, should San Diego be paying so much more than insurance? It’s not fair.” So guess what’s happening? Insurance companies have now started to buy climate change data from Moody’s, and are developing city by city and state by state models for insurance based on climate risk. We’re moving towards a future very quickly where insurance in Miami, a city very high in risk ratings, could easily be 10 times the insurance in Austin, a city that’s rated very low in climate risk. This information alone should convince you that you as a syndicator, you as a holder of people’s money, you as an investor, you have to learn more about climate change risk. But I’m just getting started.
Neal Bawa: Massive insurance hikes are really bad for business, we know that. But you know what’s worse? City downgrades. Moody’s and S&P Global are using climate risk to downgrade entire cities. We haven’t seen any states downgraded yet, but Florida and California better watch out. On the slide, you can see that a city as big as New Orleans was downgraded from a medium grade BBB+ down to a B, which in Moody’s words is considered speculative, subject to high credit risk.
So what happens when a city gets downgraded because of climate risk? Well, the city’s ability to borrow money goes down, borrowers are skittish, they charge much higher interest rates. This prevents the city from rebuilding infrastructure after a major climate change event. That makes people in the city leave, which creates a destructive spiral from which the city may never recover. And if you, Mr. Investor, were investing in a city like this – well, you may never recover.
Do you know what is much worse than city downgrades? An end to the 30-year mortgage. Take a look at the New York Times headline on the right side of the page. Now the 30-year residential mortgage, it’s an American institution. Americans have come to believe that the 30-year mortgage is our right, like it’s something that Jefferson actually wrote into the Constitution. Well, the ugly truth is that the only reason that the 30-year mortgage actually even exists is that lenders believe that the homes being financed will be worth more 30 years from today. So what happens if the lenders start losing that belief? Well, it would be disastrous. If lenders felt that 30 years from today half a million homes in the US will be flooded each year, would they actually provide a 30-year loan? Would they provide a loan to ski resorts with no snowpack in 30 years? Would they do it for cities that are projected to be hit by category five hurricanes every other year, 30 years from now? Step back and think about it. What bank would be crazy enough to offer a 30-year loan on a property that is almost guaranteed to be unlivable in 30 years?
So right now, today, in virtual conferences around the United States, members of mortgage banking associations are huddled around their iPads and making lists of cities that will switch to 20-year mortgages or even 15-year mortgages. Imagine the catastrophic impact to home prices in those cities. The residents are already battered by ever-larger climate change tragedies every year, and now their homes are falling in value. Would they be inclined to move to areas that have no climate change impact? And wouldn’t those areas become the new multi-decade American Gold Rush? Think about it. There are worse things happening than city-level downgrades, like increasing cap rates. Let’s be honest, people like you and me, we don’t set cap rates anywhere in the US. The people that set cap rates are the ones with the gigantic multi-billion-dollar portfolios, the big movers and shakers like BlackRock, the largest asset manager in the world. $24 billion real estate portfolio that they’re doubling over the next five years.
BlackRock is openly saying, openly saying, that climate risk is now central to its asset selection process, its entire strategy. They’re not just saying that about their $24 billion real estate portfolio, they’re saying that about their $7 trillion overall portfolio, 7000 billion. And when they’re applying climate change risk, it’s forcing BlackRock to slow down, or even stop investing in areas with high climate change risk. But they’re not stopping there; BlackRock is using its massive political influence to force state and local governments to take action against climate change. When they see cities and states not doing anything, they’re voting against them with their wallet, their 7000-billion-dollar wallet. This is creating winners and losers at a scale where we could see certain states and cities go up half a cap over the next 15 years, and others go down half a cap. We all know that those are absolutely gigantic, humongous numbers, right?
And before you start clogging the chat here with comments, “This is all in the future, Neal,” let me bring up one of my scariest slides. If you thought that climate change has not already forced the market to offer discounts, you’ll be wrong. Again, parts of major cities like Miami, San Francisco, Boston, New York, Tampa, are today seeing discounts of 7% for properties with just sea-level rise exposure, forget about hurricanes. Remember that this discount was 0% 10 years ago. It’s entirely reasonable to speculate that this discount is going to go from 7% to 15% within the next five to seven years. A 15% discount is the difference between a winning deal and a money-losing deal.
So let me summarize this… You now know that simply because you don’t believe in climate change, it doesn’t matter, it’s going to hurt you. This is a train that has now finally left the station. Because the people who set ratings, like Moody’s, and the people who set cap rates, like BlackRock, they believe it. So do the lenders who are figuring out whether the 30-year mortgage needs to go in certain parts of the US.
Insurance providers are factoring in climate change and are increasingly punishing investors who invest in high climate risk areas. Cities have figured out they need to fight climate change with sea walls, dams, and new power stations, and they’re going to charge real estate investors for those investments. The bottom line, this is a huge deal. It’s as big a deal as the Coronavirus but worse because the impact lasts the next 10 decades, and every year the impact is higher than the year before. What can you do? Well, arm yourself with knowledge. I offer no immediate solutions, this is just the beginning. I suggest that you sign up at my website, which is multifamilyu.com, and you’ll get an invite in the next month to a two-part deep dive climate change series. I’m going to tell you which cities are going to see a gold rush like the likes of which we have never seen before and which ones will have an exodus. I’ll give you tips on new opportunities and even new business models that are emerging from this crisis. Most importantly, I’m going to give you tips on how you can navigate this crisis safely for your properties and come out looking like a hero or a prophet.
Joe Fairless: Well, I hope you gained some useful insights and actionable advice from this previous Best Ever Conference session. Remember, if you’re looking to scale your investing in 2022, we look forward to seeing you in Denver. Get 15% off right now with code BEC15 at besteverconference.com. That is code BEC15 for 15% off at besteverconference.com.
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