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Real Estate

Managers assess Harvey’s aftermath

Full impact won't be known for months; some looking ahead

Hurricane Harvey and its sister storm, Irma — which is threatening the Southeast Coast — are beginning to shine a light on the risk the increased incidence of extreme weather is posing on investments.

The exact toll Harvey will have on investor portfolios — especially in real estate, infrastructure and energy — will not be fully understood for a month or two. Managers are in the process of determining the damage now.

For example, there are more than 1,500 properties with a balance of $19.4 billion in commercial mortgage-backed securities at elevated risk because of the flooding in Texas caused by Harvey, according to an Aug. 30 report by Morningstar Credit Ratings LLC. And close to 5,000 securitized single-borrower, single-family rental properties with a combined value of roughly $832.6 million might be affected by flooding in the Houston area, Morningstar stated Aug. 31.

While Houston is an important city for real estate investors, real estate investment trusts have less than 15% exposure to properties in Houston, said Jeremy Anagnos, ​ chief investment officer, infrastructure, in the Radnor, Pa., office of CBRE Clarion Securities, which manages listed real estate and infrastructure portfolios.

While the human toll has been horrific, Mr. Anagnos said there has been minimal damage to CBRE Clarion Securities' portfolios, he said.

Most of CBRE Clarion Securities' infrastructure investments in the region are related to energy. In some cases, energy companies closed their refining and petrochemical facilities ahead of the storm as a safety precaution, Mr. Anagnos said, and remained shut down for days after the hurricane made landfall. What's more, a change in Texas regulations means utilities in the region will be able to charge ratepayers more quickly for repair costs after the storm. CBRE Clarion Securities executives expect little impact on these utilities' bottom lines in the third and the fourth quarters because of the regulation change.

However, Mr. Anagnos said it is difficult to determine the full impact on CBRE Clarion Securities' energy infrastructure holdings because the storm could have affected areas miles away from Texas and Louisiana, he said.

"The storm may impact a company that sends energy down to the Gulf to be exported because the (ports) have been disrupted," Mr. Anagnos said. "It impacts on the value chain of the energy market."

But even as managers are in the early days of assessing the impact to their own portfolios, some are looking ahead to improvements they can make.

Refocusing

"Unfortunately, it sometimes takes a tragic dislocation like this to refocus infrastructure asset managers, including in the public sector, on the vulnerabilities of the assets under our care," said Eric Belman, partner, infrastructure, in the New York office of alternative investment manager QIC Ltd. "The sheer scale of Hurricane Harvey's impact on the Gulf Coast will challenge both the durability of critical individual infrastructure and energy assets, and the depth of redundancy for key networks and supply chains in the region. There will be crucial lessons learned about enhancing asset and performance protection, holistically addressing system level vulnerabilities, beyond adhering to codes and standards."

Edward Dittmer, senior vice president and head of credit risk services at Morningstar, said that at least in the real estate lending arena, it is difficult to take lessons learned from a "once-in-a-lifetime storm" like Hurricane Harvey.

"Katrina was not only a storm but the lake overflowed its banks," Mr. Dittmer said, referring to the 2005 hurricane that caused severe damage in New Orleans and coastal Louisiana. "There are impacts that you can't predict. Lenders can't underwrite loans based on a once-in-a-lifetime event. There is no way to lend to protect yourself from the next storm."

In the meantime, "real estate investors have to be patient until we get information on what's happening," Mr. Dittmer said. "Right now Houstonians have bigger concerns."

More expected

Even so, some real estate managers expect their portfolios will continue to be affected by an increase in extreme weather incidents like Harvey in part due to the availability of insurance that encourages real estate development.

"The Harvey-Houston flood story fits a pattern that we expect to see more often," said Jacques Gordon, global head of research and strategy in the Chicago office of real estate manager LaSalle Investment Management. "Population and urban development in the U.S. has grown rapidly in low-lying, flood-prone sections of the Atlantic Coast, the Gulf Coast and along other major waterways all across America. … The federal flood insurance program, FEMA guidelines and the willingness of private insurers to underwrite this flood risk have all played a part in this decadeslong situation."

As long as insurance premiums for flood risk are affordable, real estate investors will believe they are protected, Mr. Gordon said. But this misses the fact that insurance premiums in the region are bound to go up, just as they did after Hurricane Katrina, he added.

"LaSalle's secular trend analysis suggests that situations like Houston are going to be more common — unfortunately — as a consequence of coastal urbanization, underinvestment in stormwater infrastructure, and climate change creating more volatile weather patterns," Mr. Gordon said.

LaSalle executives thoroughly evaluate properties in riskier locations such as in flood plains and earthquake zones during the due diligence process in deciding to make an investment.

"Often times if an asset is rated at a high risk level, we may not pursue the acquisition, or it may not even make it to the investment committee stage," said Matt Schuler, LaSalle spokesman.

There is movement afoot, including one spearheaded by the Urban Land Institute, to encourage real estate and infrastructure managers and developers as well as city, county and state officials to take steps to make their assets more resilient to natural disasters, said Billy Grayson, executive director of the ULI's Center for Sustainability and Economic Performance, Washington.

Real estate owners and developers in flood zones are starting to move electrical generators to upper floors or roofs to protect them from floodwater. Use of renewable energy systems — such as solar panels — allows people to shelter in place in buildings because the energy supplies will not depend on trucked-in fuel deliveries, he said.

"Hurricane Harvey is an 800-year occurrence ... This sort of thing is happening with increased frequency," Mr. Grayson said. "From a developers' and asset managers' point of view there are a number of cost-effective things they can do to make their buildings more resilient."

Stormwater management infrastructure can double as an irrigation system and save on water, he said. While these systems wouldn't, on their own, eliminate flooding from massive weather events such as Harvey, they do decrease stormwater runoff by installing rain gardens, bioswales and green roofs, often used together with water storage and recycling equipment such as cisterns. These systems help to soak up the stormwater rather than pouring it into the streets.

Insurance breaks

Some insurance companies are beginning to entertain the idea of giving breaks on premiums or greater coverage for real estate owners that incorporate certain resiliency standards into their projects, he said.

These moves toward more resilient real estate and infrastructure are happening at a time when asset owners are incorporating climate change into their risk assessments for the investment portfolios.

The New York State Common Retirement Fund, Albany, incorporates climate change as an investment risk factor for its $192 billion pension fund, said Matthew Sweeney, spokesman, in an email. The fund has committed more than $5 billion to sustainable investments, according to a March report on environment, social and governance performance. It also expanded its integration of ESG factors, which include climate change, beyond equities to private equity, real estate and other asset classes.

The $330.2 billion California Public Employees' Retirement System, Sacramento, also is active with climate change. Last year, CalPERS adopted a five-year ESG strategic plan calling for engagement with companies to establish a carbon reduction target consistent with the Paris agreement. CalPERS spokeswoman Megan White declined to discuss the impact of Harvey on the pension fund's holdings.