Sharing, Climate and Regulation
Even respondents who agree on the significance of certain secular trends can find themselves disputing their impact. Any given development can have both positive and negative influences on real estate portfolios. Sources of disruption can intersect, overlap, and amplify each other depending on context. In order to make some sense of the myriad forces at work on their investments, we asked survey participants to comment on how they view the net effect (i.e., “pros” less the “cons”) of the trends on their activities.
Many fund managers are neutral on the rise of the sharing economy, and even those viewing it positively are more likely to see an opportunity for cost-effective modifications rather than a source of industry disruption. The elephant in the room—WeWork—was ultimately not as innovative as once thought, and low barriers to entry meant similar models could easily be adopted seamlessly into the offerings of competitors. Any market with a steady supply of entrepreneurs and small businesses is likely to support some level of co-working properties going forward.
On the residential side, some existing developments are being updated to accommodate residents with a high tolerance for shared spaces and a willingness to embrace shared services. A longtime developer in the multifamily sector, Lubeck thinks “sharing” is unlikely to revolutionize the status quo, ranking its impact at three on a scale of one to 10. Nevertheless, he points out that his firm’s properties will offer “bigger and more robust business centers for people who work from home.” They also provide conference rooms and co-working spaces that can be leased on an hourly, daily, weekly or monthly basis.
Airbnb’s impact on the hotel market is perhaps the most outright “disruptive” example of the sharing economy’s impact on a segment of the industry. According to Gerstenlauer, her firm has long avoided hotel projects for this very reason. She goes on to point out that not all locations are equally vulnerable. Hotels next to airports or business parks are much less likely to face pressure from Airbnb, VRBO and other home-sharing alternatives.
Others point out that sharing has its limits. A youthful preference for collaborative cohabitation may prove to be temporary, and a reversion to previous patterns may ultimately prove co-living to be a fad rather than a trend.
Vasquez notes that “Uber and Lyft and Spotify and Netflix and all the sharing economy darlings are great, but once people have kids, a detached home with a little breathing room is still going to be a natural thing to want, which is why we are betting on the future of residential land.” An interviewee at a large sovereign wealth fund warns that “as millennials begin to have partners and settle down, I think there will be less demand for things like communal areas and shared spaces that meet the demand for social interaction. Certain spins on the sharing model might work as people ‘graduate’ from student accommodations to adulthood, but long term I do not think you’re going to see married couples wanting to use this model.”
Climate change tops the list of potential threats. Fund managers are especially likely to consider it a net threat, and much of their attention is focused on coastal areas that are vulnerable to rising sea levels. Lubeck stated that his firm is “very cautious about coastal investments and we don’t do waterfront investments at all, mostly due to insurance.” Pat Jackson of Sabal Capital underscores the potential threat to real estate investments when he says, “You better start thinking about that ‘thousand-year flood’ happening twice in 10 years. Natural disasters that might have been historically rare are becoming regular due to climate conditions. We think about that every time we evaluate a portfolio or single investment.” The recent discovery of faster-than-expected glacial melting in Antarctica8 underscores the fact that this is no longer a hypothetical problem, but a very real challenge for millions of vulnerable property owners from New York to Shanghai.
Investors are more convinced that climate change will ultimately present a net opportunity, but much of their optimism hinges on enhancing properties rather than countering global challenges. Equipping new or renovated properties with environmentally friendly materials and technologies, for example, is one way developers can enhance the value proposition for owners or renters concerned about climate change. Lubeck points out that they “try to be as sustainable and innovative as possible when it comes to water saving, energy saving and the like.” Sound Mark Partners financed the first “passive house” residential project in the Northeast. Located in Hoboken, it is an ultraefficient building with very low requirements for heating or cooling, not only lowering costs for its residents but also contributing to a reduced carbon footprint.
There may even be an opportunity to address two challenges in one fell swoop. Vasquez observes that “climate change and housing affordability are not disconnected. You can mitigate both issues through greater density of housing in less vulnerable areas.”
The full effect of climate change is impossible to predict, but it will inevitably extend far beyond obvious effects such as coastal flooding. In light of this uncertainty, some investors are looking to their managers to help them formulate thoughtful long-term strategies. Vignesh Vijayakumar, of Miras Investments, a large Oman-based family office which has been building a program to invest in real estate managers over the past several years, illustrates this approach by highlighting the recent trend in Europe toward ‘flight shaming.’ This, he says, has produced more “emphasis on overnight train travel. If that continues, there’s going to be projects developed to serve that, but also potential ramifications for the aviation industry should it come under pressure. That would very likely impact hotels and other buildings around airports. These are difficult things to consider because people’s attitudes about these things are constantly changing. But everywhere there is more awareness about climate change and the impact of carbon footprint. As investors, the only thing you can really do is select the best fund managers who are able to take long-term views on these decisions and sit with them through a range of investment cycles.”
Incentives and tax breaks can sweeten certain deals, but regulation is widely seen as a threat to the industry. Lubeck neatly summarizes the attitude of many others in the industry when he says, “I think generally the regulatory environment tends to have rules of unintended consequences. The fewer government regulations there are the better.” Gerstenlauer expands on this by saying, “We’ve seen regulations that are promoted as favorable to renters reduce landlord’s willingness to make the investment necessary to upgrade the existing housing stock. This impacts everything from residents’ comfort to the energy efficiency of buildings.” Rent control, in some cases, can lead to properties not being properly maintained or updated in areas like cities in California such as Berkeley or Santa Monica.
Others echo this sentiment, pointing out that unintended consequences can be undesirable not only for real estate investors but also society as a whole. Rent controls are prime examples of good intentions sometimes causing harm, with artificially low rents choking the supply of housing and ultimately exacerbating the affordability crisis.
The emotional appeal of rent controls is understandable, especially in areas hardest hit by the lack of affordable housing. Nevertheless, initiatives like California’s recent foray into statewide rent control can have immediate and severe repercussions. Acutely aware of future constraints, many landlords chose to impose significant rent hikes before the law was implemented.
Vasquez thinks other types of government regulations also reduce affordable housing indirectly. “Restrictions on housing density have to go,” he says. “Politics are actually a place where the so-called ‘greedy’ developers complaining about excessive restrictions and the progressives protesting the lack of affordable housing might join forces. Current ‘below market rate’ quotas on new developments make many urban projects unprofitable. Removing height and density restrictions, thereby allowing more housing units to come on the market, would do much more to alleviate the affordable housing crisis.”
The relationship need not be adversarial. Vasquez goes on to say: “We work with the government. We’ll tell the local authorities that instead of 500 luxury homes, we’ll put in 1,000 attainable homes, including homes for active adults and first-time homeowners. We’ll put in a parking lot and a playground. Now the city is generating fees from the developer and getting property taxes from the new residents.”Read next section
8 Shola Lawal, “Temperatures at a Florida-Size Glacier in Antarctica Alarm Scientists,” New York Times, January 29, 2020.
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