Wildfires. Floods. Heat waves. Hurricanes. Each of these terms evoke a sense of unease at best and panic at worst. Of course, they’re more than just terms. They’re weather events that threaten lives, properties and if you’re in hospitality, the operating budget.
The worst part is these sorts of events aren’t one-off anomalies anymore. They’re regular disruptors that come with a price tag. As climate-related disruptions become more frequent and severe, hotel investors must future-proof their assets.
Today’s strategy doesn’t stop at building sustainably. Instead, the conversation moves into investing wisely, underwriting smarter and planning for the long-term financial impact of environmental risk.
Physical risk isn’t the only threat driving change. New SEC disclosure rules, shifting insurance landscapes and changing buyer expectations are also forcing owners and developers to reconsider how they think about the climate.
Strategy
Brianna Wheeler, director of operations for BREEAM U.S. (the U.S. arm of a global green building certification program), said one of the first steps in future-proofing against climate uncertainty is to evaluate site selection and consider the potential impacts ahead.
“Climate risk is a huge range of scenarios,” she said. “But a big part of that is thinking about that future, what those likelihoods are and building to ensure that the structure can deliver on its design intent through that entire life cycle.”
This forward-looking, future-proofing mindset is beginning to inform more underwriting and investment decisions. It even extends to redevelopment.
“A lot of the vendors that we use for redevelopment have already done a lot of the guesswork with sustainability,” said Will Garson, vice president of investments, analytics and development at MCR Investors.
This has allowed projects to incorporate renewable resources through building materials, FF&E (furniture, fixtures and equipment) and other means, saving investors the headache and manpower of starting from scratch.
“It’s not as cumbersome as the owner trying to figure out how sustainable are the materials we’re installing, because it’s either required by the brand or the subcontractor or contractor themselves are already aware and have selected the materials,” Garson continued.
It seems climate data is creeping up the list in terms of priorities. Some may argue it’s becoming nearly as critical as comps or market reports for institutional investors and developers. Its relevance lately, however, has crept far beyond that. Nowadays, climate data is becoming essential for appraisers and lenders – and even more important for exit-focused investors. After all, the latter must consider the growing liabilities if the property sites in a high-risk zone. There’s more on the line than elevated insurance premiums.
“The companies that are factoring in climate risk are really arming themselves with more information, making safer investments than they would by totally ignoring it,” Wheeler said.
Something else Wheeler argues can’t be ignored is transitional risk.
“We talk about physical risk... but transition risk is over that longer term,” she continued. “What is your buyer going to want? How are you going to position the asset to achieve the exit rate that you’re looking for?”
Increased Focus
In some cases, that positioning may involve more due diligence and an evolving definition of what makes an asset viable – or a deal pencil.
“We’ve seen a lot more upfront cash spend on these third-party reports,” Garson added. “Whether that’s just peace of mind, or having someone find something that you otherwise wouldn’t see.”
MCR recently witnessed a buyer spent $75,000 on a Phase I environmental report for a limited-service hotel in Mississippi. This, Garson notes, was an unusually high spend on a service asset. But the would-be buyer was concerned about a retaining wall. Though the deal ultimately fell through (for unrelated reasons), the example highlights how seriously some investors are taking physical risk today.
“It just goes to show that what's required of their investment committee is now a much more granular approach to things,” he continued. “I think we'll see more of that, especially if transaction volume is down. It allows more time for people to do that.”
And if today’s buyers are taking their time, developers and owners better be using theirs to plan for what happens next.
“The thing we talk about from a development standpoint is, what liabilities are you building in that the next owner is going to get?” Wheeler asked. “When we think about sustainable construction, there’s a limited value in how that's actually designed and the materials built in. It really comes down to whether or not the operations are going to prove that out over time…as the forward investor is going to be asking, ‘what liabilities do we have here?’”
The Cost of Inaction
Some climate risks – typically the headline-grabbing ones – are physical and immediate. Others, however, are structural and slower moving. Take transition risks, for example. Today, items like regulatory shifts and operational liabilities are just as likely to impact a hotel's valuation as a storm on the horizon.
In regions like New York City, owners are beginning to grapple with the financial consequences of holding onto outdated building systems. It’s something Garson is well familiar with via MCR’s Gramercy Park Hotel, which is converting its steam heating system to electric. It may be a prudent decision. With fewer buildings still using steam, the ones that are left foot a bigger share of the bill.
“We’ve converted to electric in the hopes that our bills overall may be sufficiently diminished if we don’t have to rely on this, frankly, dying breed of energy,” he added.
Insurance is also playing a major role in the future viability of certain markets. As premiums rise – or vanish altogether – some owners may find their investment thesis unravelling.
“I’ll challenge the statement of ‘there will always be insurance,’” Wheeler contended. “Insurance is a privilege, not a right. It’s not a utility. Insurers are making business decisions about their risk profile, and their data is pretty good on what that risk profile looks like.”
This often puts entire states like California, Florida and Texas on the chopping block.
Even if coverage is still attainable, it’s not always affordable. Or sufficient.
“I don’t think it’ll be inability to insure,” Garson added. “It’ll just be that the cuts to the bottom line will make [hotel investment in a high-risk climate zone] a less attractive deal. People will always find insurance, but whether it makes economic sense is the question.”
That’s one reason MCR has shifted to a shared-layer insurance program, which spreads its portfolio risk across regions and carriers. Still, Garson acknowledges that this approach requires scale, and that getting cross-complex insurance is much more difficult for geographically concentrated portfolios.
Thankfully, proactivity can ease some of the insurance burden. Those who invest upfront in their building’s resiliency (and document their strategy) are starting to move the needle on the insurance front.
“We are seeing lower increases – or even minimal increases – on that basis,” Wheeler said. “The worst thing that we've seen amongst all our clients globally is, if you say nothing at all, insurers just assume you aren’t really well prepared.”
The trend of proof and transparency extends to lenders, too.
“Most of the banks understand climate risk,” Wheeler continued. “They’ve been asked to stress test their loan portfolios against them…even though there is no regulatory mandate. The thing about climate risk is that you can’t unsee it.”
That’s where sustainability efforts are becoming a smart business advantage. Wheeler notes that many of BREEAM’s clients use their certification “to underpin revolving lines of credit…or to access cheaper capital,” particularly as lenders look for signs of resilience.
“It’s not something that’s published,” she notes. “So, right now, there is a real incentive to act before everyone else – to get that actual bump that you need.”
But the bigger question may be what happens next.
“The longer-term investors who are using these time horizons tend to see the risk sooner,” Wheeler said. “The shorter the hold period, the more it’s like a game of hot potato. Who’s going to get left with the terrible whole asset?”
For now, the market still allows room to maneuver. But the cost of inaction – on insurance, financing, operations and exit value – is mounting.
“You have to look at those plans, particularly now, as the assumptions might be changing underneath,” she added.
This article originally appeared on our sister site Hospitality Investor.