Virtually every commercial real estate developer and investor is now aware of the impacts of global climate change on almost every aspect of life – changes are occurring in weather patterns, agriculture, flood plains, and are being reflected in supply-chain issues, commodity prices and ultimately the cost of finished goods. While incomes and employment generally rose in 2021, retail prices increased even more. It is clear that we are seeing significant shifts in the U.S. economy, including emerging trends in commercial real estate.
Recent articles debate the merits of (service) returning to offices and what the future workplace will look like. Housing is certainly shifting, as commercial developers enter the single-family build to rent market. Retail and even hospitality will probably never look the same.
Climate change is certainly one of the most complex issues facing us today. Abating greenhouse gasses has becoming more and more of a factor in industrial, energy and even home construction decisions. Many investors are now focusing on Environmental, Social and Corporate Governance issues (ESG) regarding the reduction and elimination of greenhouse gas emissions.
Markets inherently produce equilibrium results that satisfy buyers and sellers. However, unregulated markets may not produce results that satisfy society overall. A classic example in economics describes the dynamics between an upstream polluter and a downstream pollutee. To resolve the “problem” either of two solutions can work: i) for the pollutee to pay the polluter to abate pollution; or ii) for the polluter to pay the pollutee to put up with the toxic waste. In the case of the environment, it’s not possible to “pay” the environment to put up with pollution, so society is developing voluntary and mandated abatement in the form of carbon offset credits. In fact, in some parts of the world, these “carbon offsets” are mandatory.
In 2021, the Federal Reserve Board began requiring lenders to require developers as well as property owners provide documentation to ensure ESG considerations are properly written into their loans. Here’s a long excerpt from their Notes:
Projections of economic activity and the accompanying greenhouse gas emissions have long been an input into climate models that estimate these climate risks. However, since the early work of Nordhaus in the 1970s, a growing body of research also treats economic activity as an output of these models, recognizing the effect that the climate has on economic and financial outcomes. These effects occur through a climate damage function, which reflects deteriorating public health, labor productivity, and agricultural yields, failing public infrastructure, rising mortality rates, and weather-related property destruction among other impacts. Such adverse effects can result in direct financial risks, prompting a reassessment of asset values, changing the cost or availability of credit, or affecting the timing or reliability of cash flows. They can also create risks to economic activity, which can themselves create or amplify financial risks. Economic and financial risks can also amplify one another—for example, weather-related property destruction can lead to bank losses, leading to less lending, leading to reduced investment, and so on.FEDS Notes
Carbon Offset Markets
While the necessary tools and standards needed to assess a property’s “carbon footprint” are still being developed, lenders and builders can make a “best effort” at incorporating environmental sensitivity into their underwriting guidelines and new development plans.
Parts of the U.S. and most of Europe and Canada are have already developed markets to facilitate the trading of carbon offset credits. Our Canadian partner has introduced a tokenized system of monetizing carbon offsets is a unique way to secure major project equity within the capital stack for new or existing projects.
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At Sofia Capital Ventures, we strive to act responsibly in order to help assist our clients to deliver a sustainable tomorrow. Let us know if you would have interest to discuss this way of financing on any of your current, to be acquired, or developed projects. CONTACT US NOW!