Coronavirus, Climate, & Commercial Real Estate – Part 2/2
Co-authored with Adam Crozier, B.Eng. Management
As COVID-19 burns through the world, and the United States is now the country with the largest number of cases, it’s worth looking into the future. This specific crystal ball is focused on commercial real estate, an important sector for clean technology. This is a longer term perspective, not a one year perspective. The projections we make are implications for the next 20 years, not just 2021.
We foresee a softening of new commercial construction, a reduction in cosmetic renovations of existing stock, an increase in renovations focused on improving the net operating income including a strong focus on heat pumps displacing gas furnaces and existing air conditioning and an increased shift to distribution-center business models.
There are 6 million commercial buildings in Canada and the USA alone and buildings are a major sector for climate action.
“Buildings and their construction together account for 36 percent of global energy use and 39 percent of energy-related carbon dioxide emissions annually, according to the United Nations Environment Program.”
There’s been an increased focus on embodied carbon as a wedge that must be addressed in new buildings, but those 6 million commercial buildings that already exist are built with a mix of high- and low-carbon material. The only addressable wedge for that set of buildings is on the energy use side, and a major portion of that is heating and air conditioning. Building construction and renovation will also be impacted by the aftershocks of the coronavirus, so we’ll cover those aspects as well.
Read the first article in this two-part series which dealt with the pertinent political changes pending due to the coronavirus, politics and global action on climate change. This second part deals with the implications for commercial real estate.
Changes To Commercial Real Estate Demand
Office space, retail space, and restaurants around the world are sitting empty now. In the middle of the social distancing, we need to flatten the curve so that our medical resources including health care workers, hospitals, and supplies are not overwhelmed. Epidemiological experts predict that it will be 12-18 months before human-approved vaccines are through trials and made more widely available, and while there are multiple efforts underway to achieve a good vaccine, it’s early days. After the vaccine is created, it will take some time to scale production and more time to get it to sufficient numbers in the population to create herd immunity.
It’s projected that countries will experience regular bumps of relaxed and then more stringent social distancing for at least a couple of years due to the coronavirus. “We need to be prepared to do multiple periods of social distancing,” says Stephen Kissler of Harvard.
For commercial office space, this means that telecommuting as a regular feature of the workforce is here to stay. Organizations with strong histories of hoteling staff in temporary desks as needed, mostly in the technology and consulting world, will consider this business as usual. But other organizations, such as the engineering firm one of the authors previously worked for, have now enabled telecommuting that they chose not to offer in the past, with objections being overcome and remote work being enabled in a couple of weeks.
Almost all meetings have become virtual, with boons for telecommunication services such as Zoom and Skype. Everyone is now enabled with work discussion technology that in many cases they had used only for virtual chats with relatives and friends.
This is here to stay. When social distancing is relaxed, many people and organizations will choose to lean into this rather than return to mass workplaces with all hands on deck. More organizations will shift to hoteling, providing more temporary desks and work carrels for the workers who choose to come into the office on any given day, and fewer desks overall. For the next two years, there will likely be significant periods when this is common practice and enforced to greater and lesser extents.
The expectation that having a head cold and coming to the office is acceptable will diminish. When people are mildly unwell but able to work, they’ll be expected to do it from home more than not. Companies will support this and often enforce it. Their employees will require them too, as will their clients.
Another aspect of this trend is the growth of distance workers with a broader catchment area for competition. If fewer workers are expected to be in the office and are able to work virtually with telepresence, the distance matters less. Other factors will drive workers to a different model of urbanized vs more decentralized labor market, but it’s not the point of this article to assess that shift.
Retail was already in the middle of a two-decade transformation from bricks to clicks. That’s just been accelerated massively. More people are shopping online than ever before, stressing every aspect of the delivery supply chain, at the same time when staffing most of that supply chain has become much more challenging.
It’s much easier to clearly reduce contagion transmission vectors with to-door delivery from controlled distribution centers than the bricks-based retail experience, where any shopper can touch any shelved item. In Tianjin, the authorities ordered more than 10,000 people into quarantine, after they traced one-third of cases in the city to a single department store.
This means that the combination of convenient, door-to-door delivery with lower contagion transmission concerns will increase and persist. Shoppers previously resistant to online shopping are being forced into this model and discovering its convenience. Expectations of in-person shopping experiences are being shattered by required social distancing.
Many retail organizations will not survive shuttering for two months, never mind successive social distancing closures over 18-24 months. Operators will make the decision to get out of the business and not return, shifting their money to growth areas.
For restaurants, a similar model will be seen. In person dining experiences will shift toward more broadly spaced and hence more expensive models. Much of existing restaurant real estate will be empty due to failures of the restaurant businesses during the social distancing process or due to a choice to shift to more profitable business models. More prepared, ready-to-eat food will be delivered, mostly by small electrified vehicles in urban areas.
Net Implications
Over the next few years, we foresee the following major trends in commercial real estate.
First, a softening of new construction. With reduced overall demand comes a reduced demand for new space. This will have benefits for the embodied carbon portion of real estates’ carbon footprint.
Second, a reduction in expensive, large scale renovations of existing real estate in the next few years. The economic downturn will persist, reducing the available cash for renovations, but also, clients and staff will often be more remote, making expensive renovations less justified.
Third, an increase in value-based building interventions, typically based on shifting to lower expense models. In part this is due to the economic downturn, but it’s also due to shifts in price points for natural gas-powered vs electrically powered HVAC solutions such as heat pumps. The economics will increasingly favor heat pumps. The combination of required replacement of capital assets and strongly differentiated operating costs will drive this, even if regulatory streamlining for heat pumps isn’t present.
Fourth, there will be an increase in distribution center-based models. Warehouses can be challenging environments for heat-pump based HVAC solutions as they tend to be poorly insulated and have gaping doors which open and close regularly throughout the operational cycle. But 24/7 distribution centers with their high HVAC costs are centralized, high-volume facilities where energy cost optimization has stronger benefits, increasing the business case. This will drive more rooftop commercial solar, 24/7 heat pump energy transfer and short term heat storage solutions.
The world has changed with the COVID-19 pandemic. Many of the changes will persist and continue long after we have this disease under control. Those changes present opportunities, and most of those opportunities are clearly better met by clean technology options than alternatives.
Adam Crozier and Michael Barnard are working with a team to develop a future-proofed business model for a low-carbon HVAC transformation company focusing on commercial real estate.
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