Building for Resilience

“He knew too what it was to live through a hurricane with the other people of the island and the bond that the hurricane made between all people who had been through it. He also knew that hurricanes could be so bad that nothing could live through them.” - Ernest Hemingway

With end of summer comes not only the start of the football season (yeah!) but also the start of hurricane season (boo!). While hurricane season is officially June 1 to November 30, the three busiest months are typically August to October.

To paraphrase Monday Night Football, are you ready for some hurricanes?

The National Oceanic Atmospheric Administration predicts an “above-normal 2022 Atlantic hurricane season,” with an expected “14-20 named storms (winds of 39 mph or greater), of which 6-10 could become hurricanes (winds of 74 mph or greater). Of those, 3-5 could become major hurricanes (winds of 111 mph or greater). NOAA provides these ranges with a 70% confidence.”

As climate changes continues its current trajectory, a chain of events will likely occur:

• Average annual temperatures will continue to rise,
• Which will cause glaciers to melt,
• Which will cause ocean levels to rise.

What this means for commercial and residential real estate is lots and lots of damage.

You May Not Believe in Science, but Science Believes in You

NPR recently took models from the National Hurricane Center and conducted simulations on three critical regions – Miami-Dade County region, New York City, and Washington, D.C. Based on these projections, the reports found that “future sea rise alone could expose about 720,000 more people to flooding in the decades to come.”

As the article illustrates, “(w)hen a hurricane makes landfall, winds powerful enough to rip a roof off a house push a wall of water onto shore.” So, considering this effect from hurricanes, NPR’s models had the following results:

• Miami – Real estate development has exploded since the aftermath of Hurricane Andrew. In southern Miami-Dade County, more than 44,000 of 85,000 parcels of land now have structures on them. If a Hurricane Irma-level hurricane hits this region head on now, over a third of this recently developed area would be prone to flooding. Based on models for 2080, close to two-thirds (28,000) of these developments would be exposed.
• New York City – Superstorm Sandy caused widespread damage in and around NYC in 2012. Based on the updated models, NPR’s “analysis found that the number of New Yorkers directly threatened by flooding could more than double from about 207,000 in 2020 to 468,000 in 2080.”
• Washington, D.C. – If a Hurricane Isabel-type event was to hit now, “just 2,100 Washingtonians are likely to be threatened by an Isabel-like storm in 2080, up from 600 people in 2020, due to sea level rise.” This lower impact is due to some resilience that early city planners unexpectedly built. When the Army Corps of Engineers began to dredge the Potomac River, the new riverfront land became parks. Hence, the park system (along with a levee system, and the city being more inland) provides DC a higher degree of storm surge protection compared to New York or Miami.

Who Wants a Dream Home Facing the Desert??

When it comes to real estate development, proximity to water is key. Whether it be on a beach overlooking the Gulf of Mexico or the banks of a flowing river (looking at you, Pedernales), people have always been attracted to the water. Therefore, places like Miami, Charleston, S.C., and Galveston are magnets. And with many Americans fleeing the larger cities after dealing with COVID lockdowns and spikes in crime, and attracted to warmer climates with the enticement of low-interest home loans, having a home with a view can be quite tempting.?

Enter Moral Hazard

As described by Investopedia , the “basic premise behind a moral hazard is that an individual or one party involved in a transaction takes on additional—and often unnecessary—risks that usually affect the other party in the transaction in a negative way.” In the terms of real estate development and insurance, the theory is that developers/owners will build structures in high-risk areas (e.g., condominiums on beaches exposed to hurricanes, homes on rivers exposed to flooding, etc.) because they know that insurance will pay for any potential damages.

As an example, in an article published by the Journal of the NPS Center for Homeland and Defense Security , the authors argue that the National Flood Insurance Program’s (NFIP) design limits “risk reduction and contribute to the rise of a moral hazard. Specifically, NFIP policies that support continued coverage of repetitive loss, use of subsidies to desensitize risk, and failure to adjust for catastrophic losses all impact the sustainability and resilience of the program.”

This means that if the NFIP didn’t exist as the insurer of last resort for flooding, and developers/owners were subject to the market forces of the insurance market, then these high-risk areas prone to flooding would be less likely to be developed. This in turn would reduce the overall financial exposure to these types of events. Furthermore, builders would be incentivized to design and build more resilient structures. Of course, more resilient structures mean higher construction costs.

According to a report issued by the consulting firm McKinsey , “(t)he projected escalation of climate risk, such as the occurrence of more floods and wildfires, may lead to underinsurance—or to no insurance at all. The result, substantial market dislocation will include premium loss, higher rates of self-insurance, and an increased demand for disaster relief from the public sector.”

Speaking of disaster relief from the public sector, Kentucky recently experienced historic flash floods that have left 37 dead (so far), roughly 12,000 homes without power , and hundreds of homes and businesses flooded. And more rainfall is expected. Clearly, we don’t have to wait decades to see the effects of climate change. Events such as these are happening with alarming and increasing frequency.

Did the Third Little Pig Work at FM Global?

Louis Gritzo, vice president and manager of research at FM Global (full disclosure: I worked there for 13 years), recently told Fast Company that “insurance companies are more hesitant to offer large [policies], rates are going up, overall it’s getting tougher and tougher for companies to protect their risk via an insurance policy.”

That’s why Gritzo predicts that firms will be “integrating climate adaptation and resilience into the design of their buildings, from waterproofing to relocating essential equipment to installing wind-resistant roofing to scrapping a risky location and moving somewhere safer.”

This might be why FM Global “will provide a 5% reduction in annual premium to its roughly 1,500 policyholders to spur them to better protect their property against risks including wildfire, floods and hurricanes.”

As the world’s largest commercial property insurance carrier, it’s not surprising to see the firm take this position to help reduce its reserve’s exposure to severe weather. I’m confident other property carriers (both commercial and retail) will be following its lead.

What Happens Next?

Let’s assume you are a real estate developer with plans to build a beautiful beachside condominium between Miami and Ft. Lauderdale. If you have the funds to build the tower yourself, then you are not required to carry property insurance and you can RETAIN the risk yourself. (On his recent podcast, Scott Galloway stated he doesn’t carry property insurance on his rental homes in Florida. His rationale is that he would rather not pay the high insurance premiums and pay for any repairs himself. Jealous much?). Most developers prefer to borrow the funds (since many don’t have a lot of cash, like a certain developer whose home in Boca Raton was raided by the FBI. Too soon?) which is fine, especially when rates are low. However, when you borrow, the banks/investors will require you to buy insurance to TRANSFER the risk to an insurance carrier until the note is paid.

The consensus in the scientific community is that the risks associated with climate change aren’t going away within 30 years (i.e., the term of a typical bank note), so this asset is going to need insurance for quite some time. If the developer hopes to sell this asset eventually, the question is whether to build the beachside condo tower using average (cheaper) materials and techniques or do they build it to be resilient (therefore more expensive), hoping to reduce potential losses in the future?

My strong recommendation is to build for resiliency. Insurance carriers love strong, well-built properties (aka, highly protected risk, or HPR) versus structures more susceptible to perils (think stick-frame apartments, which carriers hate.).

Be the third Little Pig. Build your home out of brick.

Et al....

Review: Balcones Texas Pot Still Bourbon

Ok fans, need to make a full confession. In my last newsletter, I told you I would be heading down to the Hill Country for a long weekend. And that we were getting a fantastic Airbnb with a nice backyard overlooking the Pedernales?River. And that during this trip, each evening I planned to sit outside, listen to the likes of Ray Charles or Stevie Ray Vaughn on my Bluetooth speaker, and sip on some Oregon Spirit Straight Bourbon. Well, I need to set somethings straight for the record:

• We did go to the Hill Country and got a great Airbnb...
• However, it was not on the Pedernales River, but the property backed up to a creek...
• That was unfortunately bone dry (everything is baked down there right now, see above article on climate change) but...
• I did spend my nights listening to the likes of Ray Charles and Stevie Ray Vaughn while I sipped bourbon, but...
• It wasn't Oregon Spirit Straight Bourbon...I killed that bottle before the trip.

Don't worry friends! I went down to the nearest liquor store (adjacent to the nearest HEB, which is FINALLY coming to Dallas/Fort Worth!) and got a new bourbon. This time, I picked up a bottle of Balcones Texas Pot Still Bourbon . Needless to say, I still had a great weekend.

Once Again, A Revolution Started in Texas

For many aficionados of craft/micro beer (like myself), we all know how the mass-produced swill (aka American beer) was dominated by the types of Budweiser, Coors, and Miller with all their watered-down derivates (remember Bud Ice). It was all driven by marketing (remember Bud Bowl commercials during the Super Bowl) and in the end, it all tasted the same.

No originality, no effort...

Then along came Jim Koch with Samuel Adams Boston Lager and the world of American-made beer has never been the same. God Bless you Mr. Koch!

Now think about the world of craft spirits before 2010. In short, it didn't exist. It was then that Balcones (started in Waco, Texas) started selling a whisky called Baby Blue. It went on to win double gold at the San Francisco World Spirits Competition (same as Oregon Spirit Straight Bourbon). The history behind the creation of Balcones is rather colorful (just like my home state of Texas) which was reported by the The New York Times some years ago. Needless to say, like any great artist that reaches the pinnacle of its craft - there is usually some drama involved.

That being said, I bought this bottle of tastiness and went back to my Airbnb in Dripping Springs, listened to Ray Charles and Stevie Ray Vaughn (as well as Kenny Wayne Shepherd and Candy Dulfer), and looked up at the stars each night. Good stuff!

According to the Total Wine website, it has a 3.7 out of 5 stars rating and is available for less than $30. It has traces of "Honey, Pecan, Apple" and is "Light" but "Complex". As far as I'm concerned, it passes my test when sipped neat with a single ice cube. In short, at this price point it's hard to ask for more.

Same Bat Time, Same Bat Channel

With my next newsletter, I will start to share with you my tips and thoughts on some of my favorite travel destinations. As you will soon learn, I've gotten around quite a bit in the past 20 years. In this area, I kinda know what I'm talking about.

If you enjoy what you've read here and you think I might have a clue what I'm talking about, then please reach out to me if you would like me to present to your firm or organization. I have experience talking to professional organizations, trade conferences, as well as universities. I've also appeared in newspaper articles and podcasts. Also, I'm available for birthdays and bar mitzvahs.