Monday, October 29, 2007

Market Risk Analysis: Peak Oil and Investment Real Estate

Synopsis & Recommendation

Energy company officials have estimated that global oil production will start to decline in the near to mid term (“peak oil”), if it has not started already. Experts warn that there is a strict correlation between economic growth and oil supply. Properties currently in design and construction will probably be put in service at or near the time when peak oil is expected to occur. Real estate practitioners must incorporate a more thorough assessment of energy availability and pricing within their transaction underwriting as well as think about shifting their development focus to more resilient properties and investment scenarios.

The (Latest) Download on Peak Oil

Check out Biopact's very instructive report on the connection between peak oil and economic decline. Not only have energy company executives largely agreed upon peak oil occurring around 2010-2012, experts stress that the prolonged, permanent decline in global oil production can trigger an economic crisis. Moreover, they believe that we will directly suffer from the energy crisis more quickly and a lot worse than from climate change in the same time frame.
...a new study by Dr Robert L. Hirsh, senior Energy Program Adviser at the Science Applications International Corporation (SAIC) demonstrates the economy-destroying effects of peak oil. His conclusion is that economic growth will decline at a similar rate as oil output, that is, by 2 to 5 percent per year. There is a strict correlation between economic growth and oil supply.
Remember:
A recession is defined as two quarters of negative growth in GDP.
Landlords & Energy Costs Today: "Just Passin' Through" Every real estate practitioner spends a considerable amount of time engrossed in market and economic analysis, to bullet proof their underwriting and make sure that their investments actually perform according to shareholder expectations, if not better. You constantly ask yourself, "what could go wrong?" over the life of your deals. Energy costs have been gradually rising over the past few years and those costs are a key factor in real estate construction, operation and maintenance, not to mention at every point of the business supply chain. So far, the timing and velocity of energy price increases have allowed them to be absorbed by tenants, so investments continue to perform within expectations and we practitioners have not had to radically adjust the structures of our deals or property design and construction. Time for a New Scenario Analysis Because we have been able to pass through any increased energy costs to tenants, investment professionals have not had to grapple with the ways in which a permanent change to energy availability and cost would affect the way they do business. The common underwriting practice is the correlate energy price increases with projected inflation, but I have never seen a deal package that analyzed the potential effects of
  • energy prices increasing significantly above the rate of inflation,
  • tenants broadly resisting further energy cost increases, meaning that the landlord now "eats" further cost increases,
  • widespread reduced petroleum availability, and worse still --
  • all of the above occurring at the same time.
If the two to four year timing of peak oil happens as predicted, then most of the properties under construction right now could be put into service in markets facing energy-related economic shocks a short time later. That means that we all could be working on transactions right now that are doomed to go sideways. Building New Green Buildings Does Not Help Currently, green building is just beginning to be taken seriously within the investment real estate community. However, even though the gross value of green building activities should nearly double to nearly $12 billion in 2007, most of it represents new construction, albeit with greater energy efficiency over that of non-green buildings. Unfortunately, in the context of an energy crisis, the current green buildings in production today still largely rely on petroleum-based energy -- meaning they are "less bad", but are still unfortunately not "good". Very few green buildings being put in service actually run 100% on renewable energy. So even though investment professionals are doing the great work of going green, the property construction and performance standard required to adapt to a peak oil economy is still much more sophisticated than the green buildings we will most likely be living and working in when energy conditions deteriorate. (Re-)Positioning Real Estate Investments for a Peak Oil Economy While no one can foresee how to navigate the market uncertainty coming from the energy crisis predictions, real estate practitioners can start positioning their businesses and portfolios in such a way that they will have better options to improve their outcome when such events occur by:
  • factoring in a larger volatility in energy costs during deal underwriting to account for the growing risk of potentially increased operating expenses.
  • investigating switching as much of your properties' energy sources to renewable energy.
  • focusing on adaptive reuse investment plays and renovating existing properties for higher energy efficiency,
  • obtaining the maximum rating possible, when going for certification on green buildings, and achieving the maximum amount of energy efficiency points possible for that given rating, no matter what,
  • joining forces with those pushing government officials and public utilities for greater overall availability of renewable energy,
  • refocusing their investment dollars on urban properties with a smaller, more compact footprint that reduces the need for vehicle travel by occupants and suppliers
  • starting to think about sustainable markets: when preparing annual investment plans, redefine your target markets to include regions that have a combination of economic base, mass transit infrastructure and progressive policies to facilitate the above.
Photocredit: Flickr/AZRainman

5 comments:

Natal property said...

The industry have great relationship with oil prices,especially the power companies so i am agree with you.

Emerging market property said...

The prices are currently at record high level so investing in real estate is more better then investing in market.

Bucharest property said...

Yes the oil is trading at record high level so i am agree with you to invest at this time in real estate thanks.

Brazil property said...

Hi,

The oil hit a peak high and start to falling which show that it price will down now for a long time,so investing in real estate at this time is better then investing in market.

Property in Natal said...

Hi

I think these points are so effective on real estate market.