Bryan Koop: That's the telltale, to me, is going to be the insurance. If you can't get that in a mortgage, that's going to turn things upside down in a big way.

Arthur Segel: I tell my students that developers in Miami are building like there's no tomorrow, right now. And they're correct, there is no tomorrow.

David Abel: I'm David Abel, and this is Climate Rising, a podcast from Harvard Business School. From Miami Beach to Boston, relentless pace of development along our coasts has left many of our cities increasingly vulnerable to rising sea levels. A report this year by the First Street Foundation estimated that property value losses from coastal flooding amounted to nearly $16 billion dollars in 17 States between 2005 and 2017.

The real estate industry, however, will have to grapple with more than rising seas. Financing of homes and commercial buildings will become more difficult in many of our coastal cities, as banks become more stringent about the terms of their loans. Development will likely face a host of new, potentially expensive regulations about how to build and where they can build. And much of the existing real estate will have to be retrofitted to reduce the amount of emissions they produce. Joining us to discuss the climate challenges confronting the real estate industry are Arthur Segel, a real estate magnate and Professor of Management at Harvard Business School; and Bryan Koop, an Executive Vice President of Boston Properties, one of the largest commercial real estate development companies in the country, with a portfolio of nearly 50 million square feet of property.

I started by asking Koop whether rising seas and other climate concerns play an increasing role in whether his company decides to back a project.

Bryan Koop: We have a strategy of longterm ownership, and with that comes an advantage to think forward in the future, but it gives you an advantage to be able to look at risk for the future. And it's a perfect alignment for the ability to forecast this, versus our industry where the average length of ownership in Boston right now, for commercial office buildings, is something like 47 months. That's a very short period of time. So, when you have an ownership perspective, a longterm, it really comes into all your decision making, whether it's operating, developing, or acquiring.

David Abel: What can be done to promote designs and planning that can stand for the longterm, that can withstand the impacts of the onslaught of changes that we're expecting as we see warmer temperatures and rising seas?

Bryan Koop: This isn't true of every city, but certainly in the city of Boston. We're lucky to have a mayor who's focused on this and put together a climate action plan. But I also think that the marketplace is starting to recognize this, whether it's investors that are coming along with developers like ourselves... I'll give you a great example, it's Norges out of Norway. Very, very focused on climate resiliency and sustainability. It's a thesis of their investment in every investment they make. We talk about these things with them constantly. But it's also our clients, our clients are starting to focus on it as well. I wouldn't say in huge numbers yet. We're in the early innings, but the clients are starting to go there, which is your ultimate customer, the tenants in the building. There's a friend of mine, Spencer Glendon, who I think is just the foremost climate economist, and he's a senior fellow at Woods Hole.

Bryan Koop: He has really enlightened me a lot on focusing on what's going to happen in insurance, because that's the telltale sign of all investment for real estate. And he has a great phrase, which he says, "If it happens once every 100 years, it's insurable. If it happens twice every 50 years, it's expensive, but insurable. If it happens once every 20 years, it's called equity." Meaning you're not going to be able to insure it. And if you can't insure, you're not going to be able to get that and therefore everything that... The value system will change drastically. So, that's an area that I'm focused on in, for the future of how does this correct, and maybe it'll be self-correcting because of events and you won't be able to flip.

David Abel: If you, Arthur Segal, could wave a magic wand to easily overcome the powerful influence of interest groups that might oppose climate related regulations, what do you think government should be doing? What regulations are needed, on a local state or national level, that might reduce the increased risks of increased flooding and other natural disasters?

Arthur Segel: That's a big question. I think over time, the government has to step back from providing flood insurance and catastrophes. I think building codes here and tenants are increasingly requiring lead standards, which may not be perfect, but they're a good step and investors can be saying the same. I think building codes have to be rewritten to think about climate change increasingly and energy reduction. So, we can be requiring that roofs be made of a certain material, that sensors be put in buildings... which only in the last few years, can we use these sensors and big data to actually see what's happening for the first time.

Bryan Koop: Well, I'm a bit biased, of course with Boston, in saying that I think we're taking a leadership role versus other cities in the country. And the fact that we're coming up with plans for resiliency along the waterfront and they're very active and we're coming up with standards, I think it's a first step. We can come up with a bit of incentive to do the right thing and still get the right thing done, whether it's resiliency along the waterfront with higher barriers, or whether it's carbon footprint reduction in terms of what you're doing. We see it also in terms of the marketplace. So, we've reduced our carbon index over the last decade, or for intensity, by 78%. And not only is that... call it the right moral thing to do, it's the smart thing to do financially and running these buildings, but you're also rewarded by your customers.

So I think it's two parts. We are starting to see the reward for the customer. And if you look at our buildings that are LEED certified gold or higher, we always are a hundred percent, 90%, full with really premium rental rates. So, the marketplace is starting to recognize it. A lot of people in the industry will say, well that's not true, but I'll give you a great quote by one of our customers. They were asked at an association to tenants, "Would you pay more for a LEED certified building?" And a gentleman raised his hand and said, "That isn't the question. What's the discount for not being LEED certified?" I think that it is being recognized by our client base.

David Abel: How much more, though?

Bryan Koop: We're seeing as much as 15% more.

David Abel: In Massachusetts, the governor here recently proposed a real estate transfer tax that would charge owners of properties over a certain amount for a sale, and the fees from that would go toward paying for mitigation or adaptation to deal with changes from climate change. My question is, do you think that is a good idea, or do you think that we should be imposing a carbon tax, or some other kind of specific policy that would help promote sustainable development?

Arthur Segel: My bias would be to have a carbon tax, but also to put more into mass transit. Big time. Much more than we've thought about. I would support some sort of a gas tax, or maybe this tax makes sense, a transfer tax, but I also would do other things at the federal level on the taxes and I'd probably get rid of the capital gains tax at this point.

Bryan Koop: This isn't related to climate resiliency, but still under sustainability. We're working hard to decouple from our call it brown energy sources to more green energy sources. And where we've had incentive to do so, we've really taken advantage of it. We crossed the threshold of something like one million kilowatt hours that we're producing for our projects. I think we're one of the largest producers of green energy now in Massachusetts with just solar panel installations. So, we certainly have taken advantage of the incentives that go along with that, but also our partnership with Eversource where we are working with them yearly on MLUs and all kinds of strategic goals that we're not going off each year that have tremendous bottom line effects. But that's taking advantage of incentives that have been put in place by government. It always surprises me how our industry doesn't take as much advantage as they should with these things. But it's been highly productive. And I mentioned our role with reducing this carbon footprint of ours, I'm so proud of our team and doing this, but it's... You got to be after it every year. It's got to be a priority to take advantage of the incentives that are there by government. But if they're there, I think they can get used.

David Abel: When we think of climate change, we often think of catastrophic consequences. But, in some cases, there could be benefits from climate change. And I'm just wondering, on the flip side, if, Arthur Segel, you see any opportunities that climate change presents to the real estate industry or other businesses thinking about where to locate and how to distribute their products?

Arthur Segel: I keep worrying about all the development along the water, and not necessarily water rise, but the storm surges. We saw info only last year. And I know there are buildings that just are not prepared for that. And I don't think our utility grid is ready for that, and that's where we're going to need much more investment. I see student after student creating companies, whether it be in the solar arena or possibly wind, but ... or recycling gray water. So, all these energy or carbon neutralizing companies are being set up by dozens of my students every year. And I find that very exciting.

Bryan Koop: We have this pyramid, we formed a picture, Maslow's Hierarchy.... Except we call it the Resiliency Hierarchy Pyramid. At the bottom, you have water. Essential power, after that. Transportation, after that. That's all in the public sector, right? In terms of the things that we all share together. And we know that we have infrastructure that needs to be repaired with a lot of investment, and climate resiliency can be just one more reason and one more giant factor to get this done once and for all. Because, otherwise, you just have this continuous kick the can down the road. So, the opportunity to get behind something, whether... When Kennedy said, "We're going to the moon," we got behind something, right? Climate resiliency is about our future and it's about our children's future. And that is an incredible reason to start to focus on these three things.

David Abel: Are we, Bryan, going to see more companies pulling out of coastal cities as we have more of these events? Is that a serious prospect that we should be concerned about?

Bryan Koop: We haven't seen any evidence of it. What we have seen evidence of is companies very focused on... Let's back this up to what's important to them. A company comes to a city for talent. It looks at how you're going to get the talent to work. So, then it starts to focus on transportation and all the rest of these things. I think it's been more a focus with our clients at least... Let's use Verizon, as an example. We're doing an innovation headquarters for them. I think one of the most sophisticated real estate groups out there... John Vazquez, their leader, a longtime leader in real estate... Focused not only on sustainability, how efficient this building was, the carbon footprint etcetera, but then he got into how he's going to get talent to it. So, he looked at it like, when there is an event, what first is going to get fixed and how am I going to get my people to this place of work? So, that's where we're seeing the focus.

David Abel: Arthur, what are some examples of developers or others that are doing the right thing in this space? What should companies be doing?

Arthur Segel: There are great companies. Sidewalk Labs under Dan Doctoroff and... Which is part of Alphabet, is trying to... I think it's called Quayside in Toronto, is trying to find examples using sensors, big data. They call it CLT, cross laminated timber to look for new ways of building and developing cities. Prologis and the industrial arena... Boston Properties has been a leader. Hudson Yards and related in New York have been terrific. Energy issues are more pronounced in places where energy doesn't exist, such as in China or in India, so I think in some ways they've been much more ahead of us in their development methods than we have.

David Abel: And same question to you, Bryan Koop. Do you see specific examples of companies that are doing the right thing here and what should be done?

Bryan Koop: As mentioned earlier, I see it in our client base, whether it's Biogen or Google or great companies like that... Verizon, I mentioned earlier. They're focused on this, from climate resiliency for their own talent, but also the sustainability part. One of the things that we're still in the early innings of is data, and data having to do with this historic basis of how we look at climate. And again, I'll refer back to Spencer Glendon where he says, "The financial world and the insurance world is still stuck in a virtual world of estimations." And we think that the past risk is not really the forecaster or the barometer for future risk with climate change and climate resiliency. We think it's a different ball of wax. And I think the data part... getting us anchored in the physical world... The physical world, as Spencer says, doesn't lie. And that's the zone we're in.

David Abel: I should say that Arthur Segel is holding up a map that shows Boston over time. And on this map you can see this sort of new land that was put there, and it's the entire Seaport district. And this area has basically gone from a no man's land, maybe 20 years ago, to now the center of a city, in some ways. The relentless pace of development has brought new condos and office towers in this neighborhood. And I wonder, for both of you guys... This neighborhood is pretty much at sea level. Was it a mistake to have all this development without major protections put in?

Arthur Segel: The new developments are building berms, so they're as high as 13 feet above sea level, so that will work. But how their tenants, if there's a storm surge, get back and forth from one building to another and so on is going to be a problem. So it was it a mistake? In hindsight, it may have been a mistake without more fill, but it does suggest going forward that government policy should restrict... Particularly if the government is building new and affordable housing, which we're trying to promote. It should be built in the interiors.

Bryan Koop: If you really look at the whole city, it's that the focus tends to be the seaport. But one of the concerns by many scientists is that we have a Houston phenomenon, which is... The water that actually hurt Houston the most was the rain that came back down the rivers and inlets heading back to the ocean. Could we have the same type of thing? But it's our whole city and our whole region for that matter.

Arthur Segel: I worry that the people who are at least able to afford it will be affected. So, there are all kinds of issues of equity here. And that we may not have the political apparatus or the structures to deal at a regional level.

Bryan Koop: Arthur, I think this is an important thing for the future is this climate democracy. And we have a greater dialogue of climate justice for those neighborhoods that are going to be susceptible but may not be at the focal center of the capacity to do things. You're seeing more and more of this coming out in terms of climate justice. It's becoming a bigger and more talked about factor, but we've got a way to go, because it tends to be just these vocalized areas that get all the press.

Arthur Segel: There's one other issue that we're not talking about, which is in 50 years we are projecting to have 90 days of 90 degree weather or more, as opposed to... we have roughly 12 now or something, if you believe the scientists. And we don't really know, it's in 50 years in the future, but that Boston could have a climate similar to Alabama. And if that's the case, it raises all kinds of issues that we’re going to have to be dealing with.

Bryan Koop: We need to compare more notes with other cities because London is already seeing it. London is not equipped for air conditioning, and the past three summers you're hearing a bunch of people in real estate ownership talking about this.

David Abel: And they just had record high winter temperatures in Great Britain. Let's end this on hopefully a more positive note.

Arthur Segel: A warmer note.

David Abel: A warmer note. Of course. There's a lot of doom and gloom in these climate conversations. Is there any signs for optimism here, for the real estate industry in terms of how it's going to cope with the changing climate?

Bryan Koop: I'm optimistic, but I tend to be an optimist by nature. I love our leadership and what we're doing in the city. It's not just the mayor's office or the governor's office, it's also within every sector of industry focused on it. There's not a lot of arguments about it when you get together with business leaders. It's becoming first and foremost. So, in the future, leadership is coming from cities to begin with in this nation right now, and I don't think it's going to be any different when it comes to climate resiliency. We have an opportunity to be that city, to be the city to lead not only our nation, but also the country in sustainability and climate resiliency. And we're making great steps. We got to be proud of what we've accomplished, but we've got to work a whole lot faster.

Arthur Segel: And my optimism is you just have to walk into any of our classrooms here, and have 102 students in front of you, and 100% are believers in climate change and want to go out and deal with environmental issues. You see in this next generation people who really want to work at this and make it better for all of us.

David Abel: Thank you both for joining us. Bryan Koop is an executive vice president of Boston Properties, and Arthur Segel is a professor of management at Harvard Business School.

David Abel: And now, with some thoughts about how climate change is affecting the real estate industry, Mike Toffel, a professor of environmental management at Harvard Business School.

Mike Toffel: Climate change is affecting real estate development in a variety of ways. One thing that's far from settled is the role of flood insurance. In the U S, about 5 million properties buy subsidized flood insurance from the federal government's National Flood Insurance program. But the program's in trouble. Recent hurricanes, including Katrina in 2005, Sandy in 2012 and Harvey in 2017, have led to huge claims and the program is increasingly in debt. And climate change is only increasing the risk and magnitude of flooding, placing more property at risk, which further burdens the program.

Because government provided flood insurance is subsidized, this means its premiums aren't high enough to accurately price risks. That leaves the taxpayer on the hook while property developers and property owners get the gains from engaging in risky behavior, like developing property and flood prone areas to enjoy seaside views, but don't pay the full cost of protecting themselves against flood risks. Like all subsidies, this leads to over consumption of the subsidized behavior, including rebuilding in the same place after a flood occurs, despite an increased probability that it'll get hit with another flood.

Climate change is increasing the risks and costs of flood damage, which means the cost of the government subsidizing flood insurance is likely to rise. Arthur Segal argued that the government should step back from providing subsidized flood insurance. What would happen if this were to occur? First, the private sector might step in, though because it wouldn't be subsidized, insurance prices would be higher in these high risk areas. That might encourage the development of more resilient infrastructure, and buildings might be required to meet more resilient building standards that private insurers might require as a condition for insuring their property.

Second, if the government stopped providing subsidized flood insurance, we might see the private sector developing a more sophisticated way of pricing risk. In a recent Harvard Business Review article entitled, "How the Insurance Industry can Push Us to Prepare for Climate Change," Matthew Kahn, Brian Casey and Nolan Jones noted that private insurance companies could take advantage of big data and advances in geospatial sciences to better calculate risks and set prices that more accurately reflect those risks, on a property by property basis rather than setting the same price for all properties in a flood zone. This form of price differentiation, common in other areas of insurance could encourage a more targeted approach from the private sector regarding where to build and how much resilience to incorporate in a building's design. This price differentiation could also make it too expensive to build in the highest risk areas, which would steer development toward lower risk areas.

Finally, for residents and owners of current properties already located in high risk areas, more expensive private insurance would likely lead some to abandon insurance, believing it to be too expensive. But if that happened, once a flood hit, the big question is whether the government would still bail them out. It could be that flood victims might be viewed as too many to fail, which could create political pressure to reimburse them anyway, which could unravel the private insurance market. To prevent this, the government might require them to purchase flood insurance, though again, that's a political fight. And it's important to keep in mind that if the government threatened to leave this market, millions of property owners would be hurt and the rest of the citizens would only gain a little, a classic collective action problem that makes it politically difficult to convince governments to stop providing flood insurance.

And so, I think it's hard to imagine that the US government will actually abandon the National Flood Insurance Program anytime soon. Meanwhile, the federal government is trying to improve the program in ways that can try to incorporate some of the sophistication that the HBR article discussed. A program called Risk Rating 2.0 is underway, that seeks to have the government program more precisely assess and price risk using new maps and modeling techniques. This will result in less risky properties paying lower premiums, and higher risk properties paying higher premiums. Opposition has already delayed its implementation for at least a year to October, 2021.

The flood insurance market in the US could also shift to approach a scene in other countries. First, the government could require insurers to offer policy holders the option to purchase supplemental coverage for flood damage, akin to what happens in Germany and Italy. Or, insurers could offer bundled coverage, which combines flood insurance with protection against other risks such as fire in windstorm. This would distribute risk across larger geographic areas and reduce the correlation between catastrophes. This type of bundling occurs in the UK, Spain, and Japan. A third approach is to have the government be a secondary insurer, offering compensation only after private insurance policies pay out.

What are the implications of all this? Real estate investors need to keep an eye on how innovations in the flood insurance market play out, as changes can have a big impact on real estate valuation. At the same time, citizens should keep an eye on this too, because the taxpayer cost of government subsidized flood insurance will rise as climate change brings flooding more often and more intensively. At some point, the citizenry might get tired of subsidizing the development of flood zones.

When thinking about how climate change is affecting real estate, the role of insurance is one of the most interesting topics that hasn't yet made it into everyday conversation, but I think it's an area we should all be watching.

David Abel: Thanks for joining us. I'm your host, David Abel. This is Climate Rising, podcast produced by the Business and Environment Initiative at Harvard Business School. You can subscribe on Apple Podcasts, or wherever you listen. And please leave us a review. We appreciate the feedback.