Real Estate and Real Risk

Real Estate and Real Risk

Photograph by Thomas Barwick/Getty Images

Commercial real estate professionals took note last February as Yahoo and then Best Buy rescinded their work-from-home policies, requiring staffers to show up in person. This being a period of deep doldrums for commercial construction, any factor influencing demand naturally draws attention. According to independent reports, less than 1.6 million square feet of new office space came online in the first quarter of 2013—that’s the lowest quarterly figure since 1999. Again, the effect is to relocate the variables and market drivers over to the demand side, at least in the cubicles-and-conference-rooms end of the business.

Any senior executive in a global insurance group will have served their field time in one business category or another. For Mike Halvey the proving ground has been commercial real estate, with all its ownership structures, asset classes and semi-predictable market cycles. “When it comes to risk and commercial real estate, I’ve been part of that conversation for a long time,” comments Halvey, who is Head of Middle Markets within Zurich in North America. “Among all the market forces in real estate today, mobility of the workforce is a significant one. Executives and investors I talk to see it as one reason that their tenant footprint has been getting smaller.”

That metric, expressed in square feet per employee, is receiving due attention from the REITs and private equity firms that tend to own office buildings. Their conventional wisdom views telecommuting as a practice that will endure. “When the head count is declining—which we’ve certainly seen—your risk does tend to decline with it,” says Halvey.

Halvey and his colleagues in real estate have another societally driven change to keep track of: Environmentalism and the “New Urbanist” ethic continue to strongly influence the permitting process for renovation and construction. These imperatives introduce a layer of reputation risk, as well; tenant companies occupying “infill” properties, where tech-savvy young workers will be headquartered, are in need of a sustainability story about the physical space that houses their operation.

“We’ve spent time recently preparing for LEED v4, the latest hike in standards from the U.S. Green Building Council [USGBC], which take effect in November,” says Halvey. He notes that the use of sustainable materials in commercial building is “projected to be near 48 percent by 2015.” The LEED codes—voluntary, but ever-harder to skirt due to public awareness and the mood of permit-issuers—are also impacting the metrics of daily operation.

Issues of this nature were part of the proceedings recently when 6,500 underwriters gathered for a “Real Estate University” event held at Zurich headquarters outside Chicago. “We had expert presenters from a lot of different industry perspectives speak to the group,” Halvey says. “We consider this type of interface with industry people essential, if we expect to continue the level of service we attain.”

Among Halvey’s speakers were a private REIT manager; a risk manager from a Zurich-insured management company; and a private-equity executive “who described to us the challenges involved in opening a shopping center in Pakistan.”

The gathered underwriters also studied the cost/benefit models around repurposing, demolition and reconstruction, as buildings move toward obsolescence. The “infill” type of project, usually a redevelopment within a cluster of existing buildings and projects, is forward-thinking in terms of urban planning and transportation access. It can also bring ROI benefits from tax incentives or even grants.

“We generally don’t like vacant buildings,” Halvey says, drawing on experiences with squatters, vandals and other interlopers. “They aren’t always as vacant as you think they are.” When construction is not being green-lighted, comprehensive understanding of older buildings and their upside or downside is vital. “We have introduced, I believe, 10 or 12 proprietary products specific to commercial real estate,” Halvey points out. In doing so, the Zurich team “is always mindful of the sleep-well-at-night factor when we present coverage ideas,” adds Halvey.