Related Group of Florida – A New Meaning to ‘Underwater’ Real Estate
Miami's biggest real estate developer will have to face the music sooner or later. As Will Smith notes: “Yo I heard the rain storms ain’t nuttin’ to mess wit / but I can’t feel a drip on the strip, it’s a trip.”
Related Group of Florida is one of South Florida’s largest luxury real estate developers, with over 100 million square feet developed in the region since 1979.[i] With upwards of 30 projects[ii] totaling $10.7 billion in assets under development, Related Group proves that the boom in real estate in South Florida is as strong as ever, with ~11,000 condos across over 100 buildings currently under construction in Miami-Dade, Broward and Palm Beach counties[iii]. In an area marked by development excess, Related emerges as the leader – it has been estimated that 1 in 4 high-rise dwellers in Miami lives in a Related building[iv].
Southern Florida has long been subject to a boom and bust real estate market. Miami Beach, for example, is one of the most populated barrier islands in the world thanks to decades of development that have established the city as a top destination for tourists seeking a luxurious beach experience. Unfortunately, the city also happens to be one of the lowest lying municipalities in the country, and the situation is not much better for the broader Miami-Dade County, 60% of which sits less than 6 feet below sea level.[v]
BOOM? BUST? THAT’S JUST THE SOUND OF THE LEVEES BREAKING.
As climate change progresses, these low-lying areas will increasingly be subject to rising sea levels and more frequent – and powerful – storm surges. Given Related Group’s focus on the South Florida region, there are several risks to their business model from rising sea levels related to climate change:
- Asset Risk – Related Group’s significant real estate holdings is at risk of severe physical damage as sea levels rise. The New York Times has estimated that with just the 5 foot increase in sea levels predicted over the next 100-300 years, 94% of Miami Beach will sit underwater[vi].
- Insurance risk – Insurers are already aware of the increasing risks to shoreline property damage and will continue to raise premiums for high-risk property in areas like Miami.
- Credit risk – The availability of financing may dry up for real estate investors like Related Group as institutional investors deem projects too risky[vii].
- Demand risk – Retail buyers are becoming more aware of the imminent threat that climate change poses, and as this trend increases demand is likely to dry up among that population. In its place, Related has come to rely more on foreign investors who view climate change risks relative to other political economic risks in their home countries.
COWBOYS DRAWN TO A GOLD RUSH
Related Group’s CEO recognizes the impact of climate change on new development, but he also acknowledges the particular psychology that makes for a good real estate developer in the first place: “We are an industry with a lot of cowboys. Real estate developers seem to be the most optimistic of people.”[viii]
And in truth they have reason to be optimistic. Miami-Dade county, whose tax revenue comes disproportionately from property taxes, has expressed a willingness to invest significantly into capital improvement projects aimed at mitigating risks to property from rising sea levels[ix]. The public sector sinks or swims with the local property market in Miami, and Related has done a good job of forming strong relationships with government.
OPPORTUNITY IN ADAPTING?
Development in Miami will continue to be hugely profitable – until it’s not. Related can take a few steps to adapt to the future state of the world:
- Diversify beyond South Florida – While challenged by their relationship with the Related Companies’ presence in the rest of the US, the Related Group has of late been extending their relationships into Latin America to lessen their portfolio’s exposure.
- Create sustainable communities in high-lying areas near Miami – Environmental refugees will need to be housed in safer locations.
- Build amphibiously – Luxury development will take on new meaning as buildings on Miami Beach change their car parks over to yacht docks.
None of these solutions, though, present the same profitability that Miami Beach development has allowed for. It will take long-term, community-based thinking to make the leap.
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[i] http://relatedgroup.com/wp-content/uploads/2016/03/JorgeP%C3%A9rez.CommercialObserver.2.24.16.pdf
[ii] ibid
[iii] https://www.scientificamerican.com/article/seas-rising-but-florida-keeps-building-on-the-coast/
[iv] http://relatedgroup.com/wp-content/uploads/2016/03/JorgeP%C3%A9rez.CommercialObserver.2.24.16.pdf
[v] https://newrepublic.com/article/123216/miami-sinking-beneath-sea-not-without-fight
[vi] http://www.nytimes.com/interactive/2012/11/24/opinion/sunday/what-could-disappear.html?_r=0
[vii] “Where we see some headwinds is in the capital markets,” said Ezra Katz, CEO of Aztec Group Inc. in Miami, citing regulatory pressure on commercial banks to limit their exposure to real estate loan losses. “I think you’re going to see some serious setbacks in construction lending … by regulated banks.” http://therealdeal.com/miami/2016/09/27/jorge-perez-expect-residential-development-in-miami-to-slow-not-stop/
[viii] http://www.bizjournals.com/southflorida/news/2015/06/26/related-group-s-jorge-perez-dishes-on-real-estate.html
[ix] “The Sea Level Rise Task Force recommends accelerating the adaptation planning process by seeking and formally selecting the engineering and other relevant expertise needed to develop the robust capital plan, vetting the elements (i.e., flood protection, salinity structures, pump stations, road and bridge designs, etc., just to name a few possibilities) as well as what measurable indicators will trigger timely sequencing.” http://www.miamidade.gov/planning/library/reports/sea-level-rise-final-report.pdf
According to research by Zillow, one in eight Florida home would be underwater by 2100, equivalent to ~934K properties or $413 billion in property value (http://www.zillow.com/research/climate-change-underwater-homes-12890/). It seems like many developers are already thinking ahead and investing in storm-resistant and resilient buildings on more elevated land. Consumers are also more aware, and seeking information on how much of a threat sea-level rises poses to a property (https://www.scientificamerican.com/article/seas-rising-but-florida-keeps-building-on-the-coast/). Agree with your recommendation on diversifying investments outside of FL but would be great to hear what Related Group is planning to do to mitigate this risk for its existing properties in below sea-level areas.
Interesting article. I’m curious whether Related and other developers typically sell the entire buildings to property management companies or whether they manage them themselves. If Related is able to completely pass on any risk related to climate change effects (storm surges, decreasing property values, etc.), Related would have few incentives to change their practices in the short term, particularly as foreign investment replaces some demand from more concerned domestic buyers. It would also be interesting to know whether Related has partnered with engineering firms to stay ahead of the curve in developing more robust structures.
Great piece – I like the Will Smith references! This is an interesting problem for Related Companies. I don’t see them stopping development in Miami any time soon, however this is an issue they should think about for long-term sustainability. Another issue that seems more pressing in the short-term is the increase in extreme weather related to climate change. As hurricanes and other weather events increase in strength, Related Companies should be thinking of ways to mitigate their risk. I would be curious to know if there are new innovations in architecture and buildings in order to adapt to the changing environment.
Fantastic Post! Coming from the real estate industry myself I find this very interesting. All of the risks that you laid out are exactly what Related must be thinking about when doing their diligence on their Miami projects. Related is mostly building condominiums in Miami which means they are selling them to customers who take a lot of the risk (you mention this in your article from a demand risk perspective). BUT, Related is still on the hook as the developer long after the project is all sold out. Most states across the country require a 10 year minimum complete warranty on projects. A lot of projects (especially in Miami) can be 5-10 years just to plan, develop and complete. That means when these deals are being underwritten, they are looking 20 years out on the “global-warming” risk. With the rate at risk global temperatures are changing, this could prove to be detrimental at some point to Related’s development strategy.
I also wonder how Related is approaching the LEED (environmentally sustainable buildings) certification of their buildings. I would imagine that they would take an aggressive approach to building LEED certified, as they are doing a lot of development in an area of the world that could very well be hit hard by the negative affects of global warming. After looking at their website (http://www.related.com/) however, it doesn’t look like they are pushing for more LEED certified projects- most real estate developers heavily pushing the initiative are very quick to publicize it on websites, etc… Related is most likely not pushing it because these projects typically cost 8%-10% more in construction. This can be a lot of money when talking about a $100 million project with potential investors.The biggest thing we grappled with at my last firm was finding the benefit of additional cost in building LEED Certified. I wish it were easier to justify it- Especially when running the risk of global warming putting your whole project “under water”!!!
Great article! Having worked in real estate development and investing, I understand the efforts stakeholders are taking to develop sustainable buildings. That said, when we analyzed the feasibility of a given real estate deal, for example, we typically evaluated return implications over a short-term investment horizon given the nature of the business, whereas the article refers to implications for asset risk in the next 100-300 years.
While all real estate investment firms are not created equal (that is, firms have different costs of capital, investment requirements, holding periods, and best practices), an overarching theme appears to be prevalent among most investors: the long-term, proactive investment mindset has not set in for most. In fact, according PwC’s 2016 Emerging Trends in Real Estate report, investors and developers ranked “sustainable buildings” as an issue of little importance (2.8/5.0); this score compares with some issues of “great importance” such as construction and land costs, vacancy rates, financing, and infrastructure funding. Clearly, investors are still focused on achieving the return thresholds in the short term. With this in mind, how can Related convince its equity investors that sustainability is fundamentally crucial despite the fact that the potential asset risk you highlight above will likely not be relevant during their hold period and project returns may not be as strong?
References:
https://www.pwc.nl/nl/assets/documents/pwc-emerging-trends-in-real-estate-2016-us-canada.pdf