The Impact of Environmental Regulations on Real Estate

Introduction

Hey all, Mo here –

Today we’re going to be talking about the impact of environmental regulations in real estate…

Why is this important?

The landscape of environmental regulations in real estate has evolved significantly. From the early days of basic building codes to today's complex web of laws covering everything from energy efficiency to carbon footprints, these regulations have transformed how properties are developed, used, and managed.

Let’s Talk About What Some Of Them Are…

The real estate industry is significantly influenced by environmental regulations, with key laws like the Clean Air Act, the Clean Water Act, and the Toxic Substances Control Act playing a central role.

• The Clean Air Act was enacted to control air pollution on a national level. It requires the Environmental Protection Agency (EPA) to develop and enforce regulations to protect the public from airborne contaminants. In real estate, this act impacts everything from industrial property development to the choice of building materials and HVAC systems in urban projects, ensuring healthier indoor air quality.

• The Clean Water Act aims to regulate the discharge of pollutants into U.S. waters and maintain surface water quality standards. This is crucial for real estate developments near water bodies, as it affects wastewater management and stormwater runoff systems. Compliance with this act is essential in avoiding hefty fines and ensuring sustainable property development practices.

• The Toxic Substances Control Act gives the EPA the authority to require reporting, record-keeping, testing, and restrictions relating to chemical substances. The implications for real estate are significant, particularly when redeveloping brownfield sites, where hazardous substances might be present. Ensuring compliance is crucial to avoid legal repercussions and to safeguard public health.

• The California Environmental Quality Act (CEQA) plays a critical role in real estate development within the state. It requires state and local agencies to identify and mitigate the environmental impacts of their actions. For retail investments and new developments, this can mean extensive environmental impact assessments and potential alterations in project plans to mitigate identified risks. The process, while ensuring sustainable development, can often lead to increased testing costs and extended project timelines, affecting the overall feasibility and profitability of real estate ventures.

How Does This Affect Real Estate

Real estate is ultimately a numbers game. The more you invest into an asset, you hope returns are higher. Environmental regulations are usually an added expense that doesn’t return much more of a rental premium.

1. Compliance Costs: Properties requiring upgrades modifications to meet new environmental standards are costly and usually don’t increase property value much. This is not an improvement, just “bringing it up to code”.

2. Risk Management: Environmental regulations help in identifying and mitigating risks related to environmental hazards. This can protect investors from potential liabilities and loss of property value due to environmental damage or lawsuits. Some insurance companies will not insure properties in flood zones.

3. Market Demand: Properties that are environmentally compliant or certified (like LEED-certified buildings) may attract more tenants and command higher rents, thus increasing their investment appeal. LEED certified buildings are often newer and attract a higher class of tenants.

4. Financing and Insurance: Financial institutions and insurers are increasingly factoring in environmental compliance and sustainability. Rising wildfire & hurricane & freezes mean property insurance premiums have increased in FL, CA, and TX – often reducing cash flow.

5. Asset Value: Long-term value of properties can be influenced by their environmental footprint. Imagine if you owned a property in Flint, MI where the water is undrinkable. It would tank the value of the entire city.

Same thing with eastern OH where a chemical spill had happened. Long term tailwinds may include local economies and attractions not wanting to be there.

6. Regulatory Uncertainty: Changing regulations can create uncertainty, affecting investment decisions. This includes investors who used to flock to Florida for great cash flow. With regulations changing & insurance going up, the cash flow isn’t what it used to be.

7. Development Restrictions: Regulations can limit development in certain areas (e.g., protected natural habitats), impacting land value and potential for future projects. CEQA is a great example of this – it greatly affects infill redevelopment opportunities.

8. Tax Incentives and Credits: Some governments offer incentives for environmentally friendly developments, which can be financially beneficial for investors.

9. Public Perception and CSR: Compliance with environmental norms enhances corporate social responsibility (CSR) profile, which can be beneficial for real estate companies looking to attract investors who prioritize sustainability.

10. Resilience to Climate Change: Properties built or modified to withstand environmental challenges (like flooding or extreme weather) can be more attractive as long-term investments. You can see this with properties that are beachfront and retrofitted with stilts.

How does money come into play?

Environmental regulations offer real estate investors a few ways to monetize, namely in the the form of tax credits and grants.

Grants are offered to investors who pursue the different variants of LEED certification & energy efficient appliances. Corporations also may get federal and state tax benefits if they put solar panels or recycle waste water for irrigation. It often varies from state to state.

Installing low flow toilets & showerheads may save a landlord money and increase their net operating income. This is directly equating to an increase in property value due to reducing expenses.

If something is found during a property inspection stemming from environmental regulation, it could also be used as a bargaining chip to get a lower price. This can lead to a significant discount to be used to remediate the site and juice up returns.

Environmental tests on things like dry cleaners & gas stations can often fail so “highest and best” use may not be usable. This could lend itself useful to newer concepts like a restaurant or bar.

Conclusion

I hope you enjoyed this edition of Property Playbook. It’s been a while, but I really enjoy making these. If you want to chat more about real estate or investing in one of my projects, please respond to this email.

Cheers,

Mo