Traditional methods of property investment risk assessment are insufficient in a world facing unprecedented challenges such as rising sea levels, overpopulation, inequality and access to natural resources; which are changing the basic patterns of the last two centuries.
This belief led the Grosvenor Group, a major real estate investor, to publish a ranking of 50 global cities by environmental and social resilience. The privately-owned, London–based group (with £11.8 billion in assets under management) now uses this research as part of its investment risk analysis to go beyond the traditional methods such as standard deviation of returns, projected vacancy rates and forecast rental returns.
Grosvenor knows that its future success is tied to the sustainable growth of the cities in which it has a presence. This has led to a deep understanding of what makes successful cities and the drivers of value including GDP, population growth and connectivity. What has been lacking in the wider property industry, and is becoming increasingly important in an ever changing world, is a systematic and quantifiable way to evaluate environmental and social risk at the city level.
Grosvenor’s three-year study, ”Resilient Cities,” seeks to redress this. Originally undertaken by Grosvenor to better understand and manage its global portfolio it has clear implications for the wider property industry. For the purposes of the study, resilience is defined as “the ability of cities to continue to function as centres of production, human habitation, and cultural development despite the challenges posed by climate change, population growth, declining resource supply and other significant long term negative trends.”
These trends are labelled “vulnerabilities” and include: climate, community, infrastructure, resources and environmental; and ”adaptive capacity,” which covers the characteristics of cities that are able to overcome and bounce back, including governance, planning systems, funding structures, technology and institutions. These two components are combined to arrive at an overall resilience score.
The findings show that Canadian cities are the most resilient, with Toronto, Vancouver and Calgary taking the top three positions, respectively. This is due to a unique combination of low vulnerability due to good access to natural resources, high air quality and high adaptive capacity as the cities are well governed and planned.
Chicago and Pittsburgh complete the top five most resilient cities. American cities are interesting as they perform well overall, but are not without vulnerabilities. Typically, these include high levels of urban sprawl, lack of investment in utilities and inequality, but they are countered by strong adaptive capacity: good access to funding, democracy, transparency of government and policy implementation. New York has the highest adaptive capacity of the 50 cities in this study, most recently demonstrated with its ability to cope when Hurricane Sandy hit.
Scores for European cities are more mid-range, though score relatively highly so should still be seen as resilient. Zurich, Amsterdam and Frankfurt are the most resilient European cities, which are all in highly developed societies, with a strong tradition for social equality. Vulnerabilities typically relating to European cities include lower affordability, ageing populations and higher energy costs.
The least resilient cities of the 50 studies are in the emerging markets and include Mexico City, Sao Paulo and Mumbai. Typically, they are highly vulnerable due to high levels of environmental degradation and inequality coupled with low adaptive capacity–poor governance and lack of infrastructure investment. It is also worth noting that these cities are expected to have the highest growth in population, which is likely to compound the challenges they face in the short term.
The research provides Grosvenor with a powerful tool to use when looking at the risks and opportunities of long-term real estate investment in cities around the world, which is helping Grosvenor develop an informed long-term real estate investment strategy. It provides a clear and systematic way to evaluate long-term investment risk and has clear implications and opportunities for organisations with a fiduciary duty to guard the value of their investments over the long term—including pension funds, insurance companies, sovereign wealth funds, trusts, and others. The insights provided can also help long-term investors create portfolios that optimize returns to minimum vulnerability scores or maximum adaptive capacity.
The research findings shouldn’t be seen to suggest that investors should avoid cities placed lower down the rankings, but, instead, highlights the risks those cities face and enables more informed decision-making. In some cases there could be greater opportunities, especially where a city has demonstrated its commitment to improving its adaptive capacity.
And, if you are investing with a short-term perspective, a portfolio of buildings in the most resilient cities won’t necessarily be less volatile; in fact, you would have a more volatile portfolio if you only invested in the top five cities as they are very similar and moving in the same cycle. However, investors with a long-term perspective, such as pension funds or sovereign wealth funds can deploy capital in these cities and be confident that if they take a knock they will bounce back in a relatively short term. These cities are safe havens in a rapidly changing global environment.
The research has met with significant interest, especially in Canada, where it was launched at the Urban Land Institute’s annual Spring Conference in Vancouver, Canada, but also in the Philippines, America and Great Britain. The authors have now been invited by business groups and city governments to present and discuss the findings so that they have a better understanding of what they can do to decrease their vulnerability and improve their adaptive capacity.
Kate Brown is the group director of sustainability at the Grosvenor Group, based in London, and a member of NREI's Sustainability Board of Advisors.
This article was republished with permission from National Real Estate Investor.