An untold story: the upside of physical risk
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I spend way too much time on YouTube, where I watch a lot of business and politics content and indulge a few guilty pleasures. Unsurprisingly, my viewing habits don’t intersect very much with those of my Gen Z daughter, who mainly follows trendy style gurus and cultural commentators I’ve never heard of.
However, one channel we both watch regularly (though never together of course, duh) is Bright Sun Films. The US-based videographer, Jake, has carved out a niche filming abandoned commercial properties like shopping malls, resorts, hotels, and theme parks, and documenting their sudden, spectacular demise as they are reclaimed by nature. The videos are always thoroughly researched. In each episode the history of the property is recounted, its ownership described, and luscious footage from before and after their abandonment provided.
For anyone interested in commercial property corpses, Jake provides many useful case studies. The channel has both the Gen X and Gen Z seals of approval for watchability, which is quite a rare combination in this day and age.
For those concerned with financial climate risk, the video posted a few days ago is especially pertinent.
Jake travels to a large apartment complex on the west coast of Florida made up of 36 separate buildings containing over 400 residential units. Hurricane Ian, which blasted the state in 2022, unleashed 16 inches of rain and plunged many of the low-lying apartments under water. Jake reports that 20 buildings suffered some flood damage and that several were subsequently abandoned. The number of flood-damaged buildings that were repaired and reinhabited was not reported, nor was the number of undamaged apartments that continue to be occupied to the present day.
The property was built in 1974, mainly to house students at a nearby university. A former resident interviewed in the film suggests that many families also lived there. Ownership of the structure last changed hands in 2014, when it was sold for $21.3mn, meaning that the units had an average value of around $53,000. The complex apparently had a long history of flood-related incidents, having also suffered significant damage during Hurricane Irma in 2017.
“Shouldn’t I just go and watch the video?” I hear you ask. Well, yes, but I think I can help add some context that Jake, quite sensibly, glosses over in his carefully curated film. Before I continue, I first want to acknowledge the suffering experienced by the residents – you can rest assured that I will never downplay the costs of climate change to those in any way less fortunate than myself.
In terms of the financial costs and benefits, the experiences of the owners, bankers, and insurers are far removed from those of the ordinary people. The film doesn’t discuss the financial arrangements behind the 2014 deal, but it is safe to infer that the owners funded the transaction and the operation of the complex with a mix of debt and equity. Given the nature of the property, I suspect that the banks’ exposures were limited to the provision of working capital and that any funding provided at acquisition was paid off by the time Ian struck, eight years later. Given the local history, one suspects that flood insurance was either prohibitively expensive or unavailable, meaning that the risk was likely borne by the equity owners and bankers.
Why would a deal like this appeal to the buyers? It was and is a rundown apartment building that gets knocked around by hurricanes. It is low-lying and therefore highly susceptible to flooding.
On the plus side, it is close to a university, which means a steady stream of prospective tenants is assured. I’m not sure of its precise location, but in southwest Florida, renting an older-style one-bedroom will currently set you back about $1,200 a month. The footage of the complex suggests that while it was fitted out cheaply, steps had been taken to make the apartments at least somewhat desirable.
It seems pretty clear that the owners avoided making expensive upgrades – air conditioning units and faux granite benchtops aren’t particularly costly if you buy wholesale in bulk. Student digs are always serviced in a rudimentary fashion; after all you know there will be a new batch of victims each year, so a dollar spent to keep the current residents happy is a dollar wasted. Jake reported that reviews of the complex tended to be rather harsh.
Let’s be conservative and assume that average rent revenue was $500 per month per apartment, implying a gross return of 11%. With careful cost control and low interest rates they should have been making a decent return. If the complex had continued to operate in this way for another decade or two, I’m sure the owners would have been quite satisfied
The key question, though, is how they feel about its destruction.
The owners must have known a calamity was possible when they signed the contract. Were they gambling that they could squeeze 20 years of revenue from the property, or was eight years more than enough for them to make bank?
Frankly, I suspect they were popping champagne corks the day after Ian struck.
You see, while southern Florida experienced the Mother of All Housing Booms in the mid 2000s, prices had fallen in 2014 when the complex last changed hands. The market was still pretty quiet when Irma struck in 2017, but conditions were radically different in 2022. The chart below shows the evolution of house prices in Cape Coral-Fort Myers, the city that bore the brunt of Hurricane Ian. I put a marker in Q4 2014, roughly when the property last sold.
So, might Ian have caused the property’s market value to rise?
Immediately prior to the hurricane, the owners of the 50-year-old complex were stuck in 400 separate binding legal contracts with tenants. Had they applied to the city to redevelop the property prior to the disaster – with a view to cashing in on the unfolding boom – they would have faced considerable opposition from officials justifiably concerned about the supply of affordable housing in the city.
Post-Ian, they have a newfound justification to terminate all the contracts and start from scratch. Their development application now covers an abandoned, crumbling, dangerous eyesore (through no fault of the owners) that the city will be desperate to rectify. Jake mentioned in passing that a development application had recently been approved by the relevant council.
They can now replace the cheap student apartments with plush condos, upgrading the flood preparedness of the property into the bargain. This may have even been the original end game envisaged when the owners first bet on the property in 2014.
Conclusion
I mentioned in a recent article that hold-to-maturity returns were just as relevant as mark-to-market when assessing climate risk.
Restricting attention to market value, there’s a tendency across the industry to imagine that the owners of the apartment complex suffered a $21.3mn loss when Ian struck, rendering the apartments uninhabitable. In so many ways this assumption is naive. You lose the buildings, true, but sometimes the very existence of the structures depresses the value of the land on which they sit. In economics there’s this concept called opportunity cost which is apparently too subtle for many climate-focused central bankers. They persist with the fiction that physical risk is, always and everywhere, on the downside for anyone with a financial interest.
You may think buildings with negative value is a rare situation, but in actual fact it is remarkably common.
If you don’t believe me, spend an afternoon checking out Bright Sun Films. You’re invited to ask why a rational business owner would allow a property to fall into disrepair. Often it’s forced; sometimes it’s strategic.
It’s generally not because they are ignorant or stupid.
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