Office Owners In ‘Resilience Arms Race’ To Outrun Weather-Fueled Obsolescence

Houston has one of the highest office vacancy rates in the country, and local CRE players are quick to point out that it’s easily explainable: Much of the vacancy is concentrated in older buildings that lack amenities or a prime location to make them appealing, rendering them functionally obsolete.

This summer has revealed another long-term threat to the city's office market. Over just a month's time, a derecho with hurricane-force winds caused billions in property damage and a tropical storm swept through, knocking out power for days.

Climate change is making weather events more frequent and severe, meaning office buildings must keep their resilience infrastructure up-to-date or prepare to become irrelevant. And if Houston is a guide, the same could be in store for other disaster-prone cities in California, Florida and elsewhere.

“I don’t think there’s a path forward for those assets,” said Jonathan Pearce, managing director of U.S. real estate investments for CDPQ. “That’s going to be very challenging. Some people are going to need to sober up to tackle this going forward.”

Keeping up with new resilience and efficiency standards won't be easy. Doing so is costly, and won’t be affordable or logical for some owners, Pearce said. 

Yet each storm reveals infrastructure weaknesses that could be the straw that breaks the camel’s back. With scientists predicting weather will only get more extreme, more owners are likely to abandon buildings, leaving them to indefinitely boost office vacancy in Houston and other cities facing an accelerated pace of natural disasters. 

The costs of infrastructure to keep buildings running and insurance to repair damage are rising, and that will continue if more severe weather hits, Pearce said. Many office building owners are already struggling with financial distress and low occupancy, so spending money to fortify buildings has no logical path for return. 

“It’s a really challenging situation because there are fixes available, but does it really make sense to spend the money?” he said. “And therefore, if you don’t spend the money, what happens to these buildings? Basically, they become zombie buildings.” 

Houston offices built since the 2000s have lower vacancy rates, maxing out at about 12%, according to Avison Young. Meanwhile, office buildings built in the 1980s have a 31.3% vacancy rate, the same report shows. 

To stay functional, buildings will not only need to be prepared for extreme weather but also meet anticipated climate-related pressure from investors and legal regulatory requirements, said Holly Neber, CEO of AEI Consultants.

“We’re starting to see this bifurcation of the market where buildings are prepared for climate change, or they’re not,” she said. 

Keeping a building up-to-date is important, both to preserve an exit strategy for the investment and to attract tenants, Neber said. 

Resilience stacks another element onto the flight-to-quality trend, one that rendered many buildings obsolete as companies rightsized and zeroed in on amenities after the onset of the pandemic. 

“It used to be an amenities arms race,” Pearce said. “Now it’s almost like a sustainability and resilience arms race.” 

Tenants discover more about their buildings after each storm, information that could impact lease renewal decisions. CDPQ’s Ivanhoe Cambridge and Hines developed Texas Tower, a 47-story Downtown Houston office building that was finished in 2021. 

Its developers went beyond basic efficiency and resiliency requirements, with parking making up the first 11 floors for flood protection, curtain walls and reflective roofing that reduce a heat island effect, and electrical redundancy and generators for backup, Pearce said. 

Most office buildings have generators, but older buildings tend to only have them for life safety systems, such as to operate one elevator in the event of power cuts. The power diversity of newer buildings can keep an entire building running, offering extended hours for tenants after disasters, he said.

This was in high demand after Hurricane Beryl in July, when close to 3 million Houston customers lost power and more than 200,000 customers had yet to see it restored a week later.

Weather resilience won’t be the ultimate deciding factor, but it matters to tenants, said Noah Kruger, Houston-based senior managing director for Savills.

“It'll definitely be something that is on the typical questions asked,” Kruger said. “In the past, it was always ‘How’d you guys do in Harvey?’ Now it’s going to be ‘How was your power during Beryl?’” 

Weather is only getting crazier, though. The U.S. had 28 separate billion-dollar extreme weather events in 2023, a 56% increase from 2022 and an 180% leap over 10 years ago, according to a Deloitte Center for Financial Services analysis of Federal Emergency Management Agency data.

By 2030, that number could be up to 42 billion-dollar storms per year, the report shows.

“I don’t think you can dispute the fact that we’re getting more and more adverse events,” Pearce said. 

While fortification is a good idea, and Houston has long been built with Gulf weather in mind, its storm history has always been unpredictable, Avison Young principal and Houston Managing Director Wade Bowlin said. When Bowlin was with PMRG, the firm acquired a Houston building and built an 8-foot retaining wall to prevent flooding of the elevator switch gear on the lower level of the building, he said.

“So 8 feet, we think that’s good,” Bowlin said. “Hurricane Harvey went over 8 feet and completely flooded the lower level of the building.” 

PMRG was prepared and had people there quickly to minimize the damage, but it was a lesson in why proper response and insurance is just as, if not more, important than resilience infrastructure, he said. 

Bowlin has seen the high cost of insurance premiums deter owners from having both wind and flooding policies, he said. After Harvey, some switched to having more or exclusively flood insurance.

Then came Beryl as a wind event.

“Even though we recommend our clients to do both, we continually see them not make that decision,” Bowlin said.

With interest rates rising and property values dropping, owners who incur significant damage and don’t have proper insurance have to make difficult decisions, he said.

“Do we think the values of buildings are going to increase back to the levels they were? If not, why would you put $1M or $2M into a building that’s already not worth what it was previously?” Bowlin said.

Throwing good money after bad is tough, and no one wants to sign up for an investment where there is no path forward, Pearce said. But insurers may eventually see that a building is so behind the curve on resilience and efficiency, they won’t cover it, he said.

Insurers are increasingly pulling out of areas at high risk of severe weather like California and Florida. Insurers price policies based on available information, so more specific information about resilience measures can help, Neber said.

Yet resilient buildings are just one factor in creating an environment resistant to climate change, she said.

“No matter how resilient a property owner makes their building, if the infrastructure to and from that building is not resilient, as you found with the recent power outages… That's something that property owners need to consider when they're trying to decide ‘How much do I want to invest in this building?’” Neber said.

That is something Kruger is especially concerned about, too, and many CRE players were in a state of disbelief over CenterPoint Energy’s subpar performance and response to Hurricane Beryl. 

“The infrastructure outside the building is what needs to change more than anything,” Kruger said. 

The butterfly effect is real when it comes to maintaining an older building. Minor aspects feed off of each other and make it more expensive to run, Kruger said. For instance, seals on older windows aren’t as tight, so the air conditioner has to run more often, costing more money and shortening its lifespan, Kruger said.

If building owners can’t afford to maintain their envelope, they’ll lose their ability to attract tenants and become functionally obsolete, he said. 

One weather event might not push a significant number of buildings into obsolescence, but continuous events are likely to have a cumulative effect, Pearce said: Insurance companies will pull back, and repair costs will rise.

Even if a 40-year-old building is repaired back to its previous condition after being damaged by a hurricane, it will never be as good as a building built with modern building codes and resilience features, Pearce said. And it's inevitable that another storm will come around.

 “You’re fixing a problem, but you’re putting a Band-Aid on it,” he said. “It’s like a disease. A disease usually goes after the weakest people that are out there. Adverse weather is not going to affect all buildings equally.”