“Water, water, every where,
And all the boards did shrink;
Water, water, every where,
Nor any drop to drink.”

(From The Rime of the Ancient Mariner by Samuel Taylor Coleridge)

Water is emerging as a foundational consideration in real estate investment. Vital to our survival, but taken for granted in most developed countries, a convergence of factors has moved water up to become a critical consideration when building, buying or leasing real estate. This “Alert” summarizes why water has emerged as an issue today, identifies some of the key real estate implications, and outlines ways to integrate consideration of water into property investment due diligence.

Water’s Rise As Investment Issue

The diminishing supply of water is the fundamental issue driving water’s emergence as an investment issue. Global demand for freshwater is projected to exceed supply by 40 percent by 2030 (in 16 years), according to the Water Resources Group, with potentially calamitous implications for business, society and the environment. Water scarcity is already a tragic problem for much of the developing world, where 780 million people have no access to clean water, 2.5 billion have no access to modern sanitation, and over 3 million people die each year – primarily children — due to water, sanitation, and hygiene-related causes. Future projections are even more challenging–by 2025, 1.8 billion people will be living in countries or regions with absolute water scarcity, and two-thirds of the world’s population could be living under water stressed conditions.¹

In addition to severe problems in developing countries, other key international concerns include the dramatic reduction of glaciers in the Himalaya’s, whose water melt run-off is critical to over 2 billion people; severe water shortages in the huge Brazilian population centers of Sao Paulo and Rio de Janeiro; and historic water shortages in arid regions throughout the world. The Indian Planning Commission stated that the country’s existing approach to water jeopardizes its economic growth and political stability. In China, home to 20% of the global population but only 7% of its fresh water, former premier Wen Jibao said water shortages threaten “the very survival of the Chinese nation”. In Peru, violent protest from communities fearing for their own water supply has led to the suspension of a US$ 4.8 billion gold and copper mining project.²

Per Capita water use is also expected to increase as world economies grow, and related risks regarding the ability of countries to fund the huge infrastructure investments needed to service these demands, and related political risks, further elevate water’s prominence as a global real estate investment issue. Scarcity issues and crisis are more severe in “developing countries”, but recent water supply crisis/concerns occur in the US and other “developed” countries and are also affecting investment. According to a May, 2014 report from the US Government Accountability Office, 40 out of 50 state are already experiencing — or will experience within the next ten years — freshwater shortages which will affect growth and development.³ Severe drought in California has hurt agriculture and required broad rationing. Similar severe droughts have occurred in Atlanta/Georgia, Texas⁴, and other regions in recent years. Las Vegas, Arizona and other cities in arid regions have had on-going concerns. Hurricanes Sandy and Katrina threatened water supplies and highlighted water and other infrastructure vulnerabilities.

Part of the rising stature of water as an investment issue is due to uncertainty about future supplies in some developed countries. As a result of drought and years of unmanaged use, US ground water supplies are dropping at alarming rates. A recent study covering groundwater depletion in the US from 1900 to 2008 revealed that “the rate of depletion from 2000 to 2008 was nearly three times greater than the average rate of depletion for the 108 year period covered by the study.⁵ Decreasing snow falls and more volatile precipitation patterns further complicate matters. While there is still debate about the cause of such volatile precipitation and storms, there is growing consensus of continued volatility and intensity of such weather events.

There is also uncertainty about the fiscal and political will of traditional governmental capital sources to address growing water infrastructure deficits, adding to investment risk. Water systems average over 100 years old and many need constant repair and/or replacement. Water leakage is also a huge contributor to water scarcity and risk. According to the website Watermainbreakclock.com, there are 850 water main breaks each day in North America.⁶ On average, utilities worldwide lose more than 30% of the water they distribute to leakage.⁷ Future supplies are further challenged by forecasts of growing populations—much of it in water scarce regions, and increasing per capita water consumption over the last decade.⁸

The growing recognition of the interdependence of water use and energy has also highlighted the importance and scarcity of water. The severe drought that affected more than a third of the US in 2012 limited water availability and constrained the operation of some power plants and other energy sources.⁹ Moving water and treating drinking and waste water take huge amounts of energy—19% of California’s electric energy load is related to the pumping, treatment, and consumer end use of water; 32% of the state’s gas load is related to the heating of water¹⁰ and 2-3% of all energy consumed in California is used by just one project: the State Water Project to move water over the Tehachapi Mountains into Southern California.¹¹ The substantial water required in the production of bio-fuels and natural gas¹² has highlighted scarcity issues that could force game changing water allocation decisions that will influence regional real estate winners and losers. These water-energy issues have been largely ignored to date at all levels of government, and needed programs, policies, and research have been identified.¹³

Another key factor in water’s rise as an investment consideration is the enhanced attention by regulators and governments on water supply and use issues. Governments are increasingly regulating the use of water through land-use restrictions, building codes and other mechanisms. As new strategies for conservation, repairing/replacing existing water infrastructure, and developing new water supply are promulgated, property owners can expect to play an increasingly key role in funding and executing the strategies. Water offset land use ordinances are already in place in some water-scarce regions, according to a report released by the Alliance for Water Efficiency, and more activity in this area is anticipated.¹⁴

Perhaps the most direct and important factor contributing to water’s rise as an investment issue is that it has become a critical investment issue for many businesses (tenants). Major corporations and large businesses, as well as most small businesses, rely on raw materials and/or production in countries spread throughout the world. As water scarcity and other supply problems increase worldwide, threats to critical suppliers and supplies increase. Additionally, water scarcity impacts regions and businesses differently, creating real estate investment opportunities and risks as businesses and governments begin to manage and mitigate water concerns.

Businesses are also drawn to water concerns due to their critical importance to the people they serve in different regions around the world. Water has become an important consideration in corporate social responsibility reporting and related third-party rating organizations like the Carbon Disclosure Project, the Global Reporting Initiative, GRESB, and ULI Green Print. Sustainable use of water in some regions is moving far beyond a cost issue towards a foundation of their commitment and sensitivity to critical community concerns.

Real Estate Implications

Many of the key real estate considerations arise from the types of solutions that are being planned or implemented to address the water supply and volatility concerns highlighted above. The importance of these considerations will of course vary based on the specific investment, but should be considered as part of any investment due diligence.

Water as a Cost Issue

It is inevitable that water is going to cost more and real estate professionals will need to factor this into every development/operating budget. Capital costs can go up as a result of increased regulatory requirements that could be triggered by execution of new leases or sale, or at any time in the event of droughts or other crisis. Operating costs can increase due to price increases (new taxes, fees, or higher water rates) required to fund the repair or replacement of existing infrastructure, or to pay off bonds for new infrastructure. Costs can also rise as a result of regulations to encourage conservation in existing and new assets.¹⁵ New developments are particularly likely to be allocated an even larger portion of potential new infrastructure costs.

Desalination is an example of a solution with higher costs. Desalination is employed in over 100 countries, but the amount of drinking water produced is less than 1% of the total world consumption. Prominent in arid countries, desalination plants have been slow to gain acceptance in the U. S. because of opposition from environmental groups due to the brine disposal and energy issues and the high development and operating costs. As of 2010, Florida had the most municipal desalination plants with 148, followed by California at 45, Texas with 30, and North Carolina with12.¹⁶

Water as a Business (tenant) Issue

Businesses (tenants in a building) will be subject to varying risks related to water that end up affecting tenant demand and real estate investment performance. Businesses can be influenced by local water costs and availability. Some businesses, like agriculture or energy companies, will be directly affected by cost and availability. Other businesses will be affected by reliance on suppliers or customers in regions with water supply or quality problems. Businesses with active measurement and monitoring of corporate sustainability practices may also be highly sensitive to building water use—resulting in the most direct threat to property investment. Businesses are also increasingly concerned about supply crisis and disruptions resulting from droughts, floods, hurricanes and other weather or natural events.

The growing importance of water to business was highlighted in a 2013 report by Deloitte and the Carbon Disclosure Project that analyzed the water disclosures of 148 of the S&P 500 companies.¹⁷ Over 80% of respondents have water management plans in place, and companies reported nearly 800 actions, targets and goals to reduce their impact on water resources. Nearly half of US respondents (46%) had already experienced detrimental impacts related to water, with costs for some as high as US$400 million and projected impacts as high as US$1 billion. Over 90% of respondents could identify if their operations were located in water stressed regions, but only 43 percent knew if key inputs or raw materials come from regions subject to water-related risk – potentially leading to a lack of a necessary response due to risk uncertainty.

Key business impacts include:¹⁸

• Increased costs for pre-treatment to obtain desired water quality.
• Increased costs for wastewater treatment to meet more stringent regulations.
• Regulatory restrictions for specific industrial activities and investments.
• Increased health costs for employees in the countries that are impacted.
• Increased responsibility (and costs) to implement community water or to offset new development water needs.
• Cost of infrastructure and watershed restoration projects to mitigate reputational risks.

Water as Geographic Differentiator

The fastest growing states are ones where water scarcity is the most serious issue (California, Nevada, Arizona, New Mexico, and Texas)¹⁹. Water access and cost may become a big enough factor in regional economies to influence geographic real estate investment allocations. US Environmental Protection Agency (EPA) recognizes these threats and has just released a study titled “The Importance of Water to the US Economy” which finds that “negative impacts to the quality and quantity of water…have significant ripple effects throughout the economy.”²⁰ A 2012 U.S. Intelligence Community Assessment on Global Water Security argues that “during the next 10 years, many countries important to the United States will experience water problems-shortages, poor water quality, or floods-that will risk instability and state failure, increase regional tensions, and distract them from working with the United States on important US policy objectives.”²¹

While water cost is primarily an issue for water intensive businesses, whose concentrations in an economy can be measured, water access and uncertainty considerations, brought on by weather related events, loss of water rights, growing resource scarcity, and lack of political/fiscal will to build, repair, and replace needed water infrastructure is more difficult to analyze. Measurement and monitoring of regulator and tenant concern and action regarding water issues are possible and may lead to profitable national and international investment allocation decisions, helping to manage downside risk.

Small Water Market Issues

Water issues are not limited to developing countries or large cities. More than 97 percent of US 157,000 public water systems serve fewer than 10,000 people, and more than 80 percent of these systems serve fewer than 500 people. Many small systems face unique challenges in providing reliable drinking water and wastewater services that meet federal and state regulations. These challenges can include a lack of financial resources, aging infrastructure and high staff turnover.²²

Coastal Real Estate Concerns

Coastal real estate is some of the most valued and desired in the world. The threat of storm surges and rising seas is increasing the cost to develop in these most coveted locations. Total economic losses from Super Storm Sandy have now reached $70 billion, according to market estimates.²³ The commercial real estate community’s immediate response to the effects of mega-catastrophes and rising sea levels includes moving mechanical, electrical and plumbing equipment to higher ground and rooftops and aboveground-only new construction. Proposed long-term solutions under consideration are sea walls, levees, improved storm water management including green infrastructure, and in some areas simply abandoning development with state and city funded purchase programs.

The City of Philadelphia has received high praise for its innovative green infrastructure program. Located on the banks of two rivers, the Delaware and the Schuylkill, Philadelphia faced mounting challenges with storm-water runoff. Many articles have been penned lauding the program and the link to a 2012 article in National Geographic is listed below.²⁴

Conclusion

Water’s rise as a real estate investment issue is based on many structural factors unlikely to change in the near term. While improving technologies and scarcity mitigation strategies will improve water problems in many areas, the level and success of government and business response to problems will vary dramatically by community and country, introducing both investment risk and return opportunities for the astute investor.

____________________

Footnotes:

¹ Charting our Water Future, Economic Frameworks to Inform Decision-making, Water Resources Institute, 2009.
² From Water management to Water Stewardship, Deloitte and Carbon Disclosure Project, November 2013.
³ US GAO, Freshwater: Supply Concerns Continue, and Uncertainties Complicate Planning, May 2014
⁴ The 2011 Texas drought caused almost US$8 billion in agricultural damages, making it the costliest drought in history http://today.agrilife. org/2012/03/21/updated- 2011-texas-agricultural- drought-losses-total-7- 62-billion/
⁵ US Geologic Survey_Groundwater-Depletion-in-the-United-States-1900-2008.pdf
⁶ http://www.watermainbreakclock.com/
⁷ Water Ninja’s, Blomberg’s BusinessWeek, Global Economics, January 8th, 2015.
⁸ EPA Watersense, “Water Efficiency in the Commercial and Institutional Sector: Considerations for a Watersense Program, “http://www.epa.gov/watersense/docs/ci_whitepaper.pdf.
⁹ The Water-Energy Nexus: Challenges & Opportunities, US Department of Energy, June 2014
¹⁰ California Energy Commission, 2005 Integrated Energy Policy Report
¹¹ Water-Energy Connection, EPA Region 9 Website, January 2015.
¹² Recent expansion of hydraulic fracturing—“fracking”–uses a substantial amount of water in the production of shale oil and natural gas.
¹³ Alliance for Water Efficiency and the American Council for an Energy Efficient Economy, Addressing the Water-Energy Nexus: A Blueprint for Action and Policy Agenda, May 2011
¹⁴ Alliance for Water Efficiency: Water Offset Policies for “Net Zero” Community Growth: A Literature Review and Case Study Compilation, January 2015
¹⁵ Deep retrofits can result in water savings of 40% or more in existing properties. EPA WaterSense, “Water Efficiency in the Commercial and Institutional Sector: Considerations for a WaterSense Program,” http://www.epa.gov/WaterSense/docs/ci_whitepaper.pdf
¹⁶ According to research by water sector consultant Mike Mickley that was published in 2012 in the IDA Journal of Desalination and Water Reuse, the journal of the International Desalination Association.
¹⁷ “From Water management to Water Stewardship, Deloitte and Carbon Disclosure Project, November 2013.
¹⁸ “Water Scarcity & Climate Change: Growing Risks for Business & Investors”, CERES, 2010.
¹⁹ DOE/NETL, Water Resources and Population Growth, 2000-2020, M.Chan, July 2002
²⁰ http://water.epa.gov/ action/importanceofwater/ upload/IOW_Synthesis_ Highlights.pdf
²¹ Global Water Security, US Intelligence Community Assessment, February 2012.
²² US Environmental Protection Agency News Release, April 3, 2014
²³ 1 Year After Superstorm Sandy: Quick Economic Facts, October 29, 2013, Insurance Journal
²⁴ http://news.nationalgeographic.com/news/2012/06/120606/philadelphia-storm-water-runoff/