Developing and Valuing Hotels: still ignoring climate risks?

Question

Loss and Damage: these two words have become synonymous with the stark reality of climate change consequences.

At a governmental level: discussion is on-going on how to set up the fund (Loss and Damage Fund) that should address the financial needs of vulnerable nations faced with severe floods, droughts, or extreme heatwaves (see COP28 ^[1]). The fact remains that a country's infrastructure and economy are directly affected by such events including the hotel real estate sector.

At a business level: climate-induced damages can lead to significant financial distress for hotel companies due to direct costs (e.g. building repair costs, displacement of workforce) and indirect impacts (e.g. disruption in economic activities) as well as depreciating the real estate value significantly.

Climate risks and their influence on property asset valuations have been under debate for years. Experts^[2] point out that hotel properties not incorporating sustainable features, or those with higher exposure to environmental risks are being sold at a lower price than their market value (i.e. Brown discount). The readiness of investors to pay for properties that have sustainable features (i.e. green premiums), on the other hand, remains limited.

Despite growing climate change concerns and with destinations increasingly exposed to greater climate risks, the current hotel pipeline nevertheless shows a sharp increase in the development of hotels in the upscale and luxury market ^[3] including construction in high risk areas^[4]. Due to the nature of their operations and construction requirements with extensive facilities, luxury hotels are considerably more impactful in terms of high resource consumption (i.e. carbon footprint, energy usage and water consumption^[5]). Overall, the hotel construction pipeline suggests an industry undeterred by mounting environmental challenges…

That raises three questions (feel free to tackle only one question of your choice, or all of course):

As hotel asset valuations are increasingly linked to sustainability features and environmental risk exposure, do you foresee this trend changing the overall approach to hotel development and, if so, how?
Data suggest that the luxury hotel construction pipeline is unaffected by climate change concerns. What mitigation strategies needs to be adopted by the hospitality sector at this point to live up to the promise of decarbonization?
And more blatantly: Should the industry refrain from developing new hotels in risk areas?

References

^{[1] UNFCC. (2023). UN Climate Change Conference - United Emirates Nov/Dec 2023. https://unfccc.int/cop28}^{[2] Lee, I. (2023, Aug. 06). Investor appetite for luxury hotels continues despite environmental challenges. https://www.hospitalityinvestor.com/esg/investor-appetite-luxury-hotels-continues-despite-environmental-challenges}^{[3] Lodging Econometrics. (2023, Aug 30). Three Chain Scales Hit Record-High Project Counts in the Global Pipeline at Q2. https://lodgingeconometrics.com/three-chain-scales-hit-record-high-project-counts-in-the-global-pipeline-at-q2/}^{[4] GermanWatch. (2021). Global Climate Risk Index 2021. https://www.germanwatch.org/en/19777}^{[5] CHSB Index. (2023). Hotel Sustainability Benchmarking Index 2023. Cornell University Library. https://hdl.handle.net/1813/113258}

Sarah Habsburg-Lothringen · Answer

Prohibiting development will not necessarily achieve the desired results. Tourism is a force for good and can change lives through job creation and other benefits to the destination. The mitigation strategy that is missing is education. I believe it is only through education that we will achieve sufficient behavioural change for sustained positive action. We need to increase literacy around why things should be done differently; why buildings should be constructed differently; and why all areas of operations need to embrace sustainability thinking. We need to teach people in hospitality roles why they matter to the process and how to apply sustainable action to their everyday tasks. We need to share the cost benefits of reducing resource use as well as the environmental advantage; plus examples of social sustainability best practice that change lives and positively support future generations. "Someone else" will not solve the problem. Just like flying is not the problem, it is the emissions from the fuel used to power the plane; development in the hospitality industry is not necessarily the problem, it is how we go about it and who we involve from conception that needs to change. Raising awareness through education is the feasible solution.

Swantje Lehners · Answer

The good news is that hotels can achieve decarbonisation more easily if compared with airline or shipping industry. At least looking at Scopes 1 and 2 of the GHG protocol, changes in energy sources can be achieved in relatively short time by making investments, as the technology, i.e. photovoltaic or heat pump is existing and available. And of course, these more sustainable technologies should be a "must" to use from the start in any new hotel development. Unfortunately, assessing and reducing hotel emissions is getting much more complicated when looking at Scope 3 - the supply chain, i.e. emissions from purchased Food & Beverage. Scope 3 emissions make up the largest part of a hotel's total emissions and therefore should be considered in the planning, building as well as operational phases of a hotel much more than they currently are. The missing piece to achieve this, are practical tools and support for hotels to measure and reduce Scope 3 emissions. Therefore I am looking forward to the current developments to integrate further Scope 3 emissions in the Hotel Carbon Measurement Initiative (HCMI) - this will help hotels immensely to tackle this tricky but very important aspect.

Frauke Fischer · Answer

Like many other sectors of the economy, the hospitality sector assumes that forecasts and strategies for the future can be derived from a look at past developments. In view of the transgression of planetary boundaries (including climate change and the loss of biodiversity), our world will undergo massive change. So dramatically that we will have to completely rethink. Natural resources, land and the overall social and political framework will change so dramatically that, in case of doubt, only those companies that are truly sustainable will survive. Building new buildings in risk areas? In my opinion, no!

Peter Varga · Answer

As hotel asset valuations are increasingly linked to sustainability features and environmental risk exposure, do you foresee this trend changing the overall approach to hotel development and, if so, how? The European Union and some countries, such as Switzerland, seem to be going beyond greenwashing, so large companies will soon have to prepare CSR/sustainability reports as required by the CSRD and ESG guidelines. However, this enforced policy decision is making hotel companies nervous, as most are not ready for it. As an immediate response from the hospitality industry, management is initiating sustainability-related projects and more and more CSR/sustainability positions are becoming available, usually filled by hospitality graduates with an interest in sustainability. This is good news, and a clear sign of how increasing political pressure can generate change, even if it is based on unsustainable foundations. These CSR/sustainability leaders, depending on the extent of their power and influence, can have a significant impact on hospitality, but of course only if management takes a long-term and more sustainable approach to hotel development. In summary, hospitality has moved away from the status quo, but signifcant change seems too slow.

Johanna Wagner · Answer

Coming from a hotel asset management perspective and based on my empirical observations these last years, it seems to me that hotel values (both of existing properties and of development projects) are dangerously ignoreling climate risks. I believe that one main reason lies in the implied consequences of acknowledging climate risks in the valuation of new developments, which involves recognising the gap between existing assets and new assets in terms of their exposure and adaptation to various environmental risks. I see potential solutions in (i) reviewing the assumptions we're using in our holy discounted cash flow method to value hotels and (ii) generalising scenario analyses. I elaborate more on the "how" of these recommendations in this article written in May 2023: https://www.linkedin.com/pulse/integrating-sustainability-responsible-hospitality-asset-wagner/. The beautiful challenge of today's hotel asset managers and owners is to find new leverages to create sustainable value and find a new balance between investments, business resilience and asset adaptation. When it comes to the question of developing new hotels in risk areas, my answer is the same as for for biodiversity hotspots: https://www.hospitalitynet.org/viewpoint/125000152.html (in short, yes, the industry should stop these developments).

Jonathon Day · Answer

Climate change will impact all aspects of tourism, particularly lodging. How we build and operate hotels is critical if we are to contribute positively to the challenge. Hotel construction is a complex activity with many actors – from developers to REITs to management companies and brands - each playing distinct roles. Aligning the carbon reduction goals of the whole network is necessary for the best results. We must do this while building our capacity to operate every day in a more energy-efficient manner. Beyond these mitigation activities, we must be ready to change and adapt. The insurance industry is already signaling that construction in places with the greatest exposure to climate risk will be harder – and more expensive to insure. In the US, that includes places like Florida and California – two states heavily reliant on tourism. While we may very well continue to operate in these places, the cost of doing business will change significantly, as will the lifetime value of the hotel asset. Finally, we must watch the market trends as demand changes. Just deciding to go somewhere else is one of the easiest adaptations a traveler can make.

Dan Ruben · Answer

Data suggest that the luxury hotel construction pipeline is unaffected by climate change concerns. What mitigation strategies must be adopted by the hospitality sector at this point to live up to the promise of decarbonization? Hotel owners should build properties that can meet both current and future fossil fuel use regulations. They should consider achieving the Passive House certification because Passive House buildings minimize energy use, achieve excellent indoor air quality, and are very quiet. New hotels should be designed to use electricity rather than fossil fuel for heating, hot water, and cooking. That way, the owners will not have to convert their systems to electricity when governments require them to achieve net zero. Also, they will avoid the construction cost of bringing gas lines into their buildings. Some governments now require large commercial buildings, including hotels, to achieve net zero fossil fuel use in the foreseeable future. For example, Boston requires all buildings over 20,000 square feet to realize net zero by 2050 and reach interim carbon-reduction targets. Such laws will become common as climate change progresses. So, it is sensible to construct new hotels with this in mind. Building owners should consider solar panels for their roofs and parking lots. They should also evaluate the flooding and wildfire risk to their properties in light of climate change, and plan accordingly.

Elena Cavagnaro · Answer

To start with the first question, I indeed think that climate change related risks will more and more affect hotel development. The discussion on climate change impacts on real estate properties is gaining momentum both internationally ( see: https://www.unepfi.org/wordpress/wp-content/uploads/2021/08/Climate-risk-and-real-estate-value_Aug2021.pdf) and nationally (for the Netherlands see: https://www.abnamro.nl/nl/prive/hypotheken/actueel/huizenmarkt/klimaatpublicatie-economisch-bureau.html). The main mechanisms being lower prices for high-risk areas or higher insurance fees. Hotel development will be affected by both. On the second point, very high-end luxury hotels and resorts will stay unaffected by price mechanisms, as paying (even) higher prices is not an issue for this type of clientele. Only governmental interventions (e.g., denying development permits if CO2 emissions per guest are higher than net zero in 2050) will curbe the trend, I am afraid. Finally, I do believe that hotels should refrain from developing in risky areas unless the development can help benefitting the resilience of the local community to climate change related risks. Think for example of providing basins where water can be safely directed in flood prone areas.

Trevor Girard · Answer

Decisions about building hotels in risk areas should be based on comprehensive risk assessments that consider both natural and anthropogenic hazards, as well as the long-term impacts of climate change. The Cambridge Institute for Sustainability Leadership's briefing highlights the importance of reliable climate risk models for policymakers and institutions. If reliable models are used, the Loss & Damage Fund proposed at COP27 and approved at COP28 could benefit tourism destinations in vulnerable countries: Improved Risk Assessment: Proactive climate risk assessments can lead to better risk understanding and mitigation planning. Enhanced Resilience: The fund can bolster the resilience of vulnerable destinations, particularly Small Island Developing States (SIDS) heavily reliant on tourism. Increased Investment: Pre-arranged financing can incentivize investments in resilient tourism infrastructure. Global Market Opportunities: Tourism businesses adapting to climate change and investing in resilience can access green investment opportunities.

Marloes Knippenberg · Answer

As hotel asset valuations are increasingly linked to sustainability features and environmental risk exposure, do you foresee this trend changing the overall approach to hotel development and, if so, how? It should change the overall approach and In the long term it certainly will. The way we see, know, and experience hospitality must change and take on a new approach and new set of experiences. The way we build, facilities we offer, experiences guest have, how and in which quantity we use resources, they must all change and we must re-imagine hospitality. And more blatantly: Should the industry refrain from developing new hotels in risk areas? I think it depends on the risk area and what the risks are. Know where you are building / investing. For some locations, a risk could be sea levels rise, where many local owners and inhabitants have already needed to relocate due to this issue. In these scenarios, it wouldn’t be wise to build in areas that are at high risk. In some instances, the local community and builders have already started to successfully adapt themselves to increasing climate changes with new innovations.

Willy Legrand · Answer

Climate’s Titanic Moment [1]: steering a safe course in hospitality A team of scientists argued that the climate emergency can be explained through a formula factoring in risk and urgency [2], similar to steering a safe course for the Titanic away from the iceberg [1]. The formula, Emergency = R × U = p × D × τ / T, quantifies risk (R) as the likelihood (p) of an event happening multiplied by the damage (D) it will cause, and urgency (U) as reaction time (τ) divided by intervention time left to avoid a disastrous outcome (T); if the reaction time surpasses the intervention time left, control is lost. That formula can be applied to the evaluation of hotel assets. As financial distress from climate-related damages increases, it becomes apparent that sustainable features and reduced environmental risk exposure increase a property's value. The hospitality industry needs to consider factors such as erratic weather patterns and extreme events in their expansion strategies in risk-prone areas. These risks (e.g. sea-level rise, extreme weather events, wildfires etc.) could introduce vulnerable elements to investments, in terms of financial loss, physical risks and reputational damage. And it's not just about if we should build, but moreover, how should we build? New constructions would need to incorporate sustainable design and robust climate mitigation strategies, aimed at achieving decarbonization targets. Developing new hotels in risk areas should be approached with caution. Resorting to adaptive design strategies to make locations less vulnerable to climate extremities could be a way forward. That will and must include nature-based solutions to mitigate and adapt to a changing climate and to actively restore degraded areas. Think coastal rehabilitation, green walls, roofs and vertical gardens, natural rainwater harvesting, connect with those who engage in agroforestry and and and… Developers and investors must weigh the initial higher costs of climate-resilient infrastructure against the potential costs of climate-related damage down the line… and available studies shows that investing in climate-resilient infrastructure and generally pays off and it is vital to note that the benefits are not just financial – it’s about human life, community displacement, biodiversity preservation… [1] Readfearn, G. (2019, December 01). Scientist's theory of climate's Titanic moment the 'tip of a mathematical iceberg'. The Guardian. https://www.theguardian.com/environment/2019/dec/01/scientists-theory-of-climates-titanic-moment-the-tip-of-a-mathematical-iceberg [2] Lenton, T.M., Rockström, J., Gaffney, O., Rahmstorf, S., Richardson, K., Steffen, W., & Schellnhuber, H.J. (2019). Climate tipping points — too risky to bet against, Nature, 575, 592-595. doi:https://doi.org/10.1038/d41586-019-03595-0

Chalana Perera · Answer

As hotel asset valuations are increasingly linked to sustainability features and environmental risk exposure, do you foresee this trend changing the overall approach to hotel development and, if so, how? Yes, I believe this trend will change the overall approach to valuing, developing and operating hotels. Investors, developers and operators will have to adapt to changing regulations and ever-evolving policies, net-zero targets and other decarbonization legislation alongside consumer demand for more responsible accommodation options. Such changes will mandate better practices in the development and use of land, the design and construction methods employed in hotel development, the choice of materials, building footprint and volume, energy consumption, waste management and most critically, the enhancement and well-being of native biodiversity and upliftment of local communities and cultural heritage. Hotel developers will need to employ local biodiversity and ecosystems experts (scientists, ecologists, etc.), architects and designers will look increasingly towards biomimicry and biophilic design and contractors will have to invest in R&D to develop less extractive construction methods and materials, while delivering built environments that contribute positively to global climate targets. Developers and investors will seek out operators who are well-nuanced in environmentally sensitive best practices for hospitality operations, including but not limited to: circular operating models (zero or low-waste), localizing supply chains, limiting resource-intensive ancillary and extra services, placing employee well-being at the center of operations, and ecosystems and resource regeneration efforts (waste water treatment, conversion of waste to energy, etc). Other measures such as air, water and soil quality and biodiversity indices should determine if and how a hotel can be developed at a specific location. KPIs of development must include factually representative ‘quality of life’ indices for local communities as well. As much as guest review scores are important to the success and valuation of a hotel, the life satisfaction (i.e. ‘Happiness Index’) of the local community may play a pivotal role in determining property valuations in the future. Data suggest that the luxury hotel construction pipeline is unaffected by climate change concerns. What mitigation strategies needs to be adopted by the hospitality sector at this point to live up to the promise of decarbonization? Key to mitigating climate change risks is firstly understanding the ecological nuances and biodiversity make-up of a specific location. This requires looking at the ecological history of a location. Such an approach is applicable to all geographies across regions, including urban, suburban and rural locations. The hospitality sector needs to recognize the importance of ‘sense of place’ – understanding the natural balance and carrying capacity with as much scientific detail and evidence-based research as possible ahead of developing and operating in a specific location. Identifying and working within carrying capacity, carbon sequestration potential and stringent resource management are key to living up to decarbonization targets. Just as hospitality investors make financial data-driven investment decisions, hospitality investors need to make science-based decisions. Traditional due diligence and project underwriting metrics will no longer suffice. And more blatantly: Should the industry refrain from developing new hotels in risk areas? By and large the hospitality industry should certainly refrain from developing new hotels in risk areas. There is one exception perhaps, and that is if the new “hotel” development serves to demonstrate and embody scientifically proven decarbonization best practices and/or regenerative principals that restore and revive the health and integrity of a destination – to help combat the impacts of climate change. If applying the principles of regenerative development, hotel investor-developer-operators can safeguard and improve the future of ‘at risk’ areas. Bringing traditional or non-regenerative hotel projects to at-risk areas would serve detrimental to all stakeholders and ultimately compromise investor returns. Regenerative properties, those that exist to enhance the well-being of native ecosystems, local communities and both guests and staff alike, intend to transform risk into long-term opportunity and well-being for all stakeholders.

Megan Epler Wood · Answer

Capitalizing the new infrastructure required to meet Paris Climate goals and the sustainable infrastructure needs of many destinations will not be obvious or simple. There is a long way to go. Realistically, hotels will need to be part of a much larger effort, at the destination level, to bring more sustainable infrastructure to a wide range of regions. Hotels could gain economy of scale to solve key sustainability problems by working with Smart Cities, which maintain vital data on progress towards sustainability. In future, destination wide programs to build and finance sustainable infrastructure for energy, waste, wastewater, and water management will need to be calculated based on rates of return for both cities and hotel companies, as part of the work to create a well-managed destination, ensure resilience, and support on going hotel improvements - From the Forthcoming: The Costs and Benefits of a Global Transformation to Sustainable Hotels, Megan Epler Wood, Hotel Yearbook, 2023

Glenn Mandziuk · Answer

As we navigate the intertwining paths of sustainability and hospitality, it's essential to consider that hotel asset valuations are indeed becoming reflective of their environmental consciousness. This trend, in my view, will not only persist but will also bolster a paradigm shift in hotel development. It will initiate a ripple effect, encouraging developers to consider the environmental footprint from the outset, from location selection to construction materials, energy sourcing, and waste management. Despite data suggesting the luxury hotel pipeline remains seemingly impervious to climate change concerns, it is imperative to adopt a proactive stance. Mitigation strategies should focus on the integration of green technologies, waste reduction, water conservation, and sourcing renewable energy. Moreover, promoting local culture and encouraging community participation can also contribute to the sustainability ethos. As for developing new hotels in risk areas, the industry should indeed exercise caution. However, instead of completely refraining, the focus could be on creating resilient infrastructures that can withstand environmental crises, ensuring the safety of both guests and the locale. The Net Positive approach, after all, is about leaving the world better off than we found it.

Sven Wiltink · Answer

The pressure is on. Open dialogue between key stakeholders to decarbonize hotel buildings is rapidly increasing. Asset owners, investors, operators, and financial institutions sense a deep urgency to address investments in existing hotel buildings, as well as the need to aspire to, and reach sustainable building standards – including BREEAM, LEED, EDGE – for new hotels. It’s critical that these key discussions address “who pays what” to decarbonize hotel buildings. Investment in green buildings or net-zero buildings doesn’t only provide operators a licence to operate the building in the future. It also reduces numerous additional risks of related assets. With approx. 70% of existing hotels still expected to be in operation by 2050, big steps are needed to work towards net-zero. Key levers such as increasing energy and water efficiency, transitioning to more renewable energy investment, and “electrifying” buildings by reducing their reliance on traditional fossil fuel energy sources such as oil and gas, not only futureproof buildings but are also key to retaining asset value in the years to come. The time is now to scale up and develop long range investment plans to upgrade buildings and increase their energy efficiency while at the same time improving guest comfort, safety, and security. Radisson Hotel Group is increasingly using eco-modelling tools to create business cases for sustainable buildings, particularly in emerging markets, through close cooperation with property owners, investors, builders, and architects.

Developing and Valuing Hotels: still ignoring climate risks?

15 experts shared their view

References

Sustainability in Hospitality

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