Resources

• Physical climate risk data providers mentioned:
  • First Street Technology
  • Probable Futures
• Handheld real-time indoor air quality monitoring technologies mentioned:
  • Awair
  • PurpleAir
• Referenced articles and book by John Macomber:
  • Climate Risk Is Growing. Is Your Company Prepared? by John Macomber. Harvard Business Review (Oct. 26, 2022)
  • Climate Change Is Going to Transform Where and How We Build, by John Macomber. Harvard Business Review (Oct. 16, 2019)
  • Healthy Buildings: How Indoor Spaces Can Make You Sick—or Keep You Well., by Joseph Allen, and John Macomber. (Cambridge, MA: Harvard U. Press), 2022

Guests

Climate Rising Host: Professor Mike Toffel, Faculty Chair, Business & Environment Initiative (LinkedIn)

Guests: John Macomber, Senior Lecturer in the Finance unit at Harvard Business School (LinkedIn)

Transcript

Editor’s Note: The following was prepared by a machine algorithm, and may not perfectly reflect the audio file of the interview.

John Macomber:

... California and wildfire was that people will often say, "We need to harden the environment. We need to bury all the lines." Or something like that. That's super expensive and would add a lot to the rate base. You also could say, "Let's prepare the houses. Let's make sure that the brush is 30 feet away from the house and the roof isn't wood, and the under-eave greens keep out embers and not just leaves and squirrels." The third is to say, "Let's just respond faster. Maybe instead of doing those two things, we need more firemen to be able to come out and address the issue, or maybe we need better early warnings so that people know if there's a particular dry situation or there's a particular spark."

All those are arrows in the quiver that have different cost benefit equations and they're used in different places. But it goes beyond just the idea that we have to bulletproof everything for a huge amount of money, and it goes beyond the idea that we're just going to do a financial risk transfer around insurance.

Mike Toffel:

This is Climate Rising, a podcast from Harvard Business School, and I'm your host Mike Toffel, a professor here at HBS. Today's episode continues our series on climate adaptation. I'm pleased to have with me in the studio today my colleague John Macomber, who spent decades leading real estate and construction companies before he ended up at HBS. John's a senior lecturer researching and teaching about real estate climate adaptation in the future of cities.

I'll ask John to share some of the key lessons he's learned studying and teaching these topics for many years now, some of which he writes about in the Harvard Business Review, which we'll link to in the show notes. Here's my interview with HBS professor John Macomber.

John, thank you so much for joining us here on Climate Rising.

John Macomber:

I'm happy to be here.

Mike Toffel:

So let's start with an introduction. Tell us a little bit about your current role and how you got there.

John Macomber:

I'm now a senior lecturer in the finance unit here at HBS, but I'm originally from industry. I spent about 30 years in real estate and construction, and I came here 15 years ago to teach Real Estate 101. How do you build and flip an office building? And I got interested in the further implications of that. For example, how do you get bridges, roads, water, power, sewer to the office building? And that then turned into an interest in the context in which the building sits around cities and sustainable urbanization. And that's where I've been heading since then.

Mike Toffel:

How did you go from building and infrastructure and finance, I know as part of your background as well, into thinking more about climate change, and in particular about climate adaptation and resilience?

John Macomber:

I started to think about how can we think of ways to finance the construction of particularly new cities in the emerging world that are more efficient. I led a number of executive programs in India where I realized you can't just put a building in place and expect to get everything else. And of course the environment and sustainability issues are so big that you can't really ignore them.

More recently, I started to realize the kind of exposures that we have to climate threats in cities all over the world, particularly in the cities that I often study in Africa, Latin America, and South Asia, and started to think about what will happen if we have more of these climate perils.

Mike Toffel:

So which perils in particular are you thinking about?

John Macomber:

There's sort of the classic big five of sea level rise, river flooding, wildfire, extreme heat and drought. And they're really different depending on timeframe, depending on geography, depending on a lot of other factors. So you can't really look at any of them with a broad brush. And what makes it interesting is to think, when might this peril actually matter or not? How likely is it to happen? It's not like it's going to happen tomorrow, but sometime in the next decades probably will. So that becomes the essence of decision making.

Mike Toffel:

So five perils in particular and figuring out the variation of which of these are going to be most pronounced in which locations is a part of the backstory here.

John Macomber:

That's part of the backstory. And the other element is around the readiness for those perils. Some places are very ready for these things to happen and some not. I kind of liken it to the old story of the big bad wolf and the three little pigs. And the first little pig has a house made of straw and the wolf comes and blows it down. The second pig has spent more money, has a house made of wood, and the wolf has a harder time. And the third pig has a house made of brick, which the wolf can't blow down. The question becomes, how much more money is it to build in brick than in straw? How often is the wolf going to show up? Is the wolf going to see one of the other pigs? And is the wolf going to be in good breath when he gets here? So you have this question of risk times readiness, and where are the cost benefit analyses around those investments.

Mike Toffel:

Now you've been taking both executives you mentioned, but also MBAs, on a journey through these topics. And the course you offer right now to our MBA students is called Cities, Structures and Climate Shocks. Tell us a little bit about that course, what's its genesis and what are the main themes you cover?

John Macomber:

From a sustainability and carbon point of view we need to manage greenhouse gases and global warming. We need more batteries, we need more solar, we need more offsets, we need more credits. That's probably unfortunately not enough. We're likely to still have more sea rise, flood, wildfire, drought, all these issues. How in the world will business and global society figure out what to do? And there's really not enough money in most governments to think forward about these issues. They have current spending needs already. There's definitely not enough money in the development finance institutions to think about it. But there's a huge amount of money in the private sector.

There's over $100 trillion in global capital and fixed income investments, for example, most of them earning 2% or 3% real yields. Ideally, some of this would be able to go into bankable projects around adaptation. The modules of the course rollout, starting with the basics of city design and city development. We think about economic development, urban planning. Then we have a piece about infrastructure finance. You need roads, bridges, water, power to get there. And the private sector understands at the city level how to invest in roads, bridges, water, power, these kinds of things.

The third component looks much more at the probability aspects and the modeling aspects. And I know you've spoken with other people about climate models and everything really is a probability going forward. We don't know what's going to happen. And the last piece is about entrepreneurial investment opportunities given the array of skills that have been introduced in the first three modules.

Mike Toffel:

Let's talk about these and how climate change is likely to influence them. And let's start with the first topic you mentioned, which was urban design. What's the intersection between climate change and the physical changes, the five perils you mentioned? How are those flowing into different ideas for what city design will look like in the future?

John Macomber:

It's sort of a two part answer. One is what are the ideas? And the second is around the implementation. If you were in a society where there's relatively low amount of citizen engagement and a relatively low amount of friction around niceties like property rights and rule of law, it becomes a lot easier to develop a city that might be thinking about specifically density, transit, some of these things. Even about prohibiting construction in some areas.

The more you have a lot of leeway for individuals, the harder it is to accomplish some of these things, so it's one of the paradoxes of this collective action problem is, how do we think how to organize this together? Generally, it's an answer that's the same, has been in urban planning for a long time, where density is really helpful. Density means much less use of resources around transportation and energy, and it means much more walkability, and it can mean more shared protections around, particularly issues around sea rise or flooding, rather than have everybody be distributed all around.

And it can mean more protection against phenomena like extreme heat because you wind up sharing a cooling plant rather than have individual cooling everywhere else. One of the big questions is, how will these cities evolve in just sort of a sprawl-y sense in a kind of a planned sense going forward?

Mike Toffel:

Are there some best practices that you've been identifying along the way in terms of cities that are doing this Well,

John Macomber:

Yes, of course the classic would be Amsterdam and Rotterdam in the Netherlands. And Netherlands has been thinking together for 1,000 years about defeating the sea. And there's very much of faith atmosphere that we're all in it together. And in that part of the world, or in Denmark and other similar regions, there's a lot of trust in government that we're going to go ahead and do these things that are for our collective good. I've written a case study about Lynetteholm, which is an artificial island in Copenhagen Harbor that's being paid for by the excavation of soil elsewhere in Copenhagen. And it creates a flood barrier so the North Sea won't surge in. It also creates new land that will eventually become real estate that winds up repaying the debt 20 or 30 years later to have built the project. Similar to how the Metro was financed in Copenhagen. But you need to think that we're all pulling together and that the credit is going to be good for 30 years to do that.

Another classic example would be Singapore. Where there's been a lot of new land created by dredging from the sea and the Jarong area and Marina Bay where many people have been. Marina Bay is built as a flood barrier for the Singapore River. And Jarong Bay has been raised already to think about some of the climate and sea rise issues. Singapore also is very thoughtful about water recycling, because most of the water comes from outside from Malaysia and they think about how are we going to store water and also reuse water, not just use it once and dump it back into the ocean.

But in both of those situations, you have smaller, more contained nations with a lot of trust in government and a lot of homogeneity. Those lessons don't necessarily apply in Mumbai or Bangkok or New York. It becomes a different phenomenon.

Mike Toffel:

Where again, as you were mentioning before, freedom of expression and engagement with multiple stakeholders has some advantages, but has some real disadvantages in terms of slowing projects and sometimes even stopping projects. I know you recently wrote a case about a property insurance company and how they're dealing with the adaptation threat. I wonder if you can talk us through some of the lessons you learned from that and that you bring into the classroom.

John Macomber:

The case is about Allianz, which is one of the world's largest insurance companies. You're also in a situation in Turkey where all five of the perils that I mentioned exist plus seismic. So everybody is aware that there are real climate perils. The insight I got from looking at Allianz actually happened in response to a big hail event that happened. Unprecedented weather event that damaged more than a hundred thousand cars. And they all were insured and most of the people didn't want a check, they want their car fixed. But there's not near enough car repair capacity to help with that in the nation. So I asked the student-

PART 1 OF 4 ENDS [00:11:04]

John Macomber:

Car repair capacity to help with that in the nation. So I asked the students, what should they do? And many of the students say they should just write a check and get out of the car business. Other students say they should go buy auto body shops. That's interesting, but that's sort of exposed after this one incident. The more interesting piece is, what should they do about the next incident going forward? Because they're going to be more.

And they laid out to me the multiple areas in which they looked at this, and I think it's going to be relevant for not just insurance companies, but for regular businesses also. The first being, how important is the risk, really? They are worried about paying these claims. They're also worried about other issues in the company, like will our data center fail? So there's a prioritization. The second and the one where I think there's some real progress to be made is around financial risk transfer.

Most people think of an insurance product as just transferring financial risk. So if your house burns or if you get sick, you get a check and nobody changes their behavior. What Allianz and others are starting to do is to think, "Well, we can't just do financial risk transfer because the risks are getting too big. Nobody will take the other side of that deal. Maybe we should exit from covering certain people or maybe we should cherry-pick who we cover," which some insurance companies do. That's not what they wanted to do for their brand. They still wanted to insure everybody. So then they started to think, "How can we address these perils or these risks in a way that's beyond a financial transfer that doesn't change anything?"

One of the solutions was to think how to reduce their probability of incidents. How likely is it that something's going to happen? And the way they did this was by investing in a new startup technology company that had terrestrial-based towers that sends electricity in the air and give you much better predictions of short-term weather events than you get from radar. So they're able to say to their insurance, "Something is going to happen with a high probability here and we probably should get the cows out of the field or get the cars at least covered by canvas," or something like that.

He second thing they did was to think, "If we can't reduce the probability of incidents, how can we reduce the cost after the fact going forward?" And what they in fact did was to buy auto body shops and say, "We'll be able to repair the cars faster. When there's not an incident. We'll be able to use the auto body shops for regular business, but when there is, we get priority going forward." They did a number of things first around assessing how big is this risk compared to everything else. Second, is there a financial transfer of risk? But the way they've moved ahead is beyond the financial transfer of risk. Can we make it less likely this thing is going to occur? Or if it does occur, how are we going to get out of this?

Mike Toffel:

So this sounds a bit like when I worked in industry and environment health and safety and we were looking into our annual renewals of our insurance. One of the value-add service that the insurance provider who was providing fire protection did is they sent us some consultants to tour our facilities and give us advice about, "Oh, you should make sure that that risk is mitigated," or, "Do you know about these technologies to squelch a fire faster if it does arise?" it sounds to me like this is expanding that type of portfolio of supports to a broader range of areas. Is that the right way to think about this?

John Macomber:

That's correct. And bringing it in this instance into the residential space. Commercial people have known about that. That's why buildings have fire protection. The interesting analog for me in California and wildfire was that people will often say, "We need to harden the environment. We need to bury all the lines," or something like that. That's super expensive and would add a lot to the rate base. You also could say, "Let's prepare the houses. Let's make sure that the brush is 30 feet away from the house and the roof isn't wood and the under-eve screens will keep out embers, not just leaves and squirrels." The third is to say, "Let's just respond faster." Maybe instead of doing those two things, we need more firemen to be able to come out and address the issue, or maybe we need better early warnings so that people know if there's a particular dry situation or there's a particular spark.

All those are arrows in the quiver that have different cost benefit equations and they're used in different places. But it goes beyond just the idea that we have to bulletproof everything for huge amount of money, and it goes beyond the idea that we're just going to do a financial risk transfer around insurance, and goes into more and more insurance companies and mortgage companies saying, "Here's what we can do to actually reduce the real throughout the real risk," and not just do a financial risk transfer.

Mike Toffel:

Now, are companies like this able to customize their rates based on their customer's adoption of these practices that they're advising?

John Macomber:

The right question is interesting as well. Generally in commercial insurance, if you have a large property owner, like a real estate investment trust, all of their properties are covered under the same policy and then are underwritten separately. The world is now changing where some carriers will underwrite different properties differently depending on seismic risk, flood risk, wildfire risk, things like that. And that's starting to occur, and you wind up having this either cherry-picking or exclusion of some of the risks. You also have a phenomenon where third parties arise to help finance resilience, essentially, and it's not that different than in a commercial office building saying, "We'll finance fixing your lobby because you're going to get more rent." Or you and I have talked a lot, Mike, in the past about financing energy efficiency where a third party might come in and say to a warehouse owner or a hospital, "You may not have the capital to come in and change all the light bulbs and change all the pumps, but for energy efficiency we'll come in and finance this and we'll pay ourselves based on the savings."

These companies are emerging that will help to think of fire protection around places and then essentially rate them and say, "Your risk times your readiness makes us comfortable and we have arrangements with particular insurance companies that will now cover you and not just for a year, but for a longer amount of time." Because one of the problems with classic property insurance is it lasts for a year, but your mortgage might last for five years, seven years, 30 years. So the real entities at risk in my view, are going to be the lenders more than the insurance companies. The insurance companies are sort of the canary in the mineshaft, but the lenders will be starting to do this underwriting of these risks themselves. And when people can either harden their asset or think how to respond better or reduce the probability of incidents or reduce the cost of incidents, then it makes them more attractive to mortgage lenders.

Mike Toffel:

Let's talk about mortgage lenders for a moment here. Given they have long-term stake, many of them, in real estate, whether we think about our own homes or in commercial property, their money is at risk for as long as they own this asset. What are we seeing from them? I've never heard of any of my friends or colleagues being told by the banks that hold their mortgage to take measures to be more protective in these areas. Is it just too micro? It doesn't make sense because the scale problem, there's just too many varieties of homes and too many circumstances for this to operate at the residential level and that's why we see more of it in the industrial commercial space because they're much bigger properties? Or is this a big data thing waiting to come and we're all going to get customized advisory reports from our banks telling us some measures to take?

John Macomber:

I think you haven't heard of it because you live in Massachusetts. Well, there are other parts of the country where mortgage underwriters are saying, "We're not going to underwrite the house." The reason is because the insurance company isn't in place. If you buy a house in Massachusetts, one of the things a precedent to getting a mortgage, it's going to be showing you have property casualty insurance. If your property casualty insurance gets canceled or you can't renew it, then that's an aspect of default in pretty much every mortgage, at least in America. And we think this is going to happen more and more, and you'd read now about people anecdotally in Florida where their premiums are going up four times, so they're paying 400% more than they paid before. People in California that aren't insurable. We don't have empirical evidence about this, or I don't, but some people do are working on it around homes that are selling in the Los Angeles basin selling for quite a bit less than the earlier market price because they're not insurable.

And so, you have to essentially fund it yourself. So if you have that kind of capital, you can do it. This is one of the reasons why people are so excited in the United States about companies like State Farm and Allstate pulling out of California, where in Florida, almost none of the flood risk is written by private companies, it's written by a subsidized state insurance company. And this will eventually percolate through the mortgage market, and maybe their mortgage company won't foreclose, but you won't be able to sell the house to the next person if they're not able to insure it.

Or if the next person has to pay an amount for their property casualty insurance that's similar to the mortgage amount, then the discretionary income in their paycheck doesn't buy as much house. So it's likely there'll be a resetting of house values in some of these areas as lenders start to become more and more aware of these issues. In my view, that lenders haven't paid that much attention because they use insurability as a piece of due diligence rather than doing their own underwriting, they're likely to start doing their own underwriting and use tools from some of the people you've interviewed in prior podcasts, whether it's First Street Foundation or Probable Futures who are Redfin or somebody like that.

Mike Toffel:

So those who want mortgages need to have insurance. Insurance companies are raising rates in areas where the risks are growing, which is what they do, or they're exiting, which means there's less competition for those who remain. Sometimes this now becomes the residual claimant of the state, as you're mentioning in Florida, for example, with the state offering these insurance. This sounds like the beginning of the unraveling of some real estate markets. Am I hearing this right?

John Macomber:

I think you're hearing that right. And the question is how fast. And it would be possible in theory to have a taper where the state insurers gradually try and exit the market and attract the private insurers back in. But the physical risks aren't necessarily different. If the physical risks are really increasing in some areas, then those areas will wind up having a decline in values. An easy way to think about it is to assume you had no mortgage and no insurance, what would you do if it was your own money? That simplifies the issue a lot. The transition is the issue, and it could happen relatively gradually, particularly if entities like First Street Foundation and Probable Futures make this information really available to people and brokers make the information available. So if this is a piece of information that's shared, then there can be a gradual transition.

PART 2 OF 4 ENDS [00:22:04]

John Macomber:

... and that's shared, then there can be a gradual transition. The problem in my view is if all the interests who'd like to keep house prices high continue to artificially support this, and then it all falls off a cliff in the end, we really don't want to crash. And it doesn't need to be, because all of these climate issues are very slow-moving issues. If the sea comes up a quarter of an inch next year, you don't really care that much unless you think the hurricanes are more extreme. And so we have time to work through these things and there are plenty of places that don't have these impacts. So that's my hope is that there'll be a slow-rolling taper where people have full information and are able to make these decisions in the course of their regular life as they buy and sell properties. This is another factor. It's not the only factor.

And some of the most competitive cities are the ones that say, "We're thinking about this ahead and we're thinking about the resilience of our electric supply. We're thinking about how we're all working together to make sure there's not a wildfire." Maybe they're building a seawall. I'm not a fan of seawalls, but that'd be a way to address this in places like... Even Miami, as the poster child for climate issues, has something called the Resilient305. That's the area code in Miami, Southern Florida, thinking, here's how we're going to make these various assets plus our hospitals and our trains and things like that more resilient. And cities compete in that regard to be more attractive. And I think we'll see more and more of that where cities think of this as a component of attractiveness, and some will respond very favorably to that and people will move there and the values will go up. So I don't see it as just a question of playing defense. Even though we think about defending properties, there's also a question of offense. Where is there a place to go? Where is there opportunity?

Mike Toffel:

So let's talk about opportunity. You're a finance person. Where are the opportunities for financing real estate and cities and infrastructures with a clear eye on climate adaptation?

John Macomber:

I think that is a question that depends on the scale of the investment. So at the very highest level, large cities like Dhaka in Bangladesh think about what are we going to do to raise key assets? And there's a fair amount of money going into that. At the second tier, there are large infrastructure companies, notably electric generation and transmission companies like Connet or PG&E or San Diego Power and Light who think of this as a matter of course around how exposed are our transformers? How exposed are our switching stations? How exposed is the pumping? There are also entities that think how are we going to defend our transit? For example, in Boston, the blue line by aquarium station floods almost every high tide. And if the tide comes up a little bit higher, this is going to be a problem that the Mass Bay Transportation Authority will have to think about.

As you get to a smaller level, you think of individuals with a large portfolio, like Arizona State has about 700 buildings. So they think about white roofs, they think about trees. Walmart, JetBlue, Delta. They have a lot of big buildings in low areas that can get hot or can get flooded, and they're able to think in the long view around what do we think is the likelihood of the peril here? How much does it cost? Do we want to reinforce this project or do we want to plan to rebuild it? But they have a a single bottom line and a longer time horizon. And then you get down into other opportunities that aren't in the hundreds of millions of dollar range. And there's a number of entrepreneurship opportunities because almost everything we talked about involves some kind of measurement, some kind of analytics, some kind of sensors. And these are improving every day.

The ability to sense air quality, the ability to sense humidity, the ability to sense electricity in the sky, the ability to do backward-looking analytics and forward-looking analytics. The ability to bring new materials and membranes to bear. All of these things are really good venture capital, fundable, intellectual property, pay for performance kind of elements. So you can think of these in a very high scale, in the billions of dollars in the urban level or in an in-between scale in the hundreds of millions in a corporate level, or in the startup scale in the hundreds of thousands and millions saying, "I'm going to help people to address some of these issues and do some of these analytics." So there's a wide range of opportunities in that regard, all of which are helping to anticipate what do we think might happen and how do we measure the efficacy of whatever it was that we tried.

Mike Toffel:

So you've written about what you call the five Rs, which represent options that communities, cities, companies face in responding to these perils, these physical manifestations of climate change. I wonder if you can walk us through these five Rs.

John Macomber:

Sure. The five Rs is a nice alliterative way to think about what are basically the options for any of these physical assets that are in peril. And you can think about them at the household level or the portfolio level or the city level, and they're relatively simple. They are to reinforce or to rebound or to retreat or to restrict or to rebuild. So the reinforce option is one where you think this asset is kind of exposed, I'd better raise the house by 10 feet, or I'd better putting more concrete or something like that. Unfortunately, reinforcing is expensive, and if it turns out that the bad event never happens, you look like a dope that you spent all this money on reinforcing that didn't happen going forward.

The second is around rebounding and thinking, I'm not going to make this thing totally bulletproof and totally impermeable, but I am going to be ready to bounce back quickly. And this is how a lot of new buildings are being built, for example, in South Florida where the first floor is higher than the expected storm surge and the lower floors don't have any valuable mechanical equipment in them and they're actually able to flood. You get the cars out of the parking, the building floods, then the water recedes and away you go. You rebound from it. So you don't build a fortress that keeps the water out. You plan to rebound.

The third is around retreating. And there's a lot of bad feelings around the idea of managed retreat or relocating, but essentially it means moving away from where the peril is. And you see this in commercial areas like Cedar Rapids, Iowa, which moved its downtown after a flood. In Ellicott City, Maryland, which I've written about, which also moved its downtown. They said, "That's enough." And sometimes you see entities, for example, in New York or Norfolk, Virginia buying out homeowners, but I see the retreat and relocate not as a big group of people all doing this at once. I see it actually as a generational question. So maybe you live in south Louisiana and Plaquemines County where the roads are starting to flood. You may not move, but your children aren't going to live there. Or you may not be worried about the heat in Arizona, but your children may not want to live there.

And we're all wired to think in a 10 or 20-year timeframe. But you think about the generational point of view, a lot of this migration will happen over time just as it did for jobs out of the American South to the Rust Belt and then back down to the south. It's more of a generational thing than something where we're all going to organize it together.

The last is around restricting, because it's pretty well-known where some of these problem areas are could restrict people from building in the uncharted Massachusetts or in the outer banks in North Carolina. That's not really very palatable. But in Switzerland, they don't let people build in obvious avalanche corridors. There are a number of places that restrict this and it may become more of an issue. I don't actually see that the restrict option is one that policy or government will be able to enact. It's too controversial. I think it's going to be enforced by the capital markets, because if you can't get a mortgage, you're not going to build there and nobody can force the capital markets to give you a mortgage.

And the last is rebuild. And rebuild is by far the market leader. People don't want to think about reinforcing or rebounding or moving or restricting. They're going to rebuild. And the question is how fast and with whose money? So I don't know how many insurance claims you've collected, but I've never collected the amount of my loss. I've never collected it quickly. And when you look at the damages for big hurricanes in California or big hurricanes in Florida or big events in the Philippines, they talk about the insured damages and the uninsured damages. The uninsured damages are almost as much, people are losing the money. Or they think, maybe the federal government will ride to my rescue. Well, maybe they'll come and rescue New York again from their $60 billion. Maybe they won't. So this issue of rebuild is sloppy thinking unless you're going to rebuild out of your own checkbook.

But all these five are only factors if your asset is endangered to begin with. So there are many assets that actually aren't, and there are people moving to what are thought to be more climate-safe areas, or there are people who just naturally live somewhere where none of this stuff is occurring. So it's not like everybody has to worry about these. But depending on who you talk to, you can see articles now that say maybe 50% of American homeowners are exposed to one of these perils, particularly as you get more extreme rain events and people are exposed to river flooding they never expected in the middle of Vermont or in the middle of Minnesota. That's a lot different than being somewhere where you knew that you're near the ocean or knew you're near a traditional WUI or a wild urban interface where there might be a wildfire.

Mike Toffel:

So there's a lot here. There's these stressors that we've been talking about or perils as you referred to them. Then there's these mechanisms of mortgages and insurance and zoning. Then there's all these options that people need to think through. How are managers and students responding to this message as you're helping them unpack the various layers of this complicated story?

John Macomber:

It's very time-scaled in that people were not interested in this at all 10 years ago. And it was also true in the general climate space. People were thinking about mitigation, greenhouse gas warming, which people think about a lot, but for the general person on the ground, they don't see carbon in the atmosphere. They do see it if their neighbor's house burns up. So that's become, just in the last three or four years in the United States, much more visible. Also, around the world where two or three years ago, a number of people died in subways in interior China based on a rain event. That wasn't a sea rise event or a wildfire event. Similarly, that's happened in Germany also. So people are starting to think, what am I going to do about this? What are the choices?

And then what we talked about here basically is a long decision tree or set of frameworks. So I tend to parse these into the five perils I talked about, into some of the responses we also talked about, into some of the geographies we talked about. And then you can look in detail at how much risk are you really in? In the more advanced portion of the course, we look at more complex decision trees with expected value of Monte Carlo analysis and different ways to think about different probabilities-

PART 3 OF 4 ENDS [00:33:04]

John Macomber:

... Monte Carlo analysis and different ways to think about different probabilities. Most of what I've done has been around, how do I think back in the envelope, what to do around this and that? And some of it builds on work at the International Financial Corporation Group of the World Bank that promulgates a risk times readiness index. And they developed this in the Philippines. It's really simple. It's sort of like the lead point system. You don't need an engineer. You look at the four or five perils. How much is your property, in this case a house, impacted? And you look at the readiness, Am I ready for a fire? Am I ready for a flood? And there's a number that you get, or a letter actually, A, B, C, D. And then what the World Bank and IFC have done is said, "If you want to get from a C to a B, and then become financeable, here's the cost-benefit thing you should do with this particular asset, with this particular peril," and they use some of their learning that way.

So I like that application where it's really common sense around, what's my situation? What tools do I have at hand? How can I fix this without having to go to a big army of consultants and learn all this other fancy stuff?

Mike Toffel:

You've recently expanded your lens to go above and beyond the financing of buildings and infrastructure and this climate adaptation overlay to look at healthy buildings, thinking about air quality in buildings and health attributes with our colleague, Joe Allen, a professor here at the Harvard Chan School of Public Health. And you've written a book together called Healthy Buildings. Tell us a little bit about that book and how that came about.

John Macomber:

So the Healthy Buildings book is a much more circumscribed area than what we've been talking about in infrastructure. It's about buildings, and it was written for commercial office buildings and for schools and hospitals. And I heard Professor Allen talk about a cognitive function study that he had done around how well people think in atmospheres of more or less CO2 in the room, more or less particulates, more or less volatile organic compounds, double-blind experiment, referee journal reproducible with volunteers. And it was really clear that cognition got worse as there was more and more CO2 in the room. We all know this anecdotally. You get sleepy in a conference room, you get sleepy in an airplane where the fans aren't turned on, but I hadn't seen this empirically before. So for me as a real estate person, I'd been thinking about energy efficiency for a long time, and I realized we're kind of chasing pennies in energy efficiency.

A lot of this has already been discovered with better buildings that are better insulated, but we chase energy efficiency because we can measure it. We haven't been chasing cognition. So Joe and I wrote case studies, and then wrote a book together where I took the real estate finance lens and thought, what would it mean to a tenant? What would it mean to a landlord? What would it mean to a lender to have a building that was demonstrably healthier? That wound up being really a popular way to think about what are the benefits and the code benefits of public health in a landlord leasing situation. And part of our curiosity there was how long some of these concepts would propagate. Are they just for elite buildings and elite places in New York, or will it propagate out elsewhere? And it really has. People start to think about health.

And this has coincided with the ability of people to buy handheld air quality monitors. So there's 100 different air quality monitors you can get in Amazon. And if you're going to buy a condominium or rent an apartment or see how healthy your kid's school is, you can go in and measure the air quality and you start to see reviews on Glassdoor and other discussion areas about this. So what Joe and I have done next is to think about how can we expand this out into the broader world and infrastructure space with the same lesson and think about avoiding drought, or avoiding wildfire, or avoiding extreme heat? And how does that apply both to the direct asset, as we talked about before in this podcast, and also around the performance of people in the buildings? And that's the next piece we're working on. And we think that the linchpin to this will be around the health benefits.

So we can talk about the direct perils to structures that you and I have talked about for a while, but you can also start to quantify the impacts on health, particularly around heat because it's relatively easy to see in the public record. If you have a sudden heat dome like they had in Portland, Oregon two years ago, all of a sudden there's 100 excess deaths. There's deaths that wouldn't have statistically happened in other years. And you can also see morbidity like strokes, ambulance calls. It's pretty easy to quantify those numbers. And you can put... It's kind of a mercenary thing to do, but you can put a dollar value on those health impacts as well. And now, they're starting to be essentially natural experiments in buildings that have been renovated in public housing where the building is renovated with passive house principles and more filtration and more fancy air quality is much better, and there's empirical measurement of fewer ambulance calls, fewer emergency room visits, fewer asthma attacks, all these reduced items.

What we're working on now is matching up those saved costs with what would the capital expenditure be upfront and chasing the classic public health question about, we know who benefits, who's going to pay upfront?

Mike Toffel:

Great. Are there any other key messages you want to share before we get to our final question?

John Macomber:

I think the message is around the awareness of these perils because they aren't happening tomorrow. It's not like the sea is going to have six feet tomorrow. And I think that sort of discredits a lot of the thought about adaptation. It isn't that the sky is falling immediately. Things can be paced out. And the question of when is the event probably enough to worry about it, and when should I spend the money to do anything about it, is really an open question. And it begs the looking at the today probabilities and tomorrow probabilities of wildfire or flood, and today costs and the tomorrow cost of these things. And there's plenty of time to implement these things if the information is clear and available, which is why I'm so pleased that you've talked to some the other entities who are busy making climate risk information available to everybody.

Mike Toffel:

Great. All right. So let me turn to my final question, one that I ask all of my guests, but I think in your case, is a real question you probably get all the time, which is, what advice do you give those who want to get involved in this space? You've talked a lot about risk management and also lots of opportunities. You've spanned financing, banking with lending, insurance companies, advisories, software. How do people know what the opportunities are in the space?

John Macomber:

I guess I'd give the same answer that I always give when people ask these kind of questions about cities, is who are you, where are you, and what are you trying to do? Because they're absolutely not one size fits all. So if you are leading a giant investment company, it's one thing. If you're thinking about your home, it's a different thing. And if you're a student thinking about a startup in the tech space, that's a different thing. And if you are in New York, or in Bangladesh, or in Delhi, or in Singapore, or in Phoenix, those are all different aspects as well. But people's access to information is really different. And there are some very proprietary databases around some of these climate perils that are only available to customers of some of these big companies, and other people are kind of in the dark. And people's risk preferences are very different as well. They may say, "I know that my house in Chatham Mass might flood, but I'm going to live there until I die."

So that's what makes a market, when you have this information asymmetry and these differences in risk preferences. So for somebody who's a financial investor, that's the kind of thing you can play. Or you can even say, "I like this real estate investment trust better than that real estate investment trust because of the way underwrote the flood risk on their buildings." At the other end, you can imagine somebody with just a couple nickels in their pockets hanging out in our innovation lab here thinking, "I'm going to take the public information from all these air quality sensors from companies like Purple Air or Aware, and I'm going to think up a new proprietary database that's going to do predictive analytics, or even backward looking analytics around how well did these things function, how well should people perform in the future? And I'm going to wind up selling that to cities and to insurance companies."

Or you can imagine somebody saying, "Here's a membrane that is going to wind up doing a better job of separating the smoke out for substantially less cost, and we'll be able to have employers not just think about the workspace where people are eight hours a day, five days a week if they've returned to the office, but think about their homes." So one of the things that Professor Allen and I have written about is it'd be very cost effective for employers to think about air quality in their people's homes because the people are there two thirds of the day, even more if they're working from home. And it would be not that difficult to measure, what's the quality in the home? Do they need air conditioning? Do they need some other filtration? If there's a super hot event and there's an older person living upstairs, has somebody gone to make sure that the windows open? There are a number of interventions that can happen that way.

So I'm describing this from the very large scale, if you're trying to invest $5 billion, to the very small scale, if you're thinking up a startup. And all the other ones exist in between in terms of whether you're comfortable with software analytics, membranes, politics, capital structure.

Mike Toffel:

Well, John, thank you so much for sharing your wisdom and your journey with us here on Climate Rising.

John Macomber:

It was a pleasure to be here. Thanks for asking me.

Mike Toffel:

That was my conversation with John Mack Omer, a senior lecturer in the finance unit here at Harvard Business School. You've been listening to Climate Rising. I'm your host, Mike Toffel. Craig McDonald is our audio engineer. We'll be back in two weeks with another episode. See you then.

PART 4 OF 4 ENDS [00:42:43]