Inflation remains stubbornly high with three straights months of stronger than expected price increases. Hot inflation along with strong labor market data and upward revisions of the GDP, indicate there are fewer signs of an economic slowdown that would warrant interest rate cuts. The Fed was expected to announce a rate cut in June and that will most likely be delayed. Some Federal Open Market Committee (FOMC) members have communicated there is no sense of urgency when it comes to cutting rates with a couple members saying it’s possible there will be no rate cuts in 2024.
If there are no rate cuts this year, interest-sensitive industries, such as construction, will bear the brunt of an extended high-rate environment. Residential construction is carried by single-family projects. Multifamily continues to contract as increased supply dampens rent growth and credit is harder to obtain. There’s been some pullback in nonresidential as more projects struggle with higher rates and flat demand. Input prices are up slightly except for declines in pricing of steel and lumber. A concentration of mega-projects and more supply chain upheaval are likely the biggest drivers.
We examine the credit crunch, interest rates and ESG adoption in this issue’s Current Events.
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In this spotlight, Sam Holt, National Aptitude Director, discusses the rise in technology investments to support ESG-related goals for owners and operators of built environments. Aptitude: Intelligent IntegrationTM is the technology integration arm of JE Dunn; it works with IT leaders and client stakeholders to plan, design, oversee installation of, and commission efficient technology ecosystems for complex smart buildings.
“Having worked with many building owners, operators and CIOs over the years, it is crucial to make technology ecosystem planning an early priority, and make sure it’s holistic, with a solid procedure for monitoring every system, and an eye on future needs.”
The Senior Loan Officer Opinion Survey (SLOOS)) is a quarterly survey of 80 large domestic banks and 24 US branches of foreign banks.
After spending the last 12-18 months talking (and arguing) about how high the Fed would raise rates, we have finally made it to the “how long will the Fed hold rates.”
More and more companies are learning how to embrace two foundational (and related) shifts in the business world: a heightened focus on environmental, social & governance (ESG) issues; and the movement towards a multi-stakeholder model of operations.
Europe is setting the standard for environmental, social, and governance (ESG) programs worldwide. While the U.S. is moving at a slower pace, it’s critical for American companies to pay heed to Europe’s green agenda now, because if they aren’t affected already, they will be soon. The European Union’s Green Deal aims to make Europe the first carbon-neutral continent by 2050. In his Good Lab article, Decoding the EU’s ESG Regulations: What U.S. Companies Need to Know, author Ted Grozier opines, “whether directly or indirectly, EU regulations will force many companies across the U.S. to disclose their emissions and other ESG metrics1.” The question many organizations are asking is how do we effectively track emissions and report them accurately? The answer to this, of course, comes down to technology.
As ESG reporting has made the leap from bucket list to mandatory task, many companies are scrambling to have often scattered, poorly tracked data at the ready2. The intent behind these ESG asks is easy to support in theory, but in reality, the execution can be complicated. For example, the United Kingdom’s Building Safety Act requires a digital record from concept to demolition of a building across all different data points3. Many companies worldwide would be hard-pressed to present this information at short notice, if at all. Similar legislation in the U.S. is trailing Europe by a few years, but American business leaders know it’s coming and know they must get their theoretical ducks in a row.
Technology tools are essential to delivering on ESG tasks. Easily accessible operations data, building functions that strive for net zero, transparency in every facet of ESG-related business functions; it all comes down to arming organizations with the technology infrastructure and tools that help them to corral data necessary for reporting as well as provide actionable insights, and have an ecosystem in place that optimizes operational efficiency. There is a growing list of ESG-related software on the market, and IT teams are left to decipher which tools are best for their needs. Advising companies on their tech stack and how to meet operations goals with the right tools is at the heart of what Aptitude does daily. Aptitude is JE Dunn’s strategic trade partner for technology integration, born out of the growing need for one entity to ‘own’ the technology ecosystem throughout the lifecycle of a construction project. Too often, technology systems have been an afterthought, leading to inefficiency, delays and change orders. Aptitude works with owners to clearly understand the technology goals of their built environment and then designs and delivers building systems to achieve those connectivity goals.
Conversations our team has with clients who need guidance choosing tools and developing a plan for meeting ESG-related goals, are occurring more frequently than ever. In the past month alone, two CIOs reached out to Aptitude to help vet ESG software vendors and determine how their organizations can better meet mounting pressure to drive down emissions and deliver transparent sustainability metrics. Much of the related research reflects Aptitude’s experience. One example is a Gartner study aimed at executive IT leaders, Hype Cycle for Environmental Sustainability4. This study examines the emergence of technology tools designed to meet low-carbon initiatives and the shift of ESG programs from ad hoc project to high-priority program backed by the full attention of the board room.
With technology tools at the center of delivering on ESG initiatives, it’s no wonder that companies are looking to their CIOs and IT managers to lead and solve. A January CIO.com article highlighted how CIOs are positioned to be stewards of ESG reporting efforts5.
‘CIOs — who sign nearly half of all net-zero services deals with top providers, according to Everest Group analyst Meenakshi Narayanan — are uniquely positioned to spearhead data-enabled transformation for ESG reporting given their data-driven track records. But ESG data is more complex than any other type of data organizations have had to wrangle, spurring leading CIOs to educate themselves quickly on the nuanced challenges of delivering reliable, actionable ESG reporting.’
In a Forbes.com piece sponsored by PwC and AWS, the authors cite that ‘leveraging technology to help you efficiently mine the information needed for current and future disclosures allows you to ground decision-making in real-time data6.’ The article goes on to mention that a recent survey revealed ‘more executives said they plan to embed new technologies into their business model than any other strategic priority over the next three to five years… at the same time, half of all leaders surveyed said climate change poses a serious to moderate risk to their company.’ Simply put, all signs are pointing to technology playing a major role in tackling ESG issues for many companies.
As you would expect, investing in the tools to deliver on ESG goals comes with a price, and there’s data to back this theory up. For instance, Gartner projected in January of this year that worldwide IT spending will increase 6.8% in 20247. The Gartner press release does not specifically call out ESG initiatives, but it’s safe to assume collecting ESG-related data takes up some portion of many IT budgets.
Another study published by Gartner, Emerging Tech: Sustainability and ESG Software Will Underpin the New ESG Era, reports ‘exceptional levels of investment in sustainability and ESG software targeted at environmental aspects have fueled explosive growth in the number of vendors’ providing these tools. The study goes on to deduce that by 2026 the number of large companies with net-zero strategies supported by aligned financial plans will double’8.
One Harvard Law School Forum on Corporate Governance article even reports that in growing cases, ESG performance is linked to executive compensation9. If tackling climate worries, being socially responsible, and government compliance wasn’t enough, money is surefire motivation.
Developing an ESG program roadmap and wrangling needed data is daunting, but the emerging solutions available are improving all the time. One of these tools is the use of digital twin technology in buildings. A digital twin platform offers a virtual representation of every operating or technology system in a built environment. These platforms monitor operations in real time and can provide metrics that help in everything from decisions surrounding user trends or functionality to delivering the data companies need to comply with ESG reporting. A couple of simple scenarios might be that a digital twin reveals when a particular system is offline, or it reveals that 40 percent of employees exit the building by 4 p.m. on Fridays, so there is therefore no need to keep the heating and cooling unit at optimal temperatures throughout common spaces after that time.
Helping our clients solve ESG reporting challenges is being woven into our technology planning conversations more frequently. One hurdle we often encounter is that technology decisions are not in sync with construction budgets. For example, physical infrastructure is in a development budget, but where the outcomes happen is in over in a separate operating expenses budget. The challenge comes when trying to balance technology with business – the two don’t always match, but with outcomes so closely tied, they should match.
Having worked with many building owners, operators and CIOs over the years, it is crucial to make technology ecosystem planning an early priority, and make sure it’s holistic, with a solid procedure for monitoring every system, and an eye on future needs. Too often in the past, individual building systems were tacked onto buildings without any thought of how they could function efficiently together, and building system data was poorly managed. This won’t work. We can rise to higher ESG standards with a better plan, and technology will be a crucial piece of the plan.
With ESG becoming a higher priority of our clients, it is also a higher priority for Aptitude. Our team works daily to stay up to date on regulations and best practices surrounding enterprise ESG programs. As with any other system, we will remain ‘brand agnostic’ when it comes to ESG-related software but will continue to familiarize ourselves and evaluate those offerings so we can make recommendations to our clients. Aptitude has a future-forward outlook when it comes to ESG programs: They are not one and done. They are evolving and in need of ongoing attention. The U.S. generally trails Europe by a few years in terms of ESG legislation, and our business landscape is not the same. However, there are lessons we can learn from European ESG practices and how companies are meeting them. Again and again, it comes down to technology tools. Helping organizations implement technology to meet their goals is inherent to Aptitude’s mission. Reach out to our team if we can assist in this way, and keep in mind that Aptitude can provide the most value when brought in early enough to make technology planning an integral component of concept and preconstruction conversations. Learn more about Aptitude at aptitudeii.com.
Sources:
The Senior Loan Officer Opinion Survey (SLOOS)) is a quarterly survey of 80 large domestic banks and 24 US branches of foreign banks. Questions address sentiment regarding lending standards and what loan officers are seeing in terms of loan demand for different end uses like automobile funding, credit cards, or jumbo mortgages. First quarter results are due to be released soon but based on what we’ve seen through the end of 2023 it is likely to show a positive continuation in trends for construction projects and loans.
One of the indicators the construction industry zeroes in on is the Net Percentage of Domestic Banks Tightening Standards for Commercial Real Estate Loans with Construction and Land Development Purposes. The immediate fallout from the pandemic led to over 80% of domestic banks tightening construction CRE lending standards. Things calmed down over the next few quarters just in time for the dramatic collapse of three banks over five days in March of 2023, tightening lending standards once again.
We are now three quarters into a “calming of the tightening” with the share of banks that are tightening standards back down to fewer than 40%. This means that getting CRE loans for construction projects is slowly getting easier, which is a welcome development for the high-interest rate environment we are currently in and will likely remain for several more months.
After spending the last 12-18 months talking (and arguing) about how high the Fed would raise rates, we have finally made it to the “how long will the Fed hold rates” argument and for many the holding period may feel much longer than the hiking period. Part of the issue for investors, stakeholders, and other parties waiting on the sidelines is the building tension that comes from thinking that rate cuts are just around the corner only to watch as the data drives them further out into the future. The more that the expectations of lower rates get reinforced into the general consciousness, the greater the anticipation that builds for it to finally happen. Then, when it does happen, we are at an increased risk of seeing a wave of demand translate into a surge in inflation that would necessitate another rate hike from the Fed to tamp demand enough for inflation to cool. This would be very similar to what Paul Volker’s Fed dealt with in the late 70s and early 80s. The resulting economic pain led to a substantial loss of Fed credibility.
Atlanta Federal Reserve President Bostic has heard from business leaders who were “ready to pounce at the first hint of an interest rate cut… [as a result of] pent-up exuberance.” Estimates from Bloomberg identify Fed chair Jerome Powell’s remarks in December about rate cuts being a topic of discussion as having an “effect equal to lowering interest rates by 0.14 percentage points… [and adding] about half a percentage point to the CPI this year.”
Drilling down to the impact this could have on construction, if there are projects that are waiting on the sidelines, ready to go but can’t quite pencil under the current elevated rate environment, once rate cuts happen, they could move to market all at once, straining resources and causing material prices and labor rates to jump across the board.
Accounting for this possibility, amongst all the other countervailing forces that are acting upon inflation and the economy right now, means that we once again must operate through a period of very high uncertainty. While there is plenty of room to make the argument that the base case should remain “inflation falls in line and we have more than one rate cut this year,” it is still a possibility that inflation gets nudged up enough by consumer spending and a still-strong-enough labor market that no rate cuts happen- and it’s still possible for inflation to have another period of acceleration, wiping out the chance for a rate cut and bringing up the possibility of rate further rate hikes. For now, that is an outside chance, but we still aren’t far enough down the road (and balanced things out enough) to say that cuts in 2024 are a lock. The Fed needs to get ahead of the potential for “pent-up exuberance” bubbling up in expectations and forecasts must account for the chance that outsized spending triggered by rate cuts could make inflation targets that much harder to hit.
More and more companies are learning how to embrace two foundational (and related) shifts in the business world: a heightened focus on environmental, social & governance (ESG) issues; and the movement towards a multi-stakeholder model of operations. ESG concerns are being driven by investors, employees, consumers, business partners, state and federal agencies, and regulators. Accounting for all those viewpoints (multi-stakeholders) often means reexamining progress and aligning incentives. As boards and company leaders focus on incorporating nonfinancial matters into overall strategy and business planning, one of the main strategies for successfully accomplishing this is by tying ESG performance to executive pay. According to findings from The Conference Board, 73% of S&P 500 companies include ESG in executive compensation packages. This approach isn’t without its pitfalls though. The first challenge is defining how to measure ESG performance as it can mean vastly different things to different companies. Some companies are more focused on Diversity, Equity, and Inclusion (DEI) changes while others are giving greater attention to carbon footprints and emission reduction goals.
Companies are taking broad steps to properly incentivize ESG performance by:
Scholarly research published in Strategic Management Journal supports that creating long-term orientation through things like ESG-adoption leads to an increase in firm value and operating performance and strategies that align incentives for high-level decision-makers (and culture-creators) can be a key driver of successful ESG performance.
