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Can Smart Buildings Curb COVID-19?

By Greg Sumner, CFA
August 2020

Over the past decade, urbanization and a desire for a greener, more energy-efficient infrastructure has driven demand for smart buildings and created long-term growth opportunities for building management systems and heating, ventilation and air conditioning (HVAC) companies. This long-term tailwind seems likely to accelerate over the near term as these companies are also positioned to provide valuable products and services to make buildings cleaner and safer during, and after, the COVID-19 pandemic.

Interview with the Author

(disclosure)

The views expressed are those of Diamond Hill as of August 2020 and are subject to change. These opinions are not intended to be a forecast of future events, a guarantee of results, or investment advice.

As of 7/31/20, Diamond Hill owned Johnson Controls International PLC (equity), Carrier Global Corp. (equity) and Honeywell International, Inc. (equity).

Indoor Air Quality

Just a few months ago, indoor air quality was seen as part of the broader wellness trend in buildings, part of a suite of features found in cutting-edge smart buildings primarily focused on reducing pollution and odors in offices to reduce absenteeism and promote worker productivity. While there are substantial and well-documented health and productivity benefits associated with improved indoor air quality, these features have unfortunately been viewed as luxuries versus necessities by tenants and building owners. However, this view has changed dramatically with the recent pandemic. With increasing evidence that COVID-19 can spread through airborne transmission, we now view indoor air quality products and services as critical safety features in our offices, stores and schools.

To dilute indoor air pollutants such as COVID-19, the Centers for Disease Control and Prevention now recommends that ventilation systems should increase the inflow of outdoor air as much as possible. However, this can have the unintended consequence of bringing in outdoor air pollutants, so the incoming air should be treated and conditioned for occupant comfort. Furthermore, any indoor air that is recirculated, which historically has been a common practice to improve energy efficiency, should be filtered as much as possible to remove the virus. Buildings where the indoor air is likely to be contaminated, such as hospitals, should further sanitize that air before it is recirculated. However, many buildings have old, outdated air filters that should be replaced with denser filters to combat COVID-19, which is too small to be captured by most filters. In addition to increased ventilation and filtration, the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) recommends keeping relative humidity inside buildings at 40%-60%, slightly higher than normal. This helps combat the virus since humidity increases the weight of droplets and aerosols causing them to fall from the air more quickly. ASHRAE also recommends building owners install air cleaning and disinfection technologies such as ultraviolet germicidal irradiation, which can potentially help neutralize some of the virus floating in the air and/or resting on surfaces such as HVAC fans. However, for these products to work efficiently, ventilation system upgrades are needed to collect and move air to the UV light.

The increased inflow of outdoor air, higher density filters, increased humidity and UV lighting that are recommended to combat COVID-19 all require larger, more powerful and more energy-intensive HVAC systems than are currently installed in most buildings. While building owners could simply upgrade to a more powerful system, they will be incentivized to also pick more energy-efficient systems, which might have a higher upfront cost but could allow for the costs of the upgrade to be offset over time by the energy savings. Companies such as Johnson Controls and Carrier should be prime beneficiaries of these trends since both companies sell the high-capacity, energy-efficient HVAC systems and UV-treatment systems buildings need to provide higher-quality air and the sensors needed to monitor air quality and humidity.

Access Monitoring, Social Distancing & Contact Tracing

None of the previously discussed indoor air quality solutions are a silver bullet that can make buildings 100% safe from COVID-19. Therefore, the CDC has also recommended companies implement procedures to screen employees for symptoms before they enter the workplace, implement policies to ensure employees social distance, replace high-touch items with touchless solutions and encourage employees to wear masks. Johnson Controls, Carrier and Honeywell are all leading building security companies whose expertise in remote video monitoring and building access control can be repurposed to maintain building safety during the pandemic. These companies have recently introduced contactless, skin temperature scanning cameras to provide real-time monitoring of individuals to identify those who might be infected. Furthermore, their cameras and artificial intelligence software can be used to ensure that employees are wearing masks and maintaining social distance, which can be used in tandem with touchless building access systems for contact tracing should an outbreak occur in the building.

Infrastructure-Related Stimulus

The COVID-19 pandemic is placing unprecedented stress on our economy, and it seems increasingly likely that the federal government will attempt to offset some stress through an economic stimulus package. While far from certain, it seems likely that any future stimulus will include provisions to help building owners implement some of the safety measures previously discussed. This type of aid will likely prove especially beneficial to schools, churches and other organizations that often host large gatherings but likely don’t have the funds or economic incentive to pay for costly upgrades.

Former vice president and Democratic presidential nominee Joe Biden has already proposed a sweeping infrastructure plan that emphasizes clean energy and a provision to upgrade 4 million commercial buildings over the next four years with more energy efficient HVAC systems while also improving indoor air quality and ventilation in lower-income rural and urban schools. While a Trump-designed stimulus plan will almost certainly not emphasize energy-saving HVAC retrofits compared to the Biden plan, his policies have historically been friendly toward commercial construction. Additionally, barring a vaccine, his administration would have every incentive to help building owners pay for system upgrades to improve indoor air quality so that Americans feel more comfortable returning to offices and stores.

Looking Ahead

While the COVID-19 pandemic and the building upgrade and stimulus spending that is likely to result from it are creating significant opportunities for the HVAC and building controls industry, it is important to recognize that these tailwinds may be at least partially offset by the work-from-home trend. As our REIT analyst Josh Barber noted earlier this year, the pandemic has forced many companies to implement remote working. If this unanticipated experiment is viewed as successful, it could have long-term implications on the demand for office buildings. While this could prove to be a bit of a headwind, we believe that our HVAC and building control holdings will be net beneficiaries of the smart building and clean energy trends and, more importantly, have company-specific, value-creation opportunities that we believe make them attractive investments.

As of 7/31/20, Diamond Hill owned Johnson Controls International PLC (equity), Carrier Global Corp. (equity) and Honeywell International, Inc. (equity).

The views expressed are those of the research analyst as of August 2020, are subject to change, and may differ from the views of other research analysts, portfolio managers or the firm as a whole. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice.

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