The impacts of climate change, including rising seas and extreme weather events, are quickly emerging as formidable challenges for the real estate industry and our cities.
Moody’s recently warned cities to take steps to prepare for climate change or face downgrades in their bond ratings. Last year, the International Association of Insurance Supervisors and the U.N.-backed Sustainable Insurance Forum outlined universal standards for how insurers should account for climate risks.
Neither of these actions should be surprising, because the consequences of climate change are only growing costlier. Natural disasters caused a record $300 billion in damage in the U.S. in 2017, most of it to real estate.
If investors, owners, and developers don’t act to mitigate the risks that climate change poses to their portfolios, they could suffer significant losses. That’s the conclusion of Climate Risk and Real Estate Investment Decision-Making, a new report from the Urban Land Institute (ULI) and global real estate investment firm Heitman. The report found that investors worldwide aren’t waiting to see where the next disaster strikes. They’re reviewing their assets before it’s too late.
The report points out that insurance policies can cover some damages, but investors can’t rely solely on insurers for protection. Since insurers reprice annually, often using historical data to do so, premiums are not always an effective way to assess future risks.
Further, insurance can mitigate the tangible damages caused by things like flooding, but it can’t compensate an owner for any climate-fueled decline in the future value of an asset. Eventually, insurers will stop issuing policies for assets with extreme climate-linked risks, like oceanfront properties.
Managing Physical, Transitional Risks
As a result, some real estate investors are pioneering their own alternative methods of assessing and managing the physical and transitional risks posed by climate change.
Physical risks encompass catastrophic weather events and weather pattern changes, as well as the subsequent costs -- from damage repair to adaptive measures like elevating buildings. Transitional risks include changes in regulations; available resources; and location appeal that emanate from climate change, such as increased carbon taxes or lower property values.
Together, physical and transitional risks will affect virtually every factor of a real estate investment. The joint ULI/Heitman report set out to assess both types of risk and complete full resilience scans of its clients’ portfolios.
The report found that investors aren’t running scared from places like Miami -- nor should they. Coastal areas remain highly attractive markets because they’re still among the most popular places to live and work. However, investors are taking a much closer look at high-risk areas. They are performing more detailed site level analysis on physical risks, pricing these risks into the price they will pay for higher-risk assets, and underwriting this risk into the financing of major investments.
Climate Risk and Portfolio Strategies
Investors are taking what they’ve learned about climate risk and using it to shape their portfolio strategies.
First, they’re making sure their assets can withstand and recover from extreme weather events. In New York City, several building managers shored up their properties after Hurricane Sandy. They moved backup generators to higher floors and upgraded water-pumping systems to make their buildings more resilient to flooding.
Of course, investors can’t protect entire cities all by themselves, so they’re partnering with local officials to implement climate-proofing strategies on a larger scale.
Take Miami Beach, Fla., for example. In 2013, city officials initiated a 10-year, $600 million stormwater management program to respond to rising sea levels and flooding. The program focused on installing more stormwater pumps and elevating roads and sea walls. By April 2018, the city had completed 15% of the program. Policymakers then invited industry experts representing ULI, including developers, investors, and designers from around the world, to assess the stormwater management plan and make recommendations for improvement.
The ULI advisory panel was impressed with the proactive steps the city took and offered suggestions for Miami Beach officials to go the extra mile. The experts urged city leaders to review the program’s expenses at regular intervals and integrate the stormwater program into a more comprehensive resilience plan. For instance, they suggested officials might consider investing in modeling technology to determine the costs and benefits of possible approaches to managing flooding.
Investors also are using their newly acquired climate risk intel to deploy their capital more carefully. They’re assessing climate risk as part of due diligence and other routine processes when deciding whether or not to put money into a particular area. They now view determining climate risk as a crucial layer of fiduciary responsibility.
To diversify their portfolios, investors increasingly are employing climate risk information to identify markets and assets that could become profitable as investments in climate change mitigation proliferate. Some might invest in the emerging technology itself, such as a program that helps identify rising sea levels or a company engineering large-scale cooling systems.
Best Practices for Climate Risk Integration
As real estate investors begin to integrate climate risk in their decisionmaking, they can do so judiciously with several best practices. Those include
- analyzing climate risk in annual and quarterly reports,
- using big data to understand how weather changes will affect pricing and valuation, and
- working with insurers to learn how climate change will impact premiums and coverage.
Aside from using strategies to measure climate risk itself, investors should keep three important lessons in mind.
First, it makes good business sense to plan for resiliency. A severe weather event will occur sooner rather than later.
Second, frame the least vulnerable places as the most attractive spots for investment and development. Cities are already doing so with zoning policiesφ and financial incentives.
Third, the private sector plays a vital role in future-proofing our cities. Elected officials can’t do it alone and public-private partnerships are critical.
The discussion about climate risk assessment is just beginning. There’s still a lot to learn. Investors who are prepared to adapt to climate risk will find they’ll have the potential to outperform those that wait too long.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Billy Grayson is the executive director for the Urban Land Institute’s Center for Sustainability and Economic Performance.