By Meghan Hall
The protection of assets is a part of the real estate business that every investor takes seriously, with responsibility to their stakeholders driving them to consider with more frequency a threat to real estate not frequently considered in market cycles prior: climate change. According to a new report released by the Urban Land Institute and Heitman LLC, there is a pressing need for real estate professionals and investors to consider the impacts that climate change can have on the value of both residential and commercial real estate.
“Understanding and mitigating climate risk is a complex and evolving challenge for real estate investors,” said ULI Global Chief Executive Officer W. Edward Walter in a statement. Risks such as sea-level rise and heat stress will increasingly highlight the vulnerability not only of individual assets and locations but also of entire metropolitan areas. This report shows that Heitman and other leading ULI members are prioritizing this issue with provocative approaches to better gauge and develop mitigation strategies. Building for resilience, on a portfolio, property and citywide basis, is paramount to staying competitive. Factoring in climate risk is becoming the new normal for our industry.”
The real estate industry, overall, is often slow to adapt to change and has only just begun to consider on a wider scale the impact climate risk could have on assets. Globally, the number of extreme weather events has increased by more than 250 percent between 1980 and 2013. According to the report, the increase in the number and intensity of severe weather-related events, from hurricanes to earthquakes to flooding, has demonstrated the risks that climate change presents to the real estate market. The physical and transitional risks associated with climate change have financial ramifications for real estate owners and operators. Physical risks, such as catastrophes, can lead to increased insurance premiums, higher operational costs and a decrease in the liquidity and value of buildings, the report states. Traditional risks — considered those that center on the economic, political and societal responses to climate change — can also have an impact, leading to individual assets becoming less appealing, the report states.
Homes vulnerable to flooding in Florida, Georgia, North Carolina and South Carolina, for example, have lost $7.4 billion in value between 2005 and 2017, the report states. The New York Metropolitan area also saw devaluation of $6.7 billion occur over the same time period because of increased flooding from sea-level rise. Commercial real estate in areas impacted by hurricanes saw its value decrease by six percent one year after a major storm and 10.5 percent two years after.
The report found that most investment managers and investors still use insurance as their primary means of protection against climate-related events. While insurance has often been the go-to solution for the protection of investments, industry players have found that insurance premiums have gone up or that coverage has gone down. In 2017, insurers paid out $307 billion in damages in the United States alone, the National Oceanic and Atmospheric Administration estimates. While insurance provides short-term protection, Heitman and ULI find that it cannot protect investors from a long-term reduction in an asset’s liquidity or depreciation in value that occur as a result of climate change.
As a result, investors see climate change considerations as an additional layer of fiduciary responsibility to their stakeholders, revealing a need for better tools with which to identify markets and assets that will benefit from a changing climate. According to ULI and Heitman, most companies are not establishing new policies to mitigate climate risk and are rather modifying existing decision-making process to incorporate climate change considerations into the mix.
“Climate change will affect valuation and markets,” the report states. “An eventual downward repricing of higher-risk assets will be the market’s way of redirecting capital
to locations and individual assets where it is better used. But the markets are far from understanding climate risks enough to price them in today. This process will be painful for investors who are caught off guard, but those who are prepared have the potential to outperform.”
Some of the tools that could help investment managers to build climate risks into their investment processes include: mapping physical risk for current portfolios and potential acquisitions, incorporating climate risk into due diligence and decision-making processes, engaging with policy makers on local resilience strategies and portfolio diversification. These methods, the report states, are just beginning to break into the real estate investment industry, but they will be pivotal in the future for investors hoping to build more resilient portfolios.
“Opportunities are emerging across the real estate industry for investment managers and investors to better assess climate risk and navigate the potential impacts of climate change on assets and portfolios,” said Maury Tognarelli, Heitman chief executive officer. “More accurate, forward-looking data on the risks associated with climate change are becoming available, positioning the industry to incorporate climate risks into how investments are underwritten and portfolios constructed. Ultimately, we hope this report will spur discussion among real estate industry participants with the end-goal of improving the investment outcomes for our clients and constituents.”