Climate risk makes real-estate investors skittish

Investors are increasingly holding off on buying properties until they consider the likelihood of extreme weather events, and the resiliency of the buildings, affecting their profitability.

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What’s the likelihood of a cat 4 hurricane hitting that new lifestyle center within the next few years? Is that proposed mall site too close to the coast, given the encroachment of the ocean in recent years? If wildfires hit the community surrounding a strip mall, will enough of the population stick around long term to support that retail? Such thoughts are increasingly on the minds of those considering investing in real estate. And to make informed decisions, they want better data.

The most climate-aware investors are increasingly taking a hard line on local climate risk.

Real estate investors have expanded their analysis of climate risk to explore impacts at the market level, according to a new report by real estate organization Urban Land Institute (ULI) and real estate investment management firm Heitman. Core factors in investment decisions now commonly include local climate risks, such as wildfires, increasingly frequent and intense storms, and sea-level rise, Climate Risk and Real Estate: Emerging Practices in Market Assessment finds.

While exact weighting of climate risk varies from one investor to another, climate risk is influencing investment outcomes more overall. Certain investors are starting to pull back from investment in some local property markets due to lack of climate resilience.

“The most climate-aware investors are increasingly taking a hard line on local climate risk,” says Ed Walter, CEO of ULI. “They are looking beyond the individual asset and assessing a city’s preparedness for climate change, but the models and metrics they need are still in their infancy. Benchmarking cities for climate risk and resilience is a challenge, and I anticipate significant progress from the industry on obtaining this much-needed data.”

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Heitman CEO Maury Tognarelli notes that market-level risk assessment is critical component to making investment decisions. “Due diligence screens must incorporate the accelerating risks posed by climate change, fiscal policy constraints, and critical infrastructure investment, repair, and replacement,” he says. “The data management and business intelligence tools required to assist investors in making decisions about these factors continue to evolve. This evolution, combined with the depth of real estate experience and judgment found within the industry today, should result in improved portfolio construction and the proper management of these growing risks.”

Better data is needed

Investors need better data and frameworks to make market-level impacts transparent and allow benchmarking between markets, the report finds. In the context of accelerating climate change, they need information about city-scale risk and resilience in order to understand the impacts. 

The pandemic could undermine responses to climate risk.

The report warns that the global COVID-19 crisis, and the stress it has placed on local governments, could undermine responses to climate risk by diverting funding earmarked for resilience infrastructure. While investors recognize the need for temporary diversion of resources for COVID response, they cite the need for additional funding sources to develop adequate resilience infrastructure.

Investors agree that consistent and reliable information about city-scale risk is needed, according to the report, which was developed in collaboration with Arup and Milliman. Real estate investors are increasingly keen to understand the physical risks facing a city, the adequacy of existing infrastructure in the face of climate change, the planning and financing of new resilience infrastructure, and the capacity of city governance to manage risk. 

Long-term solutions needed

To date, the majority of the financial impacts of climate change have been mitigated by the operation of insurance, disaster relief, and public sector accounting conventions. These mitigants alone are unlikely to be sufficient to address the expected climate-related risks ahead. But the report points to a longer-term solution for the most affected regions that will likely encompass a collective public and private approach informed by market selection decisions of employers, residents, and institutional investors.

Information about city-scale risk will also help city governments create a more robust business case for major resilience measures, alongside more transparent accounting for the actual costs of catastrophic climate events. The economic benefits of resilient infrastructure projects include job creation and retention, preservation of the tax base, and avoided losses.

Climate Risk and Real Estate: Emerging Practices in Market Assessment sets out how the real estate industry can improve understanding of market-level climate risk, including ways to:

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• Develop strategies to measure market resilience considering the physical risks a market faces, the preparedness of its infrastructure for climate change, and the city’s fiscal condition.
• Link market-scale analysis with asset-level physical risk assessments.
• Explore the role of the real estate industry in supporting funding mechanisms for future infrastructure and resilience initiatives.
• Facilitate collaboration between policymakers, chief resilience officers, real estate investors, and investment managers.
• Work with the insurance industry and actuaries to refine tools to reflect current and future climate risks.
• Partner with the valuation industry to build climate risk into appraisals.

Cities subject to population loss from climate change

Globally, most major economic hubs are in coastal locations, river deltas, or other high-risk areas and these cities house more than half the world’s population.

Climate migration may become more common, thanks to intensifying climate change.

Some cities threatened by climate change, such as Cairo and Jakarta, are moving their populations. In the U.S., people have picked up and moved after disasters such as Hurricane Katrina, Hurricane Maria, and the 2020 wildfires. Such climate migration may become more common, thanks to intensifying climate change risks and rising costs to insure, protect, or rebuild property.

Climate change is increasing the frequency and intensity of many weather events that result in catastrophic losses, including extreme precipitation, drought, floods, tsunamis, wildfires, heat waves, and landslides. Globally, there were 40 disaster events in 2019 that resulted in at least $1 billion in near-term, direct losses each – part of an upward trend of billion-dollar disasters. Worldwide losses from extreme weather events from 2010-20, some on a smaller scale, totalled over $3 trillion.

The full report is available at http://uli.org/climateriskmarketassessment