Gone are the days of place-based property investing informed by economic growth and demographic trends alone. As the world heats up at an alarming pace, today’s private real estate investors must now factor an array of climate-related risks into their decision making, from asset obsolescence in the face of mounting sustainability priorities, to the rise of natural disasters and extreme weather.
To manage such risks, managers are beefing up their research efforts. This week alone, two of the sector’s global powerhouses announced notable upgrades to that effect.
In the latest iteration of its European Cities Growth Index, Chicago-headquartered LaSalle Investment Management included a metric for extreme weather conditions for the first time in its 24-year history. The ECGI ranks the top cities in Europe for projected occupier demand in real estate, and is calculated by weightings of 45 percent to economic growth, 35 percent to human capital factors and 20 percent to business risk and extreme heat. The metric for extreme heat is based on data that tracks worsening weather conditions over the next 50 years from Copernicus Climate Change Service.
The effect on the ranking is stark. Florence, Palermo, Bologna, Rome and Marseilles-Nice are the five cities most negatively impacted on the ECGI index by a projected increase in the number of extreme heat days in the next 50 years. Barcelona is the only Mediterranean city to feature in the top 20 cities in this year’s edition of LaSalle’s index, but in position 17, it has slid from ninth spot in 2022 – clear evidence of the projected impact of extreme heat on the city’s attractiveness.
Any adverse impact of such analysis on capital flows into markets as deep and established as Barcelona’s will take time to play out. But overlay this with another pressing set of climate-related risks and the picture becomes more complex.
Transition risk, which LaSalle’s city-level index does not take into account, is also a growing focus for managers cognizant of the huge momentum behind ESG investing – particularly in Europe, where sustainability regulation is most advanced.
A case in point, Boston-based manager AEW published a research report this week in which it combines transition and physical risk into a single climate-related risk premium for European real estate. This is the first time it has calculated such a premium, which it estimates at 19 basis points for prime assets and 46bps for non-prime assets. The firm’s head of research & strategy for Europe, Hans Vrensen, said these estimates are “manageable for the industry as a whole within the context of wider capex budgets.”
Feasibility aside, however, it is likely a view of real estate value through a holistic climate-related lens will have significant implications on capital flows in an era of capital-constrained budgets and volatile property valuations. Take transition risk out of AEW’s analysis and the map of investable cities looks very different. Take extreme weather modeling out of LaSalle’s index and there is much movement on the ranking.
Overarching financial pressures are subduing investment volumes today, making trend identification patchy. But the complexion of future investments will reveal just how much these managers are adhering to this new science.