Insurance is too short term to meet climate change’s resiliency challenge

The name of the private real estate game is creating core assets, so managers of closed-end strategies must plot investments for real estate that outlast the lives of their vehicles.

Last Friday, the US government released a significant report on climate change that should provoke the private real estate industry to take further action.

The Fourth National Climate Assessment, a co-ordinated effort by 13 federal agencies, concluded that climate change is caused primarily by human activities, the effects of which are already being felt in the US. The report observed rising seas, frequent flooding, increasing wildfires and higher temperature extremes caused by climate change, and predicts conditions will only worsen. Without action to significantly mitigate greenhouse gases and adapt to these new threats, the researchers expect substantial damages to property, infrastructure and, more broadly, the US economy.

To an extent, the private real estate industry should be commended for its efforts to curb, and respond, to man-made climate change. The sector already has a promising adoption rate of ESG standards, thanks in part to demands from institutional investors.  The GRESB benchmark has grown from less than 200 participants in 2010 to more than 900 in 2018, according to the latest GRESB Real Estate Results. Green Stars (entities scoring higher than 50 on the GRESB assessment) increased to 78 percent in 2018 from 70 percent in 2017, demonstrating an integrated organizational approach toward measuring and managing environmental indicators.

However, this latest government report shines a more severe light on resilience efforts, particularly considering the increasing frequencies of severe weather conditions and natural disasters. California’s recent Camp Fire resulted in estimated losses of $8 billion-$9 billion in residential properties and $3 billion-$4 billion in commercial assets, according to data provider CoreLogic. Hurricane Harvey, which hit Texas in 2017, caused an estimated $125 billion in damage, according to the National Oceanic and Atmospheric Administration. The threat of more natural disasters is only intensifying, Miami being a case in point with rising sea levels threatening coastal properties.

At this stage, it seems private real estate does not have a uniform response to tackle threats posed by climate change. Investment managers view insurance as the primary means of protection, according to research by the Urban Land Institute and Heitman. The Washington, DC-based nonprofit research organization and global real estate investment manager interviewed institutional investors, investment managers and investment consultants around the world for their project, Futureproofing Real Estate from Climate Risks. In conversation or at conferences, few investment managers bring up climate change as a key area of concern they are actively trying to combat.

Insurance, while helpful of course, is a short-term solution and the industry should not accept this as the standardized response to climate change. Understandably, that short-term solution is a by-product of limited life strategies unlikely to see the immediate effects of climate change. However, it is important to note that this short-term solution does not put the core investor, or the tenant customer in today’s parlance, at the heart of the equation.

There are additional measures managers can adopt in addition to insuring their assets. Some firms have begun to use climate change data to identify locations and properties that are, or will, be vulnerable to environmental changes. Choosing to actively invest in locations that will face fewer risks in years to come is one way to build a more climate change resilient real estate portfolio.  Another way is exploring the addition of physical enhancements such as seawalls, increasing asset elevation or building with fire-retardant materials. In Florida and California, local governments have already taken it upon themselves to pass building codes that require buildings to meet a level of flood resistance or fire resistance.

Each will carry their own cost implications, but these solutions are theoretically longer dated than insurance alone and should be underwritten into investments to eventually achieve core status. Insurance can help repair a property after disaster, but it cannot prevent the asset’s value from falling. Being proactive in resilience efforts can help an asset look more appealing years from now to when it is time to exit.

It is easy to forget the name of the private real estate game is creating core – and to do that, the viability of the asset must be as long and as durable as multiple leases. Meeting the resilience challenge is now a key part of that for managers and investors should see to it that they are alive to the idea.

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