Urban Land Institute on pricing in climate risk

The executive director of the Urban Land Institute’s Center for Sustainability and Economic Performance, Billy Grayson, highlights emerging best practice.

Billy Grayson

The year 2017 was a record one for property losses from extreme weather events – hurricanes, droughts, wildfires, inland flooding, and other natural disasters were responsible for $330 billion in losses, $195 billion of which was uninsured, according to The New York Times. With the frequency and magnitude of extreme weather events increasing each year, and recognition of the long-term impact of climate change increasing in both the public and private sector, investors are beginning to take a serious look at how they are integrating these risks into their real estate investments.

Understanding and mitigating the risks associated with extreme weather events and long-term impacts of climate change present a complex and evolving challenge for real estate investors – risks like sea level rise, droughts and extreme heat will have a profound impact on real estate values, but the timing and magnitude of these impacts is difficult to predict.

The future cost and availability of property insurance and the strategies cities will use to address climate vulnerabilities – and their associated cost on real estate in the form of new building codes and taxes – further complicate the challenge of assessing these risks and pricing them into investment decisions.

Leading asset managers, investors and real estate owners are working to develop strategies to assess and mitigate the long-term risk of climate change. Through their efforts to begin addressing these risks, a set of best practices is emerging for real estate.

Assess physical risks

An important first step for most investors is to better understand the physical risks in their portfolio. Some are turning to an emerging set of software and data analytics providers, which are mapping their assets’ risk using global models for the increase in frequency and severity of extreme weather events, and climate change’s anticipated impact on sea level rise, extreme heat and the prevalence of droughts and wildfires.

Others are calling on their assets to assess, report out on and start mitigating these risks using emerging global reporting standards from CDP and the Task Force on Climate Related Financial Disclosures (TCFD). Companies analyzing these risks are finding the highest risk assets are usually found in regions subject to multiple climate-related risks, and in buildings that may be outside the FEMA 100-year flood zone but in regions where this flood level has been exceeded multiple times in the last 10-20 years.

Integrating transition risks

The second step is to evaluate transition risks – the possibility that markets vulnerable to climate change will see major shifts in the cost and availability of property insurance, the cost associated with new regulations to address climate change, and a potential increase in sales and property taxes for cities to pay for building and infrastructure investments to manage their climate risks.

Investors are modeling how aggressive cities will be in mitigating their climate risks, and the way in which these cities will pay for these investments. Cities that act quickly and decisively are likely to reduce long-term risks to asset value, but may require bigger short-term costs on real estate to pay for these investments. Cities that do not make these investments in a timely manner will increase the likelihood that properties will be at a higher physical risk, and for markets vulnerable to climate change, they may become less desirable to residents and tenants over time.

Pricing climate risks into investment decisions

As investors build models to assess the risks associated with climate change, they are beginning to apply these models to their investment decisions.

Some investors are using these models in acquisition due diligence – to help them better assess the long-term value of assets in high-risk areas, and to help underwrite investments in mitigating long-term climate risk into their capital plans. Others are using climate risk to help them identify properties in their portfolio to engage around mitigating long-term climate risks – investments that ‘harden’ these buildings and make them more resistant to extreme weather events and long-term climate threats.

In the near future, some investors are considering a strategy to divest from assets that have the greatest long-term climate change vulnerabilities, and in some cases to exit markets completely where they believe the long-term risks outweigh the cities’ ability to cost-effectively mitigate them.