How can we manage climate risk in real estate investment?

Three months before the World Built Environment Forum meets for its fourth Summit on the topic of the Future of Investment in Real Assets, ULI's report: Climate Risk and Real Estate Investment Decision-Making is a timely contribution to the thinking on this complex challenge.

Published in collaboration with global investment manager Heitman LLC, the research addresses the state of current practice for assessing and mitigating climate risk in real estate as well as highlighting best practices across the industry.

The 2018 edition of the World Economic Forum's Global Risks Report 2018 identified extreme weather events, natural disasters, and the failure of climate change mitigation and adaptation as being most likely to occur and to have the greatest impact globally.

Climate risks may result in increased exposure to loss as assets become less liquid and generate lower income. In 2017, Hurricanes Harvey and Maria, and storms in Europe were important factors in insurers paying out a record $135 billion globally for damage caused by storms and natural disasters. In the US alone, the National Oceanic and Atmospheric Administration estimates that actual damages were $307 billion. Subsequent studies estimated that homes vulnerable to flooding in several US states had lost $7.4 billion in value between 2005 and 2017. The New York metropolitan area experienced devaluation of $6.7 billion in the same period due to flooding from sea-level rise.

Investors would therefore do well to gain more accurate data on the impact of climate risks; some may opt to invest in locations at the forefront of climate mitigation.

The report categorises climate risks as physical and transitional. Physical risks include extreme weather events and typically lead to increased insurance premiums, higher capital expenditure, increased operational costs, and a decrease in the liquidity and value of buildings.

Transitional risks are economic, political, and societal responses to climate change. In some cases, climate change could make entire metropolitan areas if not whole countries lose their appeal to investors and citizens.

The report cites a 2015 study published by RICS which modelled the potential for increased costs of running a building in eight European Union countries if commercial buildings were not retrofitted to address climate risks. The model indicated that by 2050 the total increase in energy bills from 2010 levels for the eight countries would be £457 billion. For Germany, Spain, and Greece, the cost would be more than eight percent of their gross domestic product.

Seeing these growing challenges, insurers are exploring new approaches, to develop better tools and common standards to help the industry better price-in climate risk.

While acknowledging the role of insurance in risk management, the report recommends that risk-financing strategies need to look at risk mitigation and risk retention. Real estate owners should build portfolios that are attractive to the widest range of risk transfer capital available.

ULI and Heitman point to several practical steps for the real estate industry:

• Improved reporting on climate risk in annual and quarterly resilience reports
• Use big data to better understand patterns around changes in asset liquidity, valuations, and weather forecasting
• Work with the insurance industry to understand data and gain knowledge on how climate change is affecting premiums and coverage.
• Engage with city leadership in vulnerable areas to support city-level commitment.

ULI will be leading a session at the World Built Environment Forum Summit in New York, in which they will discuss the impact of climate risk on real estate investment.