How Real Estate Investors are Assessing Climate-Related Risk

Topaz Simply, Senior Consultant, ESG Services
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“By 2050, up to $106 billion worth of coastal property will likely be below sea level”[1], according to the National Oceanic and Atmospheric Administration’s (NOAA) Office for Coastal Management. Given that real estate is an illiquid, long-term investment, it is especially vulnerable to the impacts of climate-related events. Therefore, proactive real estate investors are monitoring the impacts of climate change on their current and target real estate investments to determine the potential impacts.  

Specifically, climate change exposes properties to two types of risk: physical and transition[2]. Physical risk includes water damage from floods, business disruption due to facility shut down, and costs to repair damage, among others. Whereas transition risk includes reduced economic activity in vulnerable regions, increasing compliance costs, increasing insurance costs, and a resulting reduction in property value, among others.

Though there are tools and resources to help real estate investors assess the exposure level to these risks, many still struggle incorporating the risk into their investment decisions, partially because it is difficult to quantify, and partially because historical climate and weather data cannot forecast future events.

Some investors are assessing a property’s exposure level to physical risk by identifying acute (event-driven, such as floods) and chronic (longer-term shifts in climate patterns, such as sustained higher temperatures) natural disaster events that could impact the property; while evaluating exposure level to transition risk by identifying potential policies and legal trends, new technologies, and market behaviors that could impact the property. After, investors analyze the magnitude of those potential impacts and evaluate the property’s current plans and strategies, if any, to mitigate those impacts.

After assessing the risk level, investors have four primary options[3]:

  • Avoid investing in high-risk areas
  • Transfer the risk to insurance companies and tenants
  • Control the impacts by engaging with policymakers or upgrade the property’s resilience to climate impacts
  • Sell the property

As we learn more about the impacts of climate-related events, real estate investors may need to view climate-related risk analysis as an imperfect part of the new ways in which property values are evaluated.

[1] https://coast.noaa.gov/states/fast-facts/climate-change.html

[2] https://www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-TCFD-Technical-Supplement-062917.pdf

[3] https://www.msci.com/documents/10199/69c3148c-19a7-9b10-f6f0-a08b4e131860?utm_source=Real+Estate&utm_medium=website&utm_campaign=real+estate+climate+risk+2019

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