It’s not news that real estate is at risk from climate change – but what is the industry doing about facing up to future challenges?
To date the industry has been grappling with transitional risks – that is risks that result from a shift to a lower-carbon economy and using cleaner energy. These include:
- regulatory changes – such as the Minimum Energy Efficiency Standards
- economic shifts – such as a reduction in a property’s desirability due to tenant attitudes, and the changing availability/price of resources.
Most real estate investors are aware of these risks and are taking some steps towards assessing the impact on their portfolios.
However, there is another, less well understood area of risk which must be simultaneously addressed: this is the physical risk. Physical risks are impacts from:
- extreme events – such as location-specific physical threats posed by factors such as sea-level rise, hurricanes, wildfires, and heat and water stress.
- gradual changes in weather patterns
Extreme events will often result in substantial repair costs but there is also potential for increased insurance costs or reduced/no insurance availability. Tenants may also be impacted by property downtime and business disruption.
Gradual weather or climatic changes, such as increased temperature and precipitation, may cause:
- increased wear and tear leading to higher repair and maintenance costs.
- structural damage caused by soil movement due to seasonal moisture variations.
- increased overheating risks, especially in properties with large glazed areas and buildings with deep floor plates with limited natural ventilation.
- increased operating costs due to the need for more, or alternative sources of energy and/or water to operate a building.
- additional investment costs in adapting buildings (such as elevating buildings and incorporating additional cooling methods).
Insurance is seen as the foremost means to protect against weather events, but this does not cover loss in value from a reduction in asset liquidity or obsolescence. As claims increase it is inevitable that insurance premiums will rise. In addition, the insurance industry is planning to change how it funds losses and how it rewards properties that demonstrate greater climate change resilience, which means that insurance for less-resilient property will become even more costly. In order to keep premiums down real estate owners will need to ensure their property demonstrates sufficient resilience to fall within a wide enough range of insurers.
But demonstrating resilience is complicated. Although there may be clearly identifiable impacts associated with a property’s geographical location, the sector it serves and the specific building type, many risks are challenging to predict as there are so many variables. Clearly it is difficult to put a discount on something if it cannot be adequately measured. Nonetheless the onus is very much on measuring and managing the risk.
Recognising that climate change represents an economic stability risk, both voluntary and mandatory corporate reporting requirements are increasingly targeting physical risks as well as transitional.
So what can be done? Current best practice centres around four main areas.
- Mapping the physical risk associated with current portfolios and potential acquisitions by undertaking portfolio scans taking in flood, resilience, and climate vulnerability.
- Incorporating robust climate risk analysis into due diligence and other investment decision-making processes. For example, including the likely impact of climate change through flooding.
- Incorporating additional physical adaptation and mitigation measures for assets at risk – such as through using modelling for future climate scenarios to inform more resilient refurbishment.
- Exploring a variety of strategies to mitigate risk – including portfolio diversification and investing directly in the mitigation measures for specific assets through their planned maintenance or refurbishment schedules.
The assessment and pricing of climate risks is an evolving issue for the industry, especially the area of physical risk. With the complexity surrounding the emerging fields of data and technology, many are still evaluating how best to factor potential risks into their actions to mitigate perceived exposure and how to reflect concerns in financial projections. Working hand in hand with our dedicated in-house Environment, energy and sustainability team our dedicated due diligence, projects and planned maintenance teams are all on hand to provide advice reflecting the industry’s latest thinking on climate change.