Climate change is already making an impact on commercial real estate. Is the industry ready to rise to the challenge?
Infrastructure and buildings are on the front line of climate change, along with the professionals that build, support and optimize them.
“All companies are under increasing pressure to report climate change risk to their shareholders,” said CBRE Vice Chairman Paul Morassutti, speaking at the 2020 Market Outlook Breakfast. “Climate risk will manifest itself in commercial real estate in numerous ways.”
This statement comes on the heels of Morgan Stanley’s recent analysis that climate change will make it riskier to invest in commercial real estate debt, with investors owning nearly $60 billion of bonds backed by mortgages vulnerable to flooding.
That’s not to mention the estimated 35.0% of all REIT properties around the world currently exposed to climate hazards like inland flooding and hurricanes.
It’s a sobering picture, and one that requires further examination. How can the commercial real estate industry respond to these challenges – and is it ready to?
Properties at Risk
One of the most pressing climate concerns is flooding. According to a 2018 report, an estimated 300,000 residential and commercial properties could face disruptive flooding by 2045, threatening $135 billion in property damage – and that’s just in the U.S.
The same report noted that many investors and developers of coastal real estate are failing to factor flooding risk into their current value projections.
The International Monetary Fund has introduced the concept of “stranded” property assets, which become physically inaccessible and financially less valuable due to climate change.
A Multi-Headed Problem
There are more gradual climate risks to consider, including sea-level changes, varying weather patterns, drought and heat stress.
While not as dramatic or identifiable as a natural disaster, these forces can damage properties over time, leading to higher maintenance and operating costs.
Properties struggling to adjust to these changes may be more vulnerable to serious climate events, including hurricanes, wildfires, typhoons and earthquakes.
Whether it’s a single event or series of stressors, high repair and replacement costs could trigger a decrease in property value.
And while the real estate industry has traditionally relied on insurance to cover shorter-term climate risks, that could be about to change.
As climate events increase in high-risk areas, insurance availability could be drastically reduced and premiums could soar.
The Path Forward
“What has become clear is that countries and companies can forget about business as usual,” says Morassutti. “For large owners of real estate, it will become harder to raise capital if you don’t have good governance around your climate risk reporting.”
It’s a sentiment echoed by Urban Land Institute (ULI) Global CEO W. Edward Walter, who spoke of the importance of risk reporting upon the release of a climate risk report in 2019.
“Building for resilience, on a portfolio, property and city-wide basis, is paramount to stay competitive,” he shared. “Factoring in climate risk is becoming the new normal for our industry.”
Moving Ahead of the Pack
That means those looking to make their mark on the industry will have to factor climate change into every business decision, large and small.
Those who are successful at doing so could find themselves at a serious competitive advantage.
“Imagine two REITS with similar financial performance, but one has relatively low-risk assets and one has high-risk assets,” says Morassutti. “The potential for differentiation in price and future valuation is significant.”
The ULI report makes a similar point, commenting, “…this process will be painful for investors who are caught off guard, but those who are prepared have the potential to outperform.”
As data projections on climate risk become more accurate, the commercial real estate industry should begin to incorporate this information into how investments are underwritten, and portfolios are constructed.
When it comes to strategies to address the impacts of climate risk, understanding the level of exposure is the first step.
Investors will have to become proactive when examining new additions to their portfolio, using available data to make informed choices.
Mapping physical risk for current portfolios and potential acquisitions is essential, as is incorporating risk into due diligence assessments.
Investors may also consider portfolio diversification or investing directly in mitigation measures for certain higher-risk assets.
Climate change has yet to deter from commercial real estates prized status as a stable, income-producing asset class, but it has never been more important to consider climate change when planning and making investment decisions.