Climate Change Presents a Challenge for CRE Investors

The climate is changing. Just last month, a series of supercells spawned tornadoes—including one twister destroying homes and killing dozens on a 200-mile rampage in Kentucky. Canada’s 2021 wildfire season included over 54,000 fires burning more than 6.8 million acres. Some of those fires forced closures of the country’s largest timber mills, driving prices to $1,500 per thousand board feet and putting pressure on the US construction industry already struggling to supply increased demand. 

In 2020 alone, over 400 global weather events caused widespread damage totaling, according to some estimates, $268 billion. Hurricane Harvey inflicted $125 billion in damages when it clobbered Houston in 2017. The past three wildfire seasons have cost an estimated $10 billion.

There’s no question, based on the number of severe weather events that just continues to increase—and cause billions of dollars in damage globally each year—that climate change remains a significant concern. 

The commercial real estate sector has felt the effects of weather-related disasters. And according to a new report from Yardi Matrix, CRE investors and experts are factoring environmental, social, and governance (ESG) issues and factoring market-level climate risk into their decision-making at the market and asset levels.

Metros with Least (and Most) Environmental Risk

In its report, Yardi ranked 21 metros based on environmental risks, such as hurricanes, rising sea levels, tropical storms, and wildfires. The goal? Helping CRE investors assess economic impact of natural disasters and cities’ abilities to mitigate climate change’s effects through various resilience strategies.

The report identified four metros with the least environmental risk: Boston, Indianapolis, Minneapolis, and Portland. “The commonality for all was being in states that are taking environmental risk seriously,” the report said. “Boston and Indianapolis received the highest grades in three categories and the lowest grade in one. Minneapolis and Portland received high marks for government action and propensity for natural disasters and middle grades for pollution and water quality.”

Metros at the bottom of the list included Auston, Dallas, Houston, Los Angeles, and Tampa. The Texas metros scored low in both government response and natural disasters because of the February 2021 storm that resulted in nearly 10 million power outages, an estimated 400-900+ deaths, and nearly $197 billion in damages.

The World Green Building Council shared its vision for new buildings and infrastructure to achieve 40% lower embodied carbon emissions by 2030 and 100% net zero emissions in new buildings by 2050. 

Climate change includes a range of physical and indirect transitional risks within real estate which contributes—directly and indirectly—about 39% of greenhouse gas (GHG) emissions worldwide.  The greatest risk involves the threats of rising costs thanks to pricing-in of carbon emissions as well as:

  • Overall higher energy costs
  • Even more stringent building codes
  • Shifting market expectations
  • Economic obsolescence

But to mitigate and decrease exposure to those risks requires more technical tools like the new Carbon Risk Real Estate Monitor (CRREM) Risk Assessment Tool. Developed as part of a CREEM project focusing on best practices for climate change risk management, the tool will help the CRE sector better align with the Paris Climate Accord targets (limiting global warming to below 3.6°F/2°C by 2050). 

The CRREM tool was designed to give investors and stakeholders a clear roadmap for individual assets or portfolios on strategies for reducing the carbon footprint until we reach the 2050 goal. Users can measure risk of individual property and portfolio noncompliance with stricter GHG and future energy reduction targets, possibly triggering assets to become “stranded” temporarily.

According to the report, “So-called ‘stranded assets’ are properties that require costly capital expenditure by being exposed to the risk of early economic obsolescence due to climate change, as they will not meet market expectations and/or future regulatory efficiency standards. The CRREM tool incorporates the benchmark for individual building’s carbon performance against the Paris aligned decarbonization pathways to provide a carbon risk analysis including the year of stranding, excess emissions, carbon, and energy costs.”

The tool calculates each asset’s baseline emissions including the climate and grid-asset performance over time. It displays carbon performance analyses for single and aggregated (portfolio) assets. While developed within the EU, this tool allows users to choose the country and integrate the appropriate data including:

  • Energy prices and their development over time
  • Climate transition pathways/sectors
  • Country specific decarbonization pathways
  • Emission factors for different energy sources and the evolution of emission factors over time
  • Location-specific heating/cooling degree days (HDD/CDD) and their evolution over time

Adopting a Market-Risk Assessment Approach

A BlackRock survey of 425 investors found 88% of respondents controlling $25 trillion of assets agree climate change is a risk. Seventy-five percent will account for ESG in their portfolios. A majority also plans to double allocations to funds with ESG components by 2025. 

The Climate Risk and Real Estate report, released by the Urban Land institute offers other recommendations for assessing markets in a world increasingly affected by climate change. Strategies to help inform CRE investments can include:

  • Understanding the physical risks to the market—and understanding these risks may differ from individual asset risks
  • Reviewing infrastructure like flood walls, levees, and stormwater retention systems, to evaluate quality and effectiveness
  • Assess a market’s climate risk history and future exposure. Identify recent climate events or the probability of a climate event. Have companies left? Has the population moved out? Have insurance premiums increased?
  • Review local governments’ approaches to climate change. Is there a comprehensive plan to address, assess, and mitigate climate-related risk? Do tactical infrastructure and resilience-building investments exist (or have they been prioritized)?

Whatever the future holds, the CRE industry will see the development of new assessment methodologies and tools to quantify market-scale risk and resilience. As those tools are built and implemented, climate risk will factor even more significantly into investment decisions. 

For those investors considering adding properties to their portfolios—or just venturing into CRE investments—talk to the professionals at CREA United. A group of over 70 professionals with decades of CRE experience, this organization offers collaborative solutions to support business goals. 

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