How climate change affects the value and risk of real estate

Climate change poses a serious threat to our well-being, our security, our economy, and our planet. It also has significant implications for the real estate sector, which is one of the biggest and most vital in the world.

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Real estate investors should consider how climate change can impact their properties, both directly and indirectly. Direct impacts include the physical effects of climate change, such as severe storms, rising sea levels, wildfires, droughts, and heat waves, that can harm or ruin buildings and infrastructure. Indirect impacts include the transition effects of climate change, such as policy actions, regulatory interventions, technological breakthroughs, and consumer trends, that can alter the demand and supply of real estate assets and affect their costs and returns.

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In this blog post, we will explore some of the key ways that climate change can affect real estate values and risks, and how investors can prepare for them.

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_{Real estate, Physical risks}

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Forbes reported that weather-related disasters cost $258 billion in economic losses in 2020, 29% more than the average for this century. These disasters can wreak havoc on real estate properties, especially those in high-risk areas such as coastal zones, floodplains, wildfire-prone regions, and urban heat islands. Some of the possible impacts of physical risks on real estate values and risks are:

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• Lower property value: Buildings that are damaged or destroyed by weather events can lose their market value and appeal to buyers or tenants. Also, properties in high-risk areas may face less demand and more vacancy rates due to real or perceived threats from climate hazards. For example, Morgan Stanley reported that coastal properties in Florida have lost $5.4 billion in value since 2005 due to sea level rise.

• Higher insurance costs: As climate risks rise, so do insurance premiums and deductibles for property owners. In some cases, insurance companies may even deny coverage to certain properties or areas due to high exposure to climate hazards. For example, Forbes reported that homeowners insurance rates in California have risen by 50% since 2015 due to wildfires.

• More maintenance and repair costs: Properties exposed to climate hazards may need more frequent and expensive maintenance and repairs to avoid or fix damage caused by weather events. For example, Business Insider reported that homeowners in Texas spent an average of $11,000 to repair their homes after the winter storm in February 2021.

• Less rental income: Buildings that are damaged or destroyed by weather events can reduce their rental income and cash flow for property owners. Also, tenants may ask for lower rents or end their leases if they are unhappy with the quality or safety of their premises due to climate hazards. For example, Morgan Stanley reported that rental income for multifamily properties in Houston dropped by 13% after Hurricane Harvey in 2017.

_{Real estate, Transition risks}

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As climate change drives action from governments, businesses, and consumers, the real estate market will also experience major changes. These changes can offer new opportunities or difficulties for real estate investors, depending on how they react to them. Some of the possible impacts of transition risks on real estate values and risks are:

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• More regulation: As governments enact policies and regulations to lower greenhouse gas emissions and support energy efficiency and renewable energy sources, real estate investors may face higher standards and requirements for their properties. For example, Forbes reported that New York City passed a law in 2019 that requires buildings over 25,000 square feet to reduce their emissions by 40% by 2030 and 80% by 2050.

• More capital expenditures: As regulations get tougher, real estate investors may need to spend more capital to improve or retrofit their properties to comply with them. For example, Morgan Stanley reported that commercial buildings in the US may need to spend $250 billion over the next decade to meet the Paris Agreement goals.

• Changing consumer preferences: As consumers become more informed and worried about climate change, they may want more sustainable and resilient features in their homes or workplaces. For example, Business Insider reported that green-certified homes sell for 7.1% more than similar non-certified homes in the US.

• Emerging technologies: As technologies advance and innovate, real estate investors may benefit from new solutions or services that can boost their properties’ performance or value. For example, Forbes reported that smart home devices can help cut energy consumption and costs by up to 25%.

_{How to prepare for climate change impacts}

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To cope with the potential impacts of climate change on real estate values and risks, investors need to implement forward-looking and flexible strategies to handle them. Some of the possible strategies are:

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• Evaluating climate risks: Investors need to evaluate the exposure and vulnerability of their properties to physical and transition risks, using data and tools from various sources and providers. For example, Morgan Stanley provides a framework for evaluating climate risk solutions for real estate investors.

• Diversifying portfolio: Investors need to diversify their portfolio across different geographies, sectors, asset classes, and risk profiles, to lower their concentration and correlation to climate hazards. For example, Forbes suggests that investors can consider investing in inland or rural areas, or in alternative asset classes such as data centers or self-storage facilities, that may be less exposed to climate risks.

• Boosting resilience: Investors need to boost the resilience of their properties to physical and transition risks, by implementing measures such as energy efficiency upgrades, renewable energy installations, water conservation systems, stormwater management systems, fire-resistant materials, flood barriers, backup generators, and insurance coverage. For example, Business Insider suggests that investors can use green bonds or loans to fund their resilience projects.

• Engaging stakeholders: Investors need to engage with various stakeholders, such as governments, regulators, tenants, lenders, insurers, contractors, and communities, to cooperate and communicate on climate-related issues and solutions. For example, Morgan Stanley suggests that investors can join industry associations or initiatives, such as the Urban Land Institute or the Global Real Estate Sustainability Benchmark, to share best practices and advocate for policy changes.

Climate change is a fact that real estate investors must face. By knowing its impacts on real estate values and risks, and by adapting to them accordingly, investors can not only safeguard their assets and returns, but also help the global efforts to fight climate change.

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