Capital markets are seeking out climate risk data on real assets, and CRE firms will need to prepare
The threat of climate change and its devastating impacts have been known and studied for decades. As the effects of our changing world have become more tangible, companies are starting to incorporate physical climate risk into their business strategies—and investors are doing the same.
In August 2020, Moody’s Investor Service announced it will incorporate climate risk data and analytics in its research on and ratings process for US commercial mortgage-backed securities and commercial real estate collateralized loan obligations. It will obtain this data from Four Twenty Seven, a leading publisher and provider of market intelligence on the economic risk of climate change.
Four Twenty Seven provides climate risk data for real assets, helping owners and investors assess a building’s exposure to several physical or climate risk factors. Those include earthquakes, floods, heat stress, water stress, hurricanes and typhoons, rising sea levels, and now wildfires. Measurabl recently worked with Four Twenty Seven to pull climate risk data into Measurabl’s ESG data platform, allowing users to visualize their asset-level exposure to these risks compared with a database of more than 1 million buildings worldwide.
Learn more about PCRX, Measurabl’s new physical climate risk feature
Why Now?
Climate change has never been just an existential threat for real estate—its impacts are widespread, and resulting losses from severe weather events have only increased in recent years. Climate-related disasters have cost $650 billion globally over the last three years, and North America has absorbed more than two-thirds of the financial impact.
2019 was a particularly volatile year. In the United States alone, there were 14 weather and climate related disasters that cost more than $1 billion in damages, with a total estimated cost of $45 billion for the year. According to the most recent data available from NOAA, as of July 8 2020, there were already 10 weather and climate disaster events with losses exceeding $1 billion each affecting the United States—and these don’t count Hurricane Laura, or the historic wildfires in California.
In a survey of investment professionals published in the The Review of Financial Studies, only 7% of the respondents had “done nothing” to manage climate risks in the last five years. However, more than half of those who incorporate climate risk into their investment plans only started to do so within the past 5 years.
“Perhaps because the 2007/2008 financial crisis revolved around mortgage-backed securities, structured finance tends to be on the leading edge when it comes to systematic physical climate risk consideration in credit ratings,” says Sara Anzinger, Measurabl’s Senior Vice President of Capital Markets, and former Director of Sustainable Finance at Fitch Ratings.
“Given the fixed nature of real estate, it’s inherently vulnerable to natural hazards such as earthquakes and hurricanes,” she continues. “While such regional risks have been taken into account for years, it’s logical that as climate modeling and physical risk data evolves, its more granular resolution and forward-looking insights will be taken into consideration in fundamental credit analysis.”
Better Data for a Clearer View of What’s Ahead
It’s clear that decision-makers are being forced to focus more time and resources to assess their portfolio’s exposure to and prepare their assets for the inevitable risks. The concern is not new, but methods for obtaining actionable insights are evolving.
Until now, owners, lenders, and investors relied primarily on insurance policies to assess and mitigate their physical climate risk exposure. However, to make these assessments, insurers often rely on historical data rather than taking into account climate trends and projections.
“As climate modeling and physical risk data evolves, its more granular resolution and forward-looking insights will be taken into consideration in fundamental credit analysis.”
Sara Anzinger, Measurabl’s Senior Vice President of Capital Markets
Physical climate risk data analytics firms like Four Twenty Seven take a more sophisticated approach to determining exposure to climate risks. Its assessments are based on a combination of historical data and climate modeling and projections, rather than predicting future events based solely on how regions have already been affected by flooding, hurricanes, and other disasters. For example, Four Twenty Seven calculates wildfire potential based on a region’s meteorological conditions and vegetative fuel sources that make it more prone to wildfire spread—not necessarily whether fires have occurred in those places before.
“Climate risk has always been there, but being able to quantify and utilize these risks for decision making is paramount,” said Jason McIntyre, Director of Real Estate Operations and Sustainability at USAA Real Estate, on a recent webinar. “Our investors are asking if we’re incorporating climate risk into decision making.” We expect this trend to continue and evolve to more complex disclosure.
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Once a company has a better understanding of its climate risks, it can take steps to make its assets more resilient to sudden shocks and ongoing stressors. Or it could choose to offset the potential maintenance costs of its high-risk properties by investing in assets that are in low-risk areas. By having climate risk information easily accessible, organizations can determine what is material to their decision-making process.
One thing is clear: Capital markets have already begun to factor climate risk into their investment strategies, and commercial real estate firms will need to position themselves to answer those questions, or risk falling short of stakeholders’ expectations.