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Physical Climate Risk: What Does it Mean for Real Estate Owners and Investors?

The physical world around us is changing, and companies everywhere are racing to adapt. Many businesses over the past decade have focused their efforts on sustainability — adapting their practices and adopting new technologies to reduce their impact on the environment. Only recently have leaders begun to consider how to make their companies more resilient to the inevitable effects of climate change. 

For commercial real estate owners and investors, the first step toward ensuring resilience is to gather data about their assets in order to accurately assess their exposure to physical climate risk. With this information, real estate operators can mitigate or adapt to the effects of shocks (sudden climate-related events) and stressors (long-term changes).

What is Physical Climate Risk?

When we talk about physical climate risk, we’re referring to hazards caused or exacerbated by climate change that can directly affect the value of assets. These include floods, heat stress, hurricanes and severe storms, rising sea levels, and decreased rainfall. Simply put, buildings are exposed to various sets of risks depending on their location, size, design, and materials. Buildings located in areas more affected by these conditions may become increasingly expensive to repair, maintain, and insure. These assets may also become less valuable and therefore more difficult to sell. 

For a vivid illustration of this concept, see Hurricane Florence: The massive storm made landfall in the southeastern United States in September 2018, damaging approximately 5,545 commercial assets owned by 94 U.S. REITS. Such natural disasters cause business disruption and downtime, raise the costs of maintenance and repair, and ultimately increase operational costs as owners are forced to carry out expensive projects such as building hardening and constructing building risers to prepare for future disasters. 

The destruction left behind by Hurricane Florence is just a single example of a growing trend: In 2019, insurers paid out $150 billion globally for damage caused by storms and natural disasters, topping 2017’s record of $135 billion in insurance payouts. 

Rising Concerns

Major storm systems aren’t the only factors to consider when assessing a building’s physical climate risk. Investors and owners also need to consider an asset’s exposure to other shocks, like earthquakes and floods, and slow-burning, less visible stressors, like rising sea levels, warmer temperatures, and reduced rainfall. Buildings in areas affected by these conditions, which have become more severe over time, will likely incur higher operational costs as they install risers, additional cooling systems, or alternative water supply systems to compensate for drought conditions.

While stressors are often more predictable and less dramatic, they are still a very real concern: More than $130 billion of U.S. institutional real estate is in metropolitan areas that rank in the top 10 percent for exposure to sea-level rise, according to a study by Heitman and climate risk analytics firm Four Twenty Seven. 

The effects of climate change are so profound, however, that every single building is exposed to some level of physical climate risk. So the question is not “Am I exposed to risk?” but rather “What am I exposed to?” and moreover, “What is my level of exposure?”

Understand Risks to Identify Opportunities

So whose job is it to pay attention to physical climate risk? According to a study by Heitman and the Urban Land Institute (ULI), the commercial real estate sector continues to rely primarily on property insurance policies to manage climate-related risk from year to year. The problem with this dynamic is that insurance companies often rely on historical data about an area to assess risk, rather than examining climate trends that can identify regions that are vulnerable to future catastrophes. And over time, it will likely become more difficult to obtain or afford property insurance for buildings in certain high-risk areas. 

When real estate owners and asset managers take charge of their own asset-level data, they can understand their own risk on a deeper level and use that data to diversify their portfolios. They can also assess the true value of their own properties not just by examining risk but also by assigning value to projects that will make their buildings more resilient. In addition to retrofit projects, resilience can be taken into account during building design and construction — and not just in areas currently deemed high-risk.

ESG Will Play a Crucial Role

Sustainability remains a deeply important factor in the commercial real estate industry. But resilience in the face of physical climate risk is an increasingly important metric that will begin to drive investment decisions and determine which assets will thrive and which will ultimately deteriorate.

That’s where ESG comes in. ESG data measures more than just sustainability, which refers broadly to a company’s efforts to lessen their impact on the environment. It also incorporates asset-level data to examine electricity, water, and waste systems as well as building updates and projects that can increase an asset’s resilience to environmental factors and disasters. 

Having a clear, seamless way to collect, analyze, and report both sustainability and resilience data will go a long way in helping real estate owners and investors maintain access to capital and prepare to do business in an increasingly unstable climate.  

To learn more about physical climate risks and the ways they might impact your assets, register for our webinar, “Physical Climate Risk: Identifying Your Exposure with Measurabl” on June 4, 2020.

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