Government action on infrastructure development and energy efficiency can help the industry prepare for an uncertain future.
Last year, the United States incurred $91 billion in costs from weather- and climate-related disasters, making it the fourth most expensive year since 1980, with the top three years all occurring in the past decade. Fourteen events – including hurricanes, drought, wildfires, flooding, severe winter and hail storms, and tornadoes – topped $1 billion in damages, according to the National Oceanic and Atmospheric Administration.
“Climate Risk and Real Estate Investment Decision-Making,” a recent report from the Urban Land Institute and Heitman, notes that insurers paid $135 billion globally in 2017 in response to damage caused by storms and other natural disasters. The actual costs were much higher, with the National Oceanic and Atmospheric Administration estimating $307 billion in damages within the United States. The 1980-2018 average for weather and climate-related disasters is 6.3 events, but from 2014 to 2018, that average increased to 12.6 events. In March 2019, the Pentagon sent Congress a list of bases most at risk from climate change risks.
This increase in climate-related disasters and weather events is already impacting property valuations in certain risk-prone areas. A 2018 study from the First Street Foundation estimated homes vulnerable to flooding in the New York metro area collectively lost $6.7 billion in value from 2005 to 2017. Experts used this same methodology to examine residential properties in 22 states to determine the collective erosion of property values in coastal areas. The study examined three million coastal residential properties in Texas, concluding they collectively lost $76.4 million in value.
Commercial properties are also vulnerable. A May 2018 article in National Real Estate Investor noted that two years after experiencing a hurricane, five commercial property types – including apartment, industrial, office, retail, and hotel – saw a 10.5 percent drop in valuation.
Impact of Climate Risks
When examining the impact of climate change, scientists and policymakers have defined risks as either physical or transitional. Properties most vulnerable to weather-related disasters are at risk of both physical damage and a loss in value. The Urban Land Institute and Heitman report notes that physical risks include climate catastrophes that directly affect buildings through extreme weather, wildfire, and sea level rise. The impact on buildings from physical risks would include costs to replace or repair damaged property; business disruption because a property is out of service for a time period; and increased wear and tear on a property due to changes in weather patterns such as extreme temperatures, high winds, and increased precipitation.
Transition risks include changes in market preference, increasing costs of energy and water, reduced economic activity in vulnerable markets, and increasing compliance costs. Insurance will generally cover physical risks, but it may not address losses from transitional risks. As the ULI and Heitman report explains, “insurance will cover damages from catastrophic events; it will not cover loss in value from a reduction in the asset’s liquidity.”
For properties in locations especially vulnerable to flooding, fire, or other climate-related risks, it is unclear how long insurance coverage will be adequate to protect against such risks. An October 2018 Wall Street Journal article noted, “Big insurers are expanding teams of in-house climatologists, computer scientists, and statisticians to redesign models to incorporate the effect of the warming earth on hailstorms, hurricanes, flooding, and wildfires.” It remains challenging to predict such risk with precision, because historical data cannot dictate future risk.
While the impact of these risks on the insurance industry is not entirely clear, the ULI and Heitman report notes that volatility in premiums will likely increase, though mitigation measures can lower premiums or temper their increases. These measures could include additional cooling systems, building hardening to secure building structure in the face of heightened weather risks, and increasing elevation.
Climate resilience measures can mitigate climate risk’s impacts. “The insurance and real estate industries should be asking if they are building things the right way and in the right places,” says Greg Lowe, global head of resilience and sustainability for Aon, in the ULI and Heitman report.
Resiliency Planning and Infrastructure Policy
President Donald Trump and Congressional leadership have indicated support for a comprehensive legislative package to address the nation’s deteriorating transportation and water infrastructure systems. The public sector can play a vital role in ensuring investments in infrastructure utilize climate-resilient strategies that consider extreme weather, rising sea levels, and increasing heavy precipitation events. Upticks in periods of extreme temperature, heavy rain, and strong winds impact roads, bridges, railways, and runways. A report from the International Institute for Sustainable Development explains how increasing temperatures can soften asphalt and place additional stress on railway and bridge joints. Investments in infrastructure should also plan for redundancies in transportation systems to account for climate-related events that might disrupt one mode of transportation. As Congress considers an infrastructure package, these climate-related factors must be evaluated and taken into consideration. Investments to current and new systems need to not only employ climate-resilient measures, but also consider clean energy strategies.
Energy Efficiency Measures
While building owners will need to consider the physical risks related to increasing extreme weather events, government policies can incent energy efficiency in properties and help accurately measure energy efficiency. The section 179D deduction for energy efficiency encourages the construction and rehabilitation of new and existing commercial buildings to state-of-the-art efficiency levels. The deduction has been a temporary part of the tax law since 2005, but it has expired and been reinstated five times, most recently at the end of 2017. One of CCIM Institute’s legislative priorities is advocating for the retroactive and long-term extension of the deduction. In addition, the Environmental Protection Agency’s Energy Star brand indicates a building’s energy efficiency. Demonstrating a property’s reduced carbon footprint can increase its value by confirming lowered utility costs and by increasing appeal to tenants and responding to market preferences for environmentally friendly buildings.
Climate change presents many challenges to all Americans, including the commercial real estate industry. Awareness of these risks can allow commercial real estate professionals to make better informed investment choices, reduce potential risks by utilizing climate resilient building strategies, especially in vulnerable markets, and improve energy efficiency in properties to mitigate negative contributors to the climate.
Resiliency in the Nation’s Capital
In April, Washington, D.C., released a resiliency strategy to address the challenges faced by modern cities, including climate risks like flooding and extreme temperatures. Strategies discussed in the report include retrofitting buildings to better withstand flooding, extreme heat, or a lengthy power outage and processes to relieve regulatory burden without weakening green building requirements. In 2016, Washington, D.C., was selected to be part of the 100 Resilient Cities network, which is a global network founded by the Rockefeller Foundation in 2013, to assist cities in becoming more resilient to the physical, social, and economic challenges of the 21st century. Other U.S. cities in the network include Boston, New York, Norfolk, Pittsburgh, and Tulsa. New York has implemented a Cool Neighborhoods Initiative that incorporates green infrastructure efforts with communication efforts to protect residents from extreme heat. Cities that have implemented climate resiliency efforts might prove more attractive to real estate investment. For more information, visit www.100resilientcities.org.