Real estate investors and analysts who rate local government bonds already are grappling with how to evaluate the future risks from rapid climate change, panelists said at ULI’s 2019 Resilience Summit, part of the Fall Meeting in Washington, D.C.
Panelists described how their organizations are beefing up their analytic capabilities in an effort to get a handle on a problem that most in the real estate sector paid little attention to until recently. The capacity audience at the session, though, was an indication of how attention has shifted.
“This is potentially a cataclysmic issue for our industry if we don’t get in front of it,” said moderator Brian Swett, co-chair of the summit and director of cities and sustainable real estate for global engineering design firm Arup.
Swett, who previously was chief of environment, energy, and open space for the city of Boston, said local government officials increasingly are taking climate concerns into account in their regulatory policies, especially after Hurricane Sandy in 2012 showed the vulnerability of northeastern coastal areas to the increasingly severe storms expected in the future. Boston now requires developers to explain how they will deal with climate risks over the lifetime of a property, and the city is putting in more stringent resilience guidelines for waterfront development.
But while new buildings incorporate climate change into their designs, structures built before the new standards could become more risky from an investment standpoint, Swett said. For investors, how to evaluate that risk will become increasingly important.
Mary Ludgin, senior managing director and head of global research for real estate management firm Heitman, said investors are not yet pricing climate change into the risk when they buy coastal real estate. But that is likely to change, if heightened interest in climate risks from bond investors is any indication.
Leonard Jones, managing director of the public finance group at Moody’s, said that though his firm has looked at climate change for a long time when evaluating local governments’ creditworthiness, investors increasingly want to know the details of how the company calculates such risk. As a result, Moody’s is producing more research and doing outreach as well.
“We’re trying to talk about [climate change] as much as we can so people know it’s really something that has a credit effect,” Jones said.
Moody’s looks at climate change both in terms of trends—such as sea level rise and temperature increases—and “climate shocks,” such as tornadoes, droughts, wildfires, and other events that may increase in frequency and severity in the future, Jones said. To enhance its capabilities, Moody’s acquired Four Twenty Seven, a firm that has pioneered the production of climate change–related business intelligence.
Though the rating firm gets pushback from climate change skeptics, Jones displayed a chart showing that natural disasters linked to climate change have been increasing. “If we don’t do something about it, we’ll be extinct,” he said.
Jones pointed to work cities are doing to combat climate change. A Moody’s survey of 30 U.S. cities showed that 59 percent already have a climate change action plan in place, and by the end of the year that number will climb to 82 percent, he said. The cities are investing $47 billion in 240 different climate-related projects, he said. Going forward, cities that lack the resources to invest in climate remediation may see their credit ratings decline as a result, Jones said.
Whether cities invest in climate measures will also increasingly be a factor in where big developers choose to locate projects, he said.
Eric Schlenker, portfolio manager for the California Public Employees’ Retirement System (CalPERS), which holds $35 billion in real estate assets, said understanding climate-related risk is essential to delivering a return on investment. That is particularly true because CalPERS is not looking for speculative investments that offer a high return in exchange for risk, but instead is striving to provide “a stable, predictable cash yield,” he said.
CalPERS focuses on a 10-year investment return, so it may not be capturing risks that are decades in the future. Those longer-term risks “are not priced into the market today,” Schlenker said.
“We feel good about the data for our buildings, but less about the communities,” he said. He cited the difficulty of evaluating the flood risk for a regional mall that sits atop a hill. Whereas the mall itself might not be at risk for flooding, “how do people get to you? Your inventory will be fine, but nobody will be there to buy it,” he said. “It’s more of an issue than just your physical building.”
Economist Spencer Glendon, who gave the summit’s opening presentation, spontaneously joined the panel to help answer an audience question about evaluating risk. He noted that in the past, damage from rare extreme weather events did not have a significant effect on value because buildings almost always could be repaired. But with catastrophic storms and floods becoming more frequent in some areas, the value of the underlying land will be at risk as well. Insurers are not going to protect property owners against the risk that they will not be able to find a future buyer, he said.
“By the third flood, prospective buyers know you have a waterlogged building,” Glendon said. “And you lose land value.”
The rising threat to value from climate change will not be borne by insurance companies because they can re-price coverage, Glendon said. “The risk is for the people who hold the mortgages.”
Evaluating climate risk previously was hindered by the limitations of the available data, including federal flood maps that were sometimes out of date, and in other cases shaped by political considerations, Ludgin said. But the emergence of private-sector data gathering has improved analytic capabilities.