Climate risks are already impacting residential real estate values. According to a report from the Urban Land Institute in partnership with Heitmen, studies published in both 2017 and 2018 “found that homes exposed to flood risk or sea-level rise have sold for less than comparable properties or have seen values increase at a reduced rate in comparison to similar properties without flood risk.” The report also discusses the existent damage and related costs as a result of catastrophic climate events: Globally, insurers paid a record $135 billion for damage caused by storms and natural disasters, a figure not representative of the actual damages (which in the United States alone were $307 billion).
Real estate investors should definitely take note of this trend. Traditionally, investors take several factors into consideration when evaluating new assets, such as location, valuation and opportunity. Rising concerns over environmental events, driven in part by climate change, should be part of the equation when considering the purchase of an investment property. It’s important to be aware of the impact that these changes and events can have on real estate investing.
Climate risks, such as storms or wildfires, pose a significant threat to both residential and commercial buildings and can negatively impact a real estate investment. Besides causing property damage, climate events can result in more than just a decrease in property value or increased insurance rates. They can also spell expensive maintenance and operations costs. In a worst-case scenario, a natural disaster could cause a complete property loss. Despite the major consequences that climate risks evoke, there’s a lack of standardization when assessing investment risk versus opportunity. Thankfully, there seems to be increased awareness surrounding climate risks in the real estate investment industry as a whole.
Understanding Climate Risks
Real estate assets across the nation are susceptible to both gradual and more acute climate risks, depending on geographical location and other factors. Gradual climate risks might include sea-level changes, varying weather patterns (such as an increased frequency of rain or wind), drought and higher or lower average temperatures. While investors may not see an immediate impact or risk from these gradual weather events, shifting climate patterns can lead to increased wear and tear on properties and the potential need for more or alternative resources. Increased wear and tear can eventually lead to higher maintenance costs, while the need to add resources like cooling/heating methods or water sources can lead to increased operating costs. In addition, properties already suffering from the effects of gradual climate risks are likely to experience an exaggerated impact if a catastrophic climate event does take place.
The impact of catastrophic climate events is more apparent and more immediate than gradual weather events. Hurricanes, wildfires, typhoons, tornadoes and earthquakes can cause disastrous and irreversible damage, often leading to high and unexpected costs to repair or replace damaged property. In the worst cases, the damage costs from climate risks can cause property downtime and/or business disruption, and may even provoke a decrease in property value, increased insurance costs or reduced insurance availability.
Recent Climate Events And Their Impact On The Market
September 2018 saw Hurricane Florence, which resulted in economic losses of over $10 billion, damaging thousands of real estate investment properties and commercial properties. Many of the damaged properties were insured with flood insurance, but the outflow of investment in the market led to a rise in prices for flood insurance. Home sales, new construction and the vacation rental market all saw direct effects from this event.
More recently, Hurricane Dorian devastated the Bahamas, causing over $7 billion in property damage to as many as 13,000 properties and resulting in up to $3 billion in insurance payouts. Though the path of the hurricane changed, the original trajectory threatened over 6.6 million U.S. households amounting to $1.7 trillion worth of residential real estate. Real estate experts are predicting that Hurricane Dorian will put added pressure on coastal housing markets already experiencing a shortage in housing inventory.
These are just two recent examples of how a natural disaster or climate-related event can directly affect the housing market in a specific region. Investors should dig into insurance rates and historical risk factors for any region they are considering to invest in. If it is a high-risk flood zone, for example, the risks and extra expenses may outweigh the benefits of purchasing property in that area.
Best Practices For Identifying Climate Risks
Investors and investment managers need to implement practical strategies to address the potential impacts of climate risks. When considering adding a new asset to your portfolio, exploring and understanding your exposure to any form of climate risk is a crucial step. Proactive investors will analyze data and other available information to make the most educated decision possible.
• Make the evaluation of climate risks part of your investment decision-making process.
• Consider mitigation and adaptation options (seawalls, cooling systems, increased elevation, etc.).
• Proactively address potential risks with your insurance provider.
• Research policy and regulations in your market intended to address climate risks.
• Explore the local government’s preparedness for a natural disaster or other climate risks.
Climate risks shouldn’t necessarily deter you from investing in a property that may be affected, but they most certainly should be a consideration when making your decision.