In 2021 an epochal study revealed a staggering figure: If extreme weather conditions continue to occur at the current rate, the planet risks losing 8.35 million houses a year by 2040. This is equivalent to all the houses in the UK being destroyed six times! Climate change, which once used to be a parochial concern for stakeholders in the real estate sector, has now moved on top of their agendas, with many real estate players now embedding sustainability in their strategy and operations. These efforts go way beyond being ethical gestures, as sustainable practices become imperative to secure long-term investment prospects and minimise losses.
Underwater: Literally and Financially
The real estate sector is impacted significantly by the ongoing climate crisis. As extreme weather events get increasingly common - wildfires, floods, and typhoons, among other disasters, have destroyed millions of physical structures worldwide. According to one estimate, 35% of real estate assets worldwide are exposed to climate risks.
The impact of climate change on the real estate sector is further elucidated below.
Physical damages and costs
Physical risks attributable to shifting climate conditions have been significant, as natural disasters destroy and damage properties. Reconstructing and repairing structures is an expensive task, as evidenced by the many disasters that have struck countries worldwide. For example, early projections estimated that the 2018 Hurricane Florence affected more than 250,000 homes in North and South Carolina, causing about $20 billion in property damages.
The risk of disasters also has a direct impact on the costs of maintaining and managing a property, as owners and renters have recognised the need to build and improve the resilience of their assets. For instance, a study estimated that almost two-thirds of homeowners in the United States had spent money to protect their properties from climate risks. For properties situated in high-risk areas, analysts even speculate the possibility of banks declining mortgages in the future to avoid losses caused by climate impact, potentially challenging home affordability and driving value depreciation. In addition, it stalls development as Bill Gates rightly states in his book “…All of that property can eventually be replaced, of course, but doing so siphons off money and time that could be put into new investments that help the economy grow. You’re always trying to catch up to where you were, instead of getting ahead…”
Impact on asset value
Climate change also poses risks of diminishing the value of assets, especially those which are located in high-risk areas. The dramatic shifts in asset prices are evident as a 2019 study which analysed real estate transactions across the East Coast and Gulf Coast revealed that frequent floods caused by sea level rise led to a $15.9 billion loss in home value appreciation in the last 12 years alone. In addition, assets located in vulnerable regions also bear additional costs of insurance and risk mitigation, affecting asset prices.
In this regard, a report presented by Gitterman Asset Management and Entelligent states “In real estate, as in other investment classes, the question is no longer if climate change will affect asset prices, but when and how: will repricing happen in an orderly fashion or through a series of shocks and sudden drops?”
Rising Insurance prices
The increased frequency of extreme climatic events is causing a stark rise in insured losses. Swiss Re, one of the world's largest reinsurers, stated that extreme weather conditions in 2021 caused $105 billion in insured losses in North America alone. This is not a stand-alone incident, as the increasing number of climate disasters have severely impacted insurance companies worldwide. In the United States, for instance, disasters caused a whopping $42 billion in losses covered by insurance only in the first half of 2021. This has prompted premiums to skyrocket for at-risk properties, with some insurance companies even issuing non-renewal notices.
As these risks intensify, a UNEP Finance Initiative report stated that "some insurers are already signalling that climate change may make buildings uninsurable in the future."
This is creating major challenges for owners and investors as the inability to acquire satisfactory insurance coverage at an affordable price significantly brings down the value of a property.
Importance of Climate Intelligence in Mitigating Climate Risks
As the risks posed by climate change get increasingly evident, Climate Intelligence (CI) has grown to play a crucial role in mitigating these challenges. Described as business intelligence for managing climate risks, CI uses historical, current and predictive insights to determine which assets are vulnerable and how they are likely to be affected, helping craft effective responses. You can read more on the subject in our blog “What is Climate Intelligence & How Can Satellite Data Help?”.
The importance of climate intelligence in mitigating risks in the real estate sector is analyzed below:
Reevaluating assets and decision making
Climate models provide insights that aid in decision-making processes. For example, it helps stakeholders such as property owners, investors, and managers know the probability of a risk occurring and the nature of the risks across various timeframes and emission scenarios. This gives the stakeholder an idea of the extent of the risks and their probable impact on revenue, operating costs etc.
Equipped with climate intelligence, real estate leaders can factor them into business strategies and take decisions to minimise and avoid losses. It also helps stakeholders re-evaluate their assets by identifying mispriced assets and avoid being stranded with high-risk or uninsurable properties. These insights will enable them to future-proof their real-estate portfolios and minimise losses.
A McKinsey report states, "Leading real-estate players will figure out which of their assets are mispriced and in what direction and use this insight to inform their investment, asset management, and disposition choices”
Adapting and decarbonising assets
Climate intelligence provides actionable insights that can drive adaptation efforts and decarbonise real estate assets and portfolios. The importance of this was articulated by the Global Commission on Adaptation which stated, "Adapting now is in our strong economic self-interest". Undertaking decarbonisation efforts won't only help solve a crisis caused to a significant extent by the real estate sector but also helps in de-risking assets by adjusting strategies and operations to probable risks. For example, assets that are susceptible to heavy rainfalls could be retrofitted with more durable materials, or properties situated in areas prone to heat stress can have green roofs. These changes or updates won't only help in reducing carbon emissions but also helps in avoiding regulatory risks. In addition, it add’s long-term value to the asset as reducing energy costs can help in boosting an asset's Energy Performance Certificate’s (EPC’s) ratings and enhancing its value.
Promote transparency in reporting
The impact of climate risks has elicited strong responses from regulators who have been emphasising the need to disclose climate-related financial risks. Towards this end, countries such as Brazil, Hong Kong, Japan, New Zealand, Singapore, Switzerland, the United Kingdom and various countries in the European Union have made announcements requiring domestic organisations to report in line with the Task Force on Climate-related Financial Disclosure(TCFD) recommendations. Climate intelligence plays a crucial role here as it can facilitate better quality disclosures by helping stakeholders understand climate risks and articulate emission reduction plans, in addition to promoting transparency in reporting, ensuring an organisation's credibility is maintained.
Opportunities:
As climate change impacts the valuations of companies and assets, known as the "Great Repricing", it has also opened up opportunities for real-estate players which are equipped with climate intelligence. It does so by helping them recognise opportunities better and respond in a way supported by investors and tenants giving them a competitive edge. For example, there is a growing market for environmentally conscious customers, who look for features such as solar panels, better insulation, etc, as it will not only reduce carbon emissions but also bring down utility bills as green buildings can help reduce energy and water consumption significantly. This trend is evident in countries like India where a report revealed a 31% increase in green real estate assets in 6 major cities in the last ten years. Concepts such as zero energy buildings (ZEBs), which are characterized by zero net energy consumption have also been gaining traction.
Speaking of the importance of climate intelligence, a McKinsey report states "They (leading real-estate players) will also decarbonise their assets, attracting the trillions of dollars of capital that has been committed to net zero and the thousands of tenants that have made similar commitments. They will then create new revenue sources related to the climate transition."
Role of credible data
Credible data is the cornerstone of climate intelligence. However, at present, the lack of credible data has caused challenges, making important risk analysis tools such as climate models unreliable. This can derail mitigation strategies, impacting public safety and financial planning.
The following data characteristics in this regard are key to developing efficient climate models:
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High-frequency data: Climate modelling without high-frequency data has very limited utility. For instance, data gathered a few times a year cannot paint a clear picture of climate risks. High-frequency data is important to gain better insights and enables higher statistical precision in climate modelling.
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High resolution: High-resolution data is important for better mapping and monitoring of climate systems. It also helps in better quantification of vital factors such as the change in land cover. At present, most climate models are of a global scale and have to be scaled down significantly to get regional insights, which compromises the resolution.
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Near real-time data: Near real-time data allows continuous monitoring, which is helpful in identifying trends, establishing parameters, trigger levels and real quantification of risks and probabilities. Moreover, it is an important factor in developing prediction sets. Currently, climate models draw vast insights from historical data that is no longer sufficient. As climate change is driving new weather patterns, relying only on historical data reduces the model's accuracy. In addition, historical models have limitations. For example, documentation has been poor in many parts of the world, and government agencies in most countries began collecting data only towards the end of the last century.
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Wide-scope: Climate models must have a broad scope that looks at the earth as one system. Monitoring a single variable does not provide an overall understanding of the climate crisis, as most climate phenomena are interlinked. All the essential variables need to be assessed for a holistic understanding of our planetary systems.
While historically, it has been challenging to develop climate intelligence for asset-level analysis of climate-related risks, the rapid breakthrough in climate science, machine learning and artificial intelligence has now made this possible. Satellite data specifically makes up for the shortcomings of traditional monitoring tools such as IoT monitors and forest guards which are expensive and time-consuming and have emerged as effective tools in ESG reporting. Large-scale climate datasets aggregated from satellites and sensors can also provide data at a granular level. This, along with sophisticated processing systems and analytical skills, has revolutionised climate intelligence.
Conclusion
It has been rightly speculated that climate impact is going to be a major driver of “the value and performance of real estate assets." Thus, as climate-induced disasters continue to grow in intensity and frequency, climate change is likely to continue causing radical shifts in markets.The role of climate intelligence to adapt to these changes and protect the bottom line thus becomes imperative. Real estate leaders in this regard who employ climate intelligence to assess and respond to climate risks across their portfolios are likely to endure fewer losses and be able to explore more opportunities.
