The Impact of climate change on real estate values and Risks
Climate change is one of the most pressing challenges of our time, affecting every aspect of our lives, from health and security to the economy and environment. But how does it affect the real estate market, one of the world’s largest and most important sectors?
Real estate investors need to be aware of the potential impacts of climate change on their properties, both in terms of physical and transition risks. Physical risks refer to the direct effects of climate change, such as extreme weather events, sea level rise, wildfires, droughts, and heat waves, that can damage or destroy buildings and infrastructure. Transition risks refer to the indirect effects of climate change, such as policy changes, regulatory measures, technological innovations, and consumer preferences, that can affect the demand and supply of real estate assets and influence their costs and returns.
This blog post will explore some critical ways climate change can affect real estate values and risks and how investors can prepare for them.
Real estate, Physical risks
According to a report by Forbes, weather-related disasters caused $258 billion in economic losses in 2020, 29% higher than the 21st-century average. These disasters can devastate real estate properties, especially those in high-risk areas such as coastal zones, floodplains, wildfire-prone regions, and urban heat islands.
Some of the potential impacts of physical risks on real estate values and risks include:
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- Reduced property value: Physical damage or destruction of buildings can reduce their market value and attractiveness to buyers or tenants. Moreover, properties located in high-risk areas may face lower demand and higher vacancy rates due to perceived or actual threats from climate hazards. For example, a study by Morgan Stanley found that coastal properties in Florida have lost $5.4 billion in value since 2005 due to sea level rise.
- Increased insurance costs: As climate risks increase, so do insurance premiums and deductibles for property owners. In some cases, insurance companies may refuse to cover specific properties or areas due to high exposure to climate hazards. For example, a report by Forbes found that homeowners insurance rates in California have increased by 50% since 2015 due to wildfires.
- Higher maintenance and repair costs: Properties exposed to climate hazards may require more frequent and costly maintenance and repairs to prevent or fix damage caused by weather events. For example, a report by Business Insider found that homeowners in Texas spent an average of $11,000 to repair their homes after the winter storm in February 2021.
- Lower rental income: Physical damage or destruction of buildings can reduce their rental income and cash flow for property owners. Moreover, tenants may seek lower rents or terminate their leases if they are dissatisfied with the quality or safety of their premises due to climate hazards. For example, a study by Morgan Stanley found that rental income for multifamily properties in Houston declined by 13% after Hurricane Harvey in 2017.
Real estate, Transition risks
As governments, businesses, and consumers take action to mitigate and adapt to climate change, the real estate market will also undergo significant changes. Depending on how they respond, these changes can create new opportunities or challenges for real estate investors.
Some of the potential impacts of transition risks on real estate values and risks include:
- Increased regulation: As governments implement policies and regulations to reduce greenhouse gas emissions and promote energy efficiency and renewable energy sources, real estate investors may face stricter property standards and requirements. For example, a report by Forbes found that New York City passed a law in 2019 that requires buildings over 25,000 square feet to cut their emissions by 40% by 2030 and 80% by 2050.
- Higher capital expenditures: As regulations become more stringent, real estate investors may need to invest more capital in upgrading or retrofitting their properties to comply with them. For example, a Morgan Stanley report found that US commercial buildings may need to spend $250 billion over the next decade to meet the Paris Agreement goals.
- Changing consumer preferences: As consumers become more aware and concerned about climate change, they may demand more sustainable and resilient features in their homes or workplaces. For example, a report by Business Insider found that green-certified houses sell for 7.1% more than comparable non-certified homes in the US.
- Emerging technologies: As technologies evolve and innovate, real estate investors may benefit from new solutions or services that enhance their properties’ performance or value. For example, a report by Forbes found that smart home devices can help reduce energy consumption and costs by up to 25%.
How to prepare for climate change impacts
Given the potential impacts of climate change on real estate values and risks, investors need to adopt proactive and adaptive strategies to manage them. Some of the possible methods include:
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- Assessing climate risks: Investors need to determine the exposure and vulnerability of their properties to physical and transition risks using data and tools from various sources and providers. For example, a report by Morgan Stanley provides a framework for assessing climate risk solutions for real estate investors.
- Diversifying portfolio: Investors must diversify their portfolio across different geographies, sectors, asset classes, and risk profiles, to reduce their concentration and correlation to climate hazards. For example, a report by Forbes suggests that investors can consider investing in inland or rural areas or alternative asset classes, such as data centers or self-storage facilities, that may be less exposed to climate risks.
- Enhancing resilience: Investors need to strengthen the strength of their properties to physical and transition risks by implementing measures such as energy efficiency upgrades, renewable energy installations, water conservation systems, stormwater management systems, fire-resistant materials, flood barriers, backup generators, and insurance coverage. For example, a report by Business Insider suggests that investors can use green bonds or loans to finance their resilience projects.
- Engaging stakeholders: Investors need to engage with various stakeholders, such as governments, regulators, tenants, lenders, insurers, contractors, and communities, to collaborate and communicate on climate-related issues and solutions. For example, a report by Morgan Stanley suggests that investors can participate in industry associations or initiatives, such as the Urban Land Institute or the Global Real Estate Sustainability Benchmark, to share best practices and advocate for policy changes.
Climate change is a reality that real estate investors cannot ignore. By understanding its impacts on real estate values and risks and preparing for them accordingly, investors can protect their assets and returns and contribute to global efforts to combat climate change.
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