When looking at a potential investment market and trying to mitigate risk, investors typically consider factors such as population growth, the job market, and the resident demographic. One factor that doesn’t get as much attention is the climate. Regardless of where you land on the political spectrum, climate has a massive impact on real estate, and this reality has become more clear in recent months.
Below, we’re going to expand on what climate risk is, how it can cost you millions if you’re not careful, and how investors mitigate the impact of climate to maximize profits.
Climate Risk: Myth or Matter-of-Fact?
According to a recent study, residential real estate vulnerable to climate risk is overvalued by $121-237 billion. This is not a small figure. Climate risk describes weather and climate related events such as flooding, wildfires, landslides, droughts, heat waves, and extreme snowfall that can physically damage or interfere with the operations of a property.
This makes it more complicated to project future returns based on historical data, because these climate trends are relatively unprecedented. Investors will now need to take into account the risk factors relating to weather and climate in order to protect investor capital. Regardless of whether climate change is real or not, climate risk is starting to have more of an impact on where investors choose to place their capital.
As of early 2023, 14.6 million properties face at least 1% annual probability of flooding. This doesn’t sound so bad, does it? But this figure is expected to jump up to 11%, and average annual losses are expected to shoot up by a minimum of 26% by 2050.
Not only is this climate risk causing more investors to assess the climate in the markets they invest in to prevent costly property damage, but the cost of rising insurance is also eating into cash flow.
According to a The United Nations Office For Disaster Risk, there has been a surge in natural disasters over the past 50 years.
So with this increase in hurricanes, flooding, storms, and other weather-related events, there is definitely going to be an impact on the real estate in the geographic locations where these events are more prevalent and destructive.
Something Stormy This Way Comes…
As Axios said in a recent article, this increase in climate risk has a major impact on how lenders, insurance companies and others incorporate escalating flood risks into property prices. Factors such as inaccurate FEMA flood maps can make it difficult for investors to know how much risk they’re taking on. In fact, according to that study we mentioned earlier, most of the properties that are overvalued due to climate risk fall outside of existing FEMA flood map 100-year flood zones. Florida is the state with the most risk for overvalued properties due to climate risk, facing a risk of $50.2 billion. Florida has also recently seen a massive exodus of people leaving the state due to worsening hurricanes, political discourse, and the rising cost of living. So yes, Florida is one of the fastest growing states - but climate is becoming a growing concern for residents. Look at Hurricane Ian - the 2022 hurricane that was responsible for $112 billion in damage. Storms are not cheap! Investors have realized this in the form of expensive property repair costs, and in the rising cost of insurance.
Insurance costs have been skyrocketing due to the increased risk. Investors have seen policy prices rise by as much as 35% in recent years, and many are now paying double or triple for insurance. Florida isn’t the only state seeing these major changes in insurance. In May of 2023, State Farm pulled out of California and said it would stop writing insurance policies there due to the increased risk of wildfires. Farmers Insurance and Allstate made similar moves. Apparently, property insurance companies haven’t been making a profit in Florida for a few years. All this to say, climate risk is a real risk that can cost millions of dollars on a larger multifamily property.
Controlling For The Uncontrollable
So what can investors do to mitigate climate risk?
Well for one, many are looking at climate analysis tools to determine risk. Moody’s ESG Solutions is among the many tools used by groups like CBRE Investment Management to analyze potential risk relating to climate. Moody’s is a third party tool that measures what a property’s exposure is to events such as floods, heat stress, hurricanes/typhoons, water stress and sea level rise. Tools like this can be used for acquisitions and existing assets.
Measurabl’s Physical Climate Risk Exposure (PCRX) is another tool that allows investors to analyze the different physical climate hazards and risks a particular property is exposed to.
It can also be helpful to look at the property’s history of flooding, and how often flooring or severe natural disasters have occurred in the geographic area. Though, conducting official analysis using tools such as the ones mentioned above is ideal.
This is Not A Climate Apocalypse
The consequences of climate risk on real estate investors are no longer ones we can ignore. Investors must pivot their strategies to account for the potential losses and maximize opportunities in light of more hurricanes, wildfires, and natural disasters. Yes, these events are becoming more prevalent. This might make you think twice before investing in a market that looks good on paper but has seen a massive uptick in hurricanes and flooding. These events have led to increased costs of insurance and property maintenance, which can quickly turn a cash-flowing property into a bleeding one. However, there is hope for those investors that take a proactive approach to control the uncontrollable. Using climate tools, conducting thorough due diligence on geographic locations, and paying attention to weather trends can help investors limit their exposure to climate hazards. By embracing climate conscious strategies and leveraging data-driven tools, investors can thrive in the changing landscape of the real estate market and climate.
So the next time you conduct due diligence on a property, don’t forget to bring an umbrella - or to conduct a climate risk analysis. It’s the kind of thing you don’t want to save for a rainy day…