The real estate sector needs to wake up to the physical risks of climate change

21 August 2018

The impact of climate change is causing an increase in average global temperatures, precipitation irregularities (more intense rainfall, or drought) and sea level rise. These changes are expected to result in more frequent and intense heatwaves, droughts and floods, which are forecast to increase across every major European city by 2050.

The real estate industry is responsible for approximately 40% of global energy consumption and 20-30% of global greenhouse gas (GHG) emissions. To date, mitigation has therefore quite rightly been the main focus of the sector, which has been under great pressure to improve energy efficiency and reduce GHG emissions within the design and management of new and existing commercial stock.

However, the effects of climate change pose major risks to the commercial property sector. It is therefore crucial to understand potential changes and management of investments, assets and businesses to reduce exposure. It is estimated that building damage will represent one quarter of climate-change-related losses and that approximately 2.5% of all investments in real estate will require appropriate adaptation measures.

 

Understanding the risks to your portfolio

So what are the climate risks the property sector faces and what are appropriate adaptation measures? In order to answer these questions, it is important highlight that climate risk is extremely location specific. Adaption depends on a cities’ exposure and sensitivity to a given set of threats. For this reason, adaptation measures also need to be tailored to local circumstances. Some of the biggest risks include:

1. Overheating

The world is getting warmer. Global mean temperatures are estimated to increase by 1-3 degrees Celsius above 1990 levels, leading to overheating in buildings in summertime. This is likely to result in discomfort and potential associated reductions in productivity, as well as an increased demand for artificial cooling, with implied capital and operational costs. Measuring productivity is notoriously difficult. Abstracting the role of overheating in reducing productivity is even more challenging. Nevertheless, research indicates that even modest increases above 22oC (identified as the optimum temperature for productivity) can lead to 10-20% reductions in productivity. Furthermore, a study of the Sustainable Energy Research Group evaluating buildings and their façades on their vulnerability to climate change even found that several buildings in the commercial sector are in danger of being uninhabitable in the future without additional energy-intensive cooling devices.

Green roofs could reduce temperatures of the roof surfaces and surrounding air. Studies have shown that green roofs could halve the urban heat island effect by 2050. Such vegetative layers can be installed on a variety of buildings, from industrial facilities to private houses.

2. Rainfall and flooding

As a result of sea level rise and increased precipitation, the IPCC have identified risks from flooding in river and coastal regions. Urban areas are particularly vulnerable to flood exposure, due to poor drainage systems, resulting in high costs from water damage such as repairs to the external fabric and loss of occupancy. Indeed natural disaster and flooding costs in 2017 were $306 billion—nearly double the cost of 2016 – and the costs associated with flooding alone are projected to potentially rise £1 trillion by 2050. The value of commercial properties located in low-lying (e.g. harbor-side, river-side and floodplains) may depreciate and rental yields decrease. Insurance premiums are also likely to increase significantly in such areas. In these cases, adaptation is key to reducing the risk exposure of property to insurance liabilities.

Adaptation measures for flooding range from physical changes such as raising essential infrastructure above flood-prone areas and the development of sustainable drainage systems to manage rainwater run-off to greater awareness through flood mapping and zoning.

3. Wind and Storm damage

Unpredictable weather patterns also include the capacity for storms. Although concerns about global warming often focus on rising water levels and the threat of flooding, the impact of other meteorological events such as high winds must not be ignored. Climate change is projected to increase the frequency and intensity of storms, which can cause heavy damages to property and infrastructure. In the UK, even the minimum global warming expected – just 1.5C – is projected to raise the cost of windstorm destruction by more than a third in parts of the country. The overall cost of wind storms currently runs at an average of around £1bn a year, which is actually higher than the costs associated with flooding in the UK and a source of considerable concern for the Association of British Insurers. Wind loads on buildings can be reduced by appropriate window designs and impact resistant building materials.

 

Building resilience through organisational adaptation

Adaptation to climate change is about building resilience[1] and reducing vulnerability. This means mobilizing investors and redirecting existing financial flows. In April 2017, the EU adopted a new Shareholders’ Rights Directive, requiring insurance companies and pension funds to set up their engagement policy to be publicly available, thus making investment strategies more transparent. The directive raises the possibility that EU shareholders will be aware of, and therefore able to more easily divest from any investee company found in breach of human rights, involved in deforestation, or actively contributing to climate change. Concurrently, the Climate Bonds Initiative has developed market standards for green bonds and provides certification for investments that contribute to addressing climate change11.

European countries are adopting national mandatory reporting regimes and France has been a pioneer in this movement. The French Energy Transition for Green Growth Law (or Energy Transition Law) requires investors to disclose how they factor ESG criteria and carbon-related aspects into their investment policies. Other mandatory national reporting requirements do not currently exist in Europe. Climate risk reporting guidelines are evolving, however understanding climate change risk and making informed investment decisions remains a challenge for investors.

 

Future proof your property portfolio

Looking to the future, we can expect more informed investment decision making which will likely lead to an avoidance of real estate development in vulnerable areas, as investors stop making funding available and insurance premiums become excessively high. Progress, in terms of climate risk reporting has been made through the release of the Recommendations of the Task Force on Climate-related Financial Disclosures (TCFD) in June 2017. Companies are obliged to include disclosures about climate risk in corporate filings to support investors to make more informed decisions regarding climate risk. At the end of 2017, more than 240 companies, with a combined market capitalization of more than $6.3 trillion, publicly had expressed support for the TCFD recommendations. In Europe, companies in the U.K. and Germany are the most prepared to disclose climate risks in accordance with TCFD guidelines.

The real estate sector is listed by the TCFD as one of the industries with the highest likelihood of significant climate-related financial impacts, and therefore one of the sectors that would benefit most from supplemental guidance. Longevity Partners is providing support through the launch of our Climate Adaptation Service Line. We are offering our clients guidance throughout the whole climate risk adaptation process, from identifying the main risks to their assets to finding the most appropriate adaptation measures.

- We identify the main climate change threats our clients’ assets face using scientific indicators and up to date environmental data

- We spatially identify hotspots of climate risk for future allocation of assets and existing assets using the most up to date GIS tools

- Our experts advise clients on the feasibility and costs of adaptation measures

- We advise clients on the most up to date technologies for adapting to climate change risk

- We provide cost saving analysis through innovative recommendations

 

[1] Resilience is defined as the “capacity of social, economic, and environmental systems to cope with a hazardous event or trend or disturbance, responding or reorganizing in ways that maintain their essential function, identity, and structure, while also maintaining the capacity for adaptation, learning, and transformation” (GGFC, 2017)