CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING - ULI Europe
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CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING
© 2019 by the Urban Land Institute. All rights reserved. Reproduction or use of the whole or any part of the contents without written permission of the copyright holder is prohibited. ULI has sought copyright permission for all images and tables. Front cover image: Flooding in Houston after Hurricane Harvey. (istockphoto © Karl Spencer) ULI Europe ULI Center for Sustainability and Heitman 131 Finsbury Pavement Economic Performance 191 North Wacker Drive London EC2A 1NT, United Kingdom 2001 L St NW Suite 2500 Tel: +44 (0)20 7487 9570 Washington, DC 20036-4948 Chicago, IL 60606 europe.uli.org USA USA americas.uli.org/sustainability heitman.com
ABOUT ULI
The Urban Land Institute is a global, member-driven organisation comprising more than 42,000
real estate and urban development professionals dedicated to advancing the Institute’s mission
of providing leadership in the responsible use of land and in creating and sustaining thriving
communities worldwide.
ULI’s interdisciplinary membership represents all aspects of the industry, including developers,
property owners, investors, architects, urban planners, public officials, real estate brokers,
appraisers, attorneys, engineers, financiers, and academics. Established in 1936, the
Institute has a presence in the Americas, Europe, and Asia Pacific regions, with members in
80 countries.
The extraordinary impact that ULI makes on land use decision-making is based on its members
sharing expertise on a variety of factors affecting the built environment, including urbanisation,
demographic and population changes, new economic drivers, technology advancements, and
environmental concerns.
Peer-to-peer learning is achieved through the knowledge shared by members at thousands of
convenings each year that reinforce ULI’s position as a global authority on land use and real
estate. In 2018 alone, more than 2,200 events were held in about 330 cities around the world.
Drawing on the work of its members, the Institute recognises and shares best practices in
urban design and development for the benefit of communities around the globe.
More information is available at uli.org.
Follow ULI on Twitter, Facebook, LinkedIn, and Instagram.
ABOUT HEITMAN
Founded in 1966, Heitman LLC is a global real estate investment management firm with
approximately $42 billion in assets under management. Heitman’s real estate investment
strategies include direct investments in the equity or debt capitalization of a property or in the
securities of listed and publicly traded real estate companies. Heitman serves a global client
base with clients from North American, European, Middle Eastern, and Asia-Pacific institutions,
pension plans, foundations, and corporations and individual investors.
Headquartered in Chicago, with additional offices in North America, Europe, and Asia-Pacific,
Heitman’s more than 325 employees offer specialized expertise—from a specific discipline to
local insight.
i
CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING
ACKNOWLEDGMENTS
This report was made possible through a collaboration between ULI and Heitman. ULI and Heitman
would like to thank the following contributors to the development of this report:
Authors:
Katharine Burgess, Vice President, Urban Resilience, Urban Land Institute
Dr Elizabeth Rapoport, Content Director, Europe, Urban Land Institute
The authors wish to thank the following for their advice, ideas, and input:
Mary Ludgin, Managing Director, Head of Global Research, Heitman
Brian Klinksiek, Director of Strategy and Research Operations, Heitman
Laura Craft, Head of Global Sustainability, Heitman
Lisette van Doorn, Chief Executive Europe, Urban Land Institute
Billy Grayson, Executive Director, Center for Sustainability and Economic Performance, Urban Land Institute
Amanprit Arnold, Senior Manager, Research and Advisory Services, Urban Land Institute
Leah Sheppard, Senior Associate, Urban Resilience, Urban Land Institute
Andrea Carpenter, ULI Consultant
Senior editor: Jim Mulligan, Urban Land Institute; Manuscript Editor: Laura Glassman, Publications Professionals LLC
Designer: Amanda D’Arcy, Sudbury Print Group
Cars parked in the business district of a city during a snowstorm. (istockphoto © aapsky)
ii
CONTENTS
FOREWORD 1
EXECUTIVE SUMMARY 2
INTRODUCTION 3
WHY CLIMATE RISKS MATTER FOR REAL ESTATE 5
CLIMATE RISK: THE STATE OF THE INDUSTRY 8
INSURING CLIMATE RISK 8
THE CHALLENGE OF INVESTMENT HORIZONS 9
A VIEW FROM THE INSURANCE INDUSTRY 10
MARKET-LEVEL IMPACTS 11
INVESTORS AND INVESTMENT MANAGERS—WORKING IN PARTNERSHIP 11
INVESTMENT LOCATIONS: UNDERSTANDING ASSET RISK 11
THE ROLE OF CORPORATE REPORTING IN CLIMATE RISK AWARENESS 13
MEASURING AND MANAGING CLIMATE RISK: CURRENT BEST PRACTICES 14
MAPPING PHYSICAL RISKS 14
CASE STUDY: ALIGNING RISK INVESTMENT HORIZONS 15
DUE DILIGENCE AND OTHER INVESTMENT DECISION-MAKING PROCESSES 15
THE REIT PERSPECTIVE: GEOGRAPHIC RISK, ASSET-LEVEL MITIGATION, AND CITY ENGAGEMENT 16
MITIGATION FOR ASSETS AT RISK 16
CASE STUDY: BUILDING CLIMATE ANALYSIS INTO INVESTMENT DECISIONS 17
EMERGING PROPTECH FOR CLIMATE RISK 19
ADAPTING ASSETS TO MITIGATE CLIMATE RISKS 19
CASE STUDY: MIAMI-DADE: THE ROLE OF THE PUBLIC SECTOR 22
ENGAGING WITH POLICYMAKERS AND CITY-LEVEL RESILIENCE STRATEGIES 22
LOOKING TO THE FUTURE 23
DEFINITIONS 25
NOTES 26
CONTRIBUTORS 28
iii
CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING
Extreme heat increases the risk of wildfires,
as seen here near to Southern California homes.
(istockphoto © f00sion)
vi
FOREWORD
Understanding climate risk and its real ULI’s Urban Resilience program, and Center It is important for the industry to come
estate investment implications is a complex for Sustainability and Economic Performance, together as it addresses climate change.
challenge for property investors. For the have and will continue to offer resources and There are many opportunities to collaborate
immediate future, the world is seeing an research addressing these issues. to help increase our understanding of
increase in the frequency and intensity of the topic as well as to develop common
extreme weather events due to climate This report is the result of collaboration standards, and to share successful strategies
change. In the longer run, the consequences with global investment manager Heitman, and solutions.
of climate risks such as sea-level rise and which has developed a proactive approach
extreme heat will increasingly highlight to address climate risks and is at the Failure to address and mitigate climate risks
the vulnerability of individual assets forefront of investment managers looking to may result in increased exposure to loss as
and locations—and potentially entire better quantify these risks. The timeliness a result of assets suffering from reduced
metropolitan areas. and relevance of the topic was clearly liquidity and lower income, which will
demonstrated by the high response rate of negatively affect investment returns. At the
ULI has been proactive in working with ULI members asked to participate. same time, investors who arm themselves
members and city officials to better assess with more accurate data on the impact
and develop mitigation strategies to counter The research addresses the state of current of climate risks could help differentiate
these potential risks. For example, the practice for assessing and mitigating climate themselves and benefit from investing
Institute published Ten Principles for Building risk in real estate as well as highlighting best in locations at the forefront of climate
Resilience in early 2018, and launched practices across the industry. Although not mitigation.
the Developing Urban Resilience website all investors and investment managers have
(developingresilience.uli.org) to showcase been public about their work, many have We hope this research will prompt more
real estate projects with resilient design started to develop innovative strategies to investors and investment managers to join
strategies. ULI Europe also released Climate assess and mitigate near-term and the debate on how to address this critical
Change Implications for Real Estate Portfolio long-term climate risks. and complex challenge.
Allocation: Industry Perspectives in 2016.
Ed Walter, Global CEO, ULI
Maury Tognarelli, CEO, Heitman
1
CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING
EXECUTIVE
SUMMARY
An increase in the number and intensity observed a significant impact on insurance • Exploring a variety of strategies to
of severe weather-related events, such as premiums or coverage. Insurance (while mitigate risk, including portfolio
hurricanes and flooding, has demonstrated sometimes expensive) has provided coverage diversification and investing directly in the
more clearly the real risks that climate for most damages from catastrophic events, mitigation measures for specific assets;
change presents to real estate. It is an urgent but it cannot protect them from a reduction in and
and complex challenge which must be an asset’s liquidity or depreciation in value. • Engaging with policymakers on city-level
addressed but for which the industry does resilience strategies, and supporting the
not yet have a clear strategy. As a result, investors and investment investment by cities in mitigating the risk
managers said they acknowledged that using of all assets under their jurisdiction.
Both the physical and transitional risks insurance as the main protection for asset
associated with climate change have value is not an effective solution to mitigate Assessing and pricing climate risks is an
financial impacts for real estate owners the risk of devaluation, particularly because evolving issue for the industry. With the
and operators. Physical risks, such as premiums currently are largely based on complexity surrounding the emerging fields
catastrophes, can lead to increased historical analysis and are not likely to of data and technology, many industry
insurance premiums, higher capital consider future climate risks. players are still evaluating how best to factor
expenditure and operational costs, and potential risks into their actions to mitigate
a decrease in the liquidity and value of Although insurance might provide short-term perceived exposure and how to reflect
buildings. Transitional risks, which center protection, a growing group of investors and concerns in financial projections.
on the economic, political, and societal investment managers are exploring new
responses to climate change, can see approaches to find better tools and common Developers and owners can play an important
locations, and even entire metropolitan standards to help the industry get better at role in helping the investment community
areas, become less appealing because of pricing in climate risk in the future. These get better at factoring in climate risk. Those
climate-change-related events, leading to include: exploring the issue have initially committed
the potential for individual assets to become resources to information gathering and
obsolete. • Mapping physical risk for current reporting to gain understanding and
portfolios and potential acquisitions; improve awareness. However, in the coming
Currently, some industry players making • Incorporating climate risk into due years, methods are likely to become more
investments into areas with potential climate diligence and other investment sophisticated. The industry needs to be
risks have found that insurance premiums decision-making processes; able to better measure the value impact
have gone up or coverage has gone down, • Incorporating additional physical so it can base its future decision-making
but they still consider the price point and risk adaptation and mitigation measures on a quantitative rather than qualitative
acceptable. However, the majority has not yet for assets at risk; understanding of the risks and the potential
return from investing in mitigation strategies
for their assets.
2
INTRODUCTION
Many assets held by real estate investors are 2018 edition of the World Economic Forum’s understood and being prioritized. Recent
in cities that may be vulnerable to the effects Global Risk Landscape, which ranks societal, weather events caused significant physical
of climate change. These effects, ranging technological, economic, environmental, and damages to properties and infrastructure. In
from more intense and frequent weather geopolitical risks, identified extreme weather 2017, the year Hurricanes Harvey and Maria
events such as hurricanes and events, natural disasters, and the failure of hit the United States and storms battered
typhoons to gradual changes such as climate change mitigation and adaptation as northern and central Europe, insurers paid
sea-level rise or more frequent and longer being most likely to occur and to have the out a record $135 billion globally for damage
heat waves, create risks for investors that greatest impact globally.2 caused by storms and natural disasters.3
are likely to increase over time. Globally, the This figure does not represent actual
number of extreme weather events increased For leading real estate investors and damages, which in the United States alone
by more than 250 percent between 1980 investment managers, the need to equaled $307 billion, according to National
and 2013.1 Recognition is growing of the understand and develop strategies to Oceanic and Atmospheric Administration
risks these events pose to investment; the address climate-related risks is already estimates.4
Storm waves at Dawlish, England, breaking against sea wall.
(istockphoto © Moorefam)
3
CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING
Awareness of and interest in this topic is
“stillTheearlyrealin estate investment industry as a whole is
its development of strategies to recognize,
growing, and in the coming years,
understanding of this issue is expected to
understand, and manage these [climate] risks.”
increase, as are methods to incorporate
climate change into real estate investment
decision-making.
Some comparisons can be made to the
The real estate industry is also seen as by the costliest hurricanes decreased by evolution of sustainability within the real
integral in helping limit the impact of almost 6 percent one year after the storm estate industry. When companies started
climate change. In October 2018, the and by 10.5 percent two years after.9 looking at sustainability more than a decade
Intergovernmental Panel on Climate Change ago, they focused on disclosing and
(IPCC), a global group of scientists within This report, the result of a collaboration reporting, which helped raise awareness
the United Nations, released a special report between ULI and global real estate and understanding within the industry.
stating that limiting the earth’s global investment manager Heitman, looks at the Later, the industry moved to setting standards
temperature increase to 1.5° C above current state of the real estate investment on how to report and implement sustainability
pre-industrial levels would lessen the risk industry’s understanding of, and approach measures. A similar path is likely to be
of “long-lasting irreversible changes.” The to, addressing climate risk in its investment followed in addressing climate risks, although
report cites changes in land use, buildings, management and decision-making process. these risks and their impact on real estate
and transportation as part of the path toward The report comprises a literature review values are expected to be more difficult to
this goal.5 and 25 interviews carried out by ULI with real quantify.
estate investors, investment managers, and
The actual and perceived risks of climate investment consultants from North America, Some industry players have already been
change are already beginning to be reflected Europe, and Asia-Pacific, including many forced to adapt because climate risks have
in residential market pricing. A 2018 study ULI members who are industry leaders in directly affected their portfolios. Others,
determined that homes vulnerable to flooding addressing climate risk. despite the fact that their assets have not yet
in Florida, Georgia, North Carolina, South suffered from climate-related issues, have
Carolina, and Virginia had lost $7.4 billion in Its findings indicate a growing awareness of started to recognize the need to
value between 2005 and 2017. 6 . The New climate risk and its potential impact on real incorporate climate risk into their strategy.
York metropolitan area experienced similar estate among leading real estate investment In both cases, investors see climate
devaluation, collectively losing $6.7 billion managers and investors. However, the real considerations as a new layer of fiduciary
of value in the same period because of estate investment industry as a whole is responsibility to their stakeholders, as well as
increased flooding from sea-level rise.7 still early in its development of strategies an opportunity to identify markets and assets
to recognize, understand, and manage that will benefit from a changing climate.
Similar studies looking at the residential these risks and at present relies heavily
market in Germany, Finland, and Florida on insurance cover for the majority of the
found that homes exposed to flood risk or financial risks in the short term.
sea-level rise have sold for less than
comparable properties or have seen values This report highlights the types of climate
grow at a reduced rate in comparison to risks that could affect real estate investment,
similar properties without flood risk.8 the impacts they could have on investment
Commercial real estate could see similar practices and returns, and how industry
effects, as demonstrated by recent research leaders currently view these risks. It also
on the United States, which found that overall outlines some of the actions being taken to
commercial property values in areas affected better understand and manage these risks.
4WHY CLIMATE
RISKS MATTER
FOR REAL ESTATE
Aftermath of a hurricane in the Florida Keys.
(istockphoto © Jodi Jacobson)
The nature of climate risks—and how they water stress are among the most easily are not retrofitted to address climate risks.11
will affect real estate values—is a topic that observable risks to real estate investment. The model indicated that by 2050 the total
is still being explored by industry actors. They are a particular concern since many increase in energy bills from 2010 levels for
key markets for real estate investment are the eight countries would be £457 billion. For
The table in this section summarizes the in areas exposed to the physical impacts of Germany, Spain, and Greece, the cost would
main types of risks that have the potential to climate change. be more than 8 percent of their gross
affect real estate investment and their domestic product.
potential impacts. Recent analysis by Heitman and Four Twenty
Seven, which provides market intelligence To some extent, investors have already
The risks posed by climate change are often on the economic risk of climate change, begun to address transition risks as a
divided into physical risks and transition focused on institutional exposure to climate part of broader environmental, social, and
risks. Physical risks are those capable of risk. They found that more than 24 percent governance (ESG) agendas around carbon
directly affecting buildings; they include of the National Council of Real Estate reduction. These have been easier to justify
extreme weather events, gradual sea-level investment Fiduciaries (NCREIF) Property because many strategies to improve energy
rise, and changing weather patterns. Index value in the United States is in efficiency and decarbonize buildings have an
Transition risks are those that result from a metropolitan areas whose central cities are immediately quantifiable return on investment
shift to a lower-carbon economy and using among the 10 percent of cities most exposed that enhances real estate values.
new, non-fossil-fuel sources of energy. These to sea-level rise, amounting to more than
include regulatory changes, economic shifts, $130 billion of real estate.10 A survey of senior executives at real estate
and the changing availability and price of investment firms carried out for ULI Europe in
resources. In addition, a 2015 study published by the 2014 and 2015 about the risks that climate
Royal Institution of Chartered Surveyors change could pose to their portfolios found
The location-specific physical threats posed (RICS) modeled the potential for increased executives were largely focused on transition
by factors such as sea-level rise, hurricanes, costs of running a building in eight European risks.12 In contrast, several interviewees for
wildfires and forest fires, heat stress, and Union countries if commercial buildings there this report asserted that physical risks are
likely to be more of a focus in the future.
5CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING
TYPES OF CLIMATE RISK AND THEIR POTENTIAL IMPACT ON REAL ESTATE
Category Potential impact
Catastrophic events
Extreme weather such as hurricanes and wildfires. • Costs to repair or replace damaged or destroyed assets; value impairment
• Property downtime and business disruption
• Potential for increased insurance costs or reduced/no insurance availability
Changes in weather patterns
Physical risks
Gradual changes in temperature and precipitation—such as • Increased wear and tear on or damage to buildings, leading to increasing
higher temperatures, rising sea levels, increasing frequency of maintenance costs
heavy rain and wind, and decreased rainfall—which are likely • Increased operating costs due to need for more, or alternative resources
to exaggerate the impact of catastrophic events. (energy and/or water) to operate a building
• Cost of investment in adaptation measures, such as elevating buildings or
incorporating additional cooling methods
• Potential for increased damages from catastrophic events
• Potential for increased insurance costs or reduced/no insurance availability
Market
The possibility that markets vulnerable to climate change will • Reduced economic activity in vulnerable markets
become less desirable over time. Rising capital costs to pay • Reduced occupier demand for properties
for building and maintaining infrastructure to manage • Reduced asset value
climate risks. • Potential for increased real estate taxes
Policy and regulation
Regulations to address climate change—e.g., climate risk • Increased cost of doing business due to new disclosure requirements
disclosure, tougher building standards, carbon pricing, and compliance measures
emissions caps, changes to subsidies—as well as changing • Increased taxes—both those resulting from public policies such as carbon
Transition risks
policies for providing funding for infrastructure or rebuilding taxes and those for funding adaptation infrastructure
after major events. • Loss of subsidies or other funding opportunities
• Additional capital investment to comply with stricter regulation
Resource availability
Changes in the availability of key resources such as energy • Increased costs and reduced net operating income due to higher prices
and water, including water scarcity. for water and energy
• Additional capital expenditures to adapt buildings to operate with reduced/
alternative resources
Reputation and market position
Growing stakeholder preference to work with companies • Risk to company brand and reputation if no action taken
incorporating climate risk into investment decisions, and • Lower liquidity and/or reduced attractiveness of assets that have not
consumer preference for real estate products incorporating incorporated climate mitigation
climate mitigation.
6Bosco Verticale, two residential towers in Milan, Italy, which address climate change issues through green infrastructure.(istockphoto © pierluigipalazzi) 7
CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING
CLIMATE RISK:
THE STATE OF
THE INDUSTRY
This section explores the research findings According to insurance brokerage firm, 69 Accordingly, many investment managers
on the current industry perception of climate percent of real estate and hospitality clients are looking to insurance partners to help
risk and the role being played by different had seen an increase in rates in the year anticipate rising premiums caused by
types of actors in the real estate investment to the end of the third quarter 2018, with climate risks, availability of coverage, and
community. an average rate increase of 9.1 percent. to understand mitigation opportunities.
The insurance industry is also expected Currently, premiums are largely levied on the
Insuring Climate Risks to increase premiums as it changes how basis of historical analysis so are not likely to
The prevailing view among interviewees was it funds losses. Currently, insurers tend to take into consideration future climate risks.
that most investment managers and investors cross-fund property losses with other forms Moreover, premiums usually can be adjusted
for directly held assets currently use of insurance premiums, a practice that has up or down every year, and the amount of
insurance as their primary means of led insurers to believe that property premiums insurance available for a property (or any
protection against extreme weather and are priced below their risk of losses. If insurance at all) can change on an annual
climate events. “Rather than limiting property premiums are more directly related basis.
investment in particular areas, it’s been to the risk of losses, this could cause some
more a question of how to properly insure a premiums to rise. In addition, in recent years, Interviewees also noted that because most
property,” noted one investment consultant. an inward flow of alternative capital, such as premiums have not yet been affected by
“A few managers won’t go into certain areas, reinsurance capital raised through insurance- climate risk, they are not currently rewarded
but most focus on insurance.” linked securities, has helped with insurance by insurance providers for investing in
losses. If this capital decreases, disappears, resilience or mitigation with better premiums
However, insurance will cover damages or seeks a higher return, property premiums or more coverage than their less-resilient
from catastrophic events; it will not cover could increase. peers, but hope to see this happen in the
loss in value from a reduction in the asset’s future.
liquidity. In general, insurance cover needs For the future, numerous interviewees noted
to be renewed each year, whereas investors that they are uncertain how long insurance
“investment
are holding properties over longer periods. coverage will be sufficient for assets in highly
This leaves investors exposed to climate risks vulnerable locations. As one investment Rather than limiting
over the hold period and the potential for manager noted: “A plus-4-degree [Celsius]
investment devaluation. world is not insurable.” Discussing a part of
in particular
the United States that is particularly exposed areas, it’s been more
In some cases, where markets have been to extreme weather, another interviewee
a question of how
affected by extreme weather, insurance expressed his disbelief: “I find it hard to
premiums have gone up or coverage believe that people are capable of to properly insure a
availability has gone down; however, investors
felt that both the price point and risk were
underwriting all of these risks.” property. ”
still acceptable. Some interviewees noted that
they have recently seen increases in their
insurance premiums, while others anticipate
increases given the stronger and more
frequent storms arising from climate change.
8One institutional investor noted that it has (including beyond the interviewees’ hold long-term sea-level rise are unlikely to affect
recently added new procedures to ensure period). One investment consultant noted investments during their hold cycle, but that
adequate insurance for its private indirect that clients are interested in adjusting increasing severity and frequency of extreme
international portfolio. Its new process required returns to factor in climate risk; weather events like storm-surge sea-level
includes ensuring that the expected and however, it is difficult “to get a sense of how rise could have an immediate impact on
agreed upon insurance is in place as well as material that added risk premium would be.” their assets.
requesting and reviewing policy content and
rates. “We are the only one in the industry Predicting impacts is also challenging given Climate risks may also ultimately become
that we know of who requests this information the number of potential scenarios in play: more important to shorter-term investors as
on an annual basis,” the interviewee added. “The impact of risks further out on they consider their prospects for successfully
investment are more uncertain. We know that exiting an investment. One investment
The Challenge of Investment Horizons the risk will be there, but not necessarily the manager was not concerned about the
For industry leaders with hold periods over locations where it is a factor, and the impact value of an asset through its own hold period
seven to 10 years, concerns were increasing of the risk.” Other interviewees mentioned but was thinking ahead to exit liquidity and
about rising costs and protecting the value that it is challenging to quantify the effects therefore the next buyer’s hold period.
of their investments over time. “These risks that climate risk might have. In the words of
could hurt the long-term profitability of these one investor: “If we can’t measure it, how do One investor said the risks often boiled down
assets so we are protecting their we put a discount on it?” to the lower liquidity that would occur if
[investments],” said one interviewee. climate-related risks appeared to be greater
Several interviewees were struggling to than originally thought or not properly
Interviewees were not confident that they reconcile the potential impacts of very long priced. For them, addressing climate risk was
understood the potential financial impact term risks like sea-level rise with their hold about keeping assets liquid and fighting the
of climate risks and therefore how best to periods. Not knowing when these impacts obsolescence that can come from buildings
prepare; it was difficult to account for impacts may take effect made them difficult to being less marketable to tenants and
that could happen over the longer term address. Many noted that impacts like investors.
Buffalo Bayou Park, Houston, Texas, was designed to withstand flooding from torrential rainfalls common to the city.
Credit: Jonnu Singleton, SWA Group
9CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING
“in our
While we have a good supply of capital in insurance due to increased confidence
modeling, long periods of price stability should not be assumed.”
A VIEW FROM THE INSURANCE INDUSTRY
Perhaps no other sector is seen at greater risk from climate These insurance linked securities (ILS) provide an alternative
change than the insurance industry. It is often assumed that form of insurance capital for cedents looking to strengthen their
climate change will be ruinous to insurers and will cause balance sheets from natural catastrophe losses.
premiums to skyrocket. In fact, the industry simply doesn’t know
what will happen. Climate change is a serious risk to society, Insurers are also becoming masters of their books of business
but how it affects insurers and premiums for policyholders is a through better understanding and pricing of risks. Tools such as
complex process. catastrophe models offer a good starting point to assess current
risk, but until now, the insurance industry has relied on this type
Most insurance policies are less than 24 months in duration and of data from just two sources.
premiums are adjusted based on a complex range of factors:
available insurance capital, returns on insurers’ assets, demand Aon, along with other insurers, is supporting the development
for insurance, and of course, the underlying risk. Climate change of more open source models such as the Oasis Lost Modelling
can impact any of the components driving premiums. Framework to encourage a common set of standards,
transparency and more competition.
Climate change will shift the tail risks for many weather perils, but
uncertainty is widespread across many types of weather events. Parts of the industry are also starting to recognise that the
There isn’t a consensus on the impact climate change will have challenge of modeling climate risks for clients won’t come from
on tropical cyclone (hurricane/typhoon) frequency, but they are existing modeling tools alone. It needs new start-ups to play a role
likely to become more severe. Sea-level rise will exacerbate storm in improving quantitative metrics for helping clients address
surge. To date, however, there isn’t a clear trend in insurance loss climate risks.
data; losses vary from year to year.
While insurance plays a critical role in risk management, a
What are some takeaways the insurance industry can offer risk-financing strategy needs to look at risk mitigation and risk
real estate owners? First, while there isn’t a clear answer on retention. Mitigation measures could help lower premiums as it
premiums, expect more volatility. Climate change will increase might give more certainty around probable outcomes for individual
weather volatility, which will reverberate through the economy. assets. However, it has to be remembered that an effective insurer
While we have a good supply of capital in insurance due to will be crafting a portfolio around different types of risks, good and
increased confidence in our modeling, long periods of price bad. The questions for real estate owners is whether they have
stability should not be assumed. portfolios that are attractive to the widest range of risk transfer
capital available, and do they understand how these risks might
Pricing is hard to predict and influenced by macroeconomic evolve and lead to changes in risk perceptions.
events as well as policy. Previously single large events in one
location had a bigger impact on insurance markets globally. Finally, the insurance and real estate industries should be asking
With better modelling and more capital, these impacts are if they are building things the right way and in the right places.
highly regional now. It all comes back to understanding risk. Brokers and insurers
are here to help and there must be more cooperation across the
For those looking for alternatives to extend insurance periods to entire value chain.
three or five years, the capital markets have provided cover for
some types of catastrophic risk through catastrophe bonds. — Greg Lowe, Global Head of Resilience and Sustainability, Aon
10Market-level Impacts Investment Locations: Understanding
Interviewees identified potential impacts at
the market, portfolio, and asset levels. At the “managers]
We rely on [our
to be the
Asset Risk
While awareness of climate risk is growing,
market level, one investment manager had none of the investors interviewed for this
attempted to investigate whether yield differs experts in relation to research ruled out investment in assets
for assets in areas where physical risks are in otherwise attractive markets solely
higher, but found that even if a correlation
managing risks and because of climate risk. Overall, interviewees
existed, a causal link to climate was difficult opportunities in their anticipated that the attractiveness of coastal
to demonstrate isolated from other factors
that might be affecting that market.
own portfolios. ” markets vulnerable to climate risks like
sea-level rise could fall in the future, but
interest is unlikely to subside in the near-
One investment manager familiar with and mid-term. A global investment manager
Moody’s 2017 report13 warning cities to This does not mean that investors are not that assesses all new properties against an
invest in resilience or face downgrades in interested in their managers’ approach to this internal set of risk indicators that includes
their bond rating, noted that one year after issue. One large institutional investor said that climate risk noted that although a low score
this report no AAA city has actually been an investment manager’s approach to climate in this area had downgraded the overall risk
downgraded, but this interviewee believed and ESG risks more broadly is important to score of otherwise attractive cities, climate
that eventually this would happen. At the remaining competitive, particularly when risks on their own were not enough to rule out
asset level, although physical risks in terms making long-term investments in unlisted many investments.
of possible storm damage can be examined, property. Several investors interviewed also
predicting and quantifying what the impact mentioned that they evaluate their investment In part, this view reflects pragmatism about
could be are still difficult. That being said, managers’ approach to climate risk as part of where the core markets for real estate
a change in approach—by the insurance overall checks on their investment process. currently are. “The vast majority of what we
industry, by a global rating agency, or by consider core assets or core markets are in
local or national governments shifting Many interviewees reported that a small the coastal gateway areas. There’s only so
policies on funding recovery needs after number of investors are actively working to much that you can diversify away from that,”
a disaster—could lead to significant push the industry to take climate risk into noted one investment consultant. That said,
market shifts. account. Some of the investment managers interviewees emphasized the need to invest
interviewed found these investors’ efforts in a “sensible” and “smart” way in markets
Investors and Investment Managers— particularly helpful for raising awareness. where physical risks from climate change
Working Together on Portfolio Risk One investor has this year, for the first time, are evident. The challenge to doing so is
The institutional investors interviewed for sent investment managers across all asset anticipating what the risk premium could
this research were consistent in their view classes a questionnaire specifically about be—something which most interviewees
that they expect their investment managers how they are managing climate risk. felt was not sufficiently understood.
to take the lead in monitoring the potential
impact that climate risk could have on their For investment managers, the drive to more Most interviewees noted that growing
portfolios. Investors rely on the local effectively manage climate risk is motivated awareness of climate risk will influence
market expertise of their managers to by its potential impacts on the portfolio. investment strategies, but in more nuanced
understand risks, including those related to For some, it is also about getting ahead of ways than simply ruling out investing in a
extreme weather and climate. “We have to questions that may arise from their investors. particular location. For example, an
trust our partners on this,” reported an The head of sustainability at a global investment consultant posited that investors
investment director at one institutional investment manager, discussing his might adjust their strategies in vulnerable
investor. An ESG specialist at another company’s introduction of scenario cities, focusing on particular submarkets such
institutional investor concurred. “We’re not models for some assets, said: “We are doing as those further inland. Numerous
going to restrict our managers . . . We rely this to be proactive. We want to be able to interviewees also noted that their attitude
on them to be the experts in relation to understand what the upper bound of the and approaches could change, particularly
managing risks and opportunities in their value impact is, so we can adjust for it with with increased frequency of major events like
own portfolios.” our investment strategy before getting the hurricanes, better data on the likelihood of
question from all our investors.” future storms, or decreased access to
affordable insurance coverage.
11CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING
Impact of Super Typhoon Mangkhut on a Hong Kong building.
(istockphoto © winhorse)
12Broadly speaking, real estate has a built-in chance to fight obsolescence and risks, especially market risk if a particular
ability to adapt to climate change because of differentiate their assets even in more city, region, or country is not taking action to
the nature of the asset class. Unlike bonds vulnerable areas, which could help prevent reduce the threats to assets in their
or shares, property’s heterogeneity, limited locations being ruled out for investment. jurisdiction. More than one interviewee noted
stock, and the ability to actively manage that willingness to invest in cities with climate
assets give investors and investment As discussed in the previous section, the vulnerabilities hinged on seeing a proactive
managers more ability to adapt by making risks to real estate investment go beyond just approach by local government, including a
properties resilient. This gives owners the the physical. Investors also face transition commitment to invest in infrastructure.
THE ROLE OF CORPORATE REPORTING IN CLIMATE RISK AWARENESS
One evolving issue for investors and investment managers will TCFD’s supporters had a combined market capitalization of $7.9
be how to report to their stakeholders on climate-related trillion, and supporting financial firms are responsible for nearly
financial risks. $100 trillion in financial assets.15 Currently, only a handful of
real estate investment managers have expressly said they issue
Publicly listed companies have been reporting on their climate TCFD-compliant reports, but those participating are among some
mitigation and overall sustainability and social responsibility of the leading global real estate players.
efforts for more than a decade through a number of global
reporting frameworks, including the Global Reporting Initiative, Although the landscape for reporting climate-related risks is
the Carbon Disclosure Project (now just CDP), and other currently a crowded one, many investors surveyed appreciate the
standards. Companies have also looked to refine this wealth of available ESG data available on real estate companies,
reporting to be integrated into annual financial disclosures, and they are integrating climate reporting into their investment
following standards like the Sustainability Accounting Standards decisions.
Board (SASB), the UN Principles for Responsible Investment
(UNPRI), and alignment with the UN’s Sustainable Development Currently, most of them are leveraging a combination of public
Goals and UN Guiding Principles on Business and Human Rights reporting through GRESB and CDP and using their own internal
(UNGP). In real estate, many publicly listed real estate due diligence on a potential investment’s ESG programs and
investment trust (REITs) and investment funds also report to the performance. Investors participating in SASB and TCFD are
Global Real Estate Sustainability Benchmark (GRESB), which hopeful that these standards will provide some consistency to
focuses on helping real estate investors assess the sustainability climate risk and mitigation reporting and help provide more
of their real estate holdings. audit-quality data on their current and potential investments.
While most investors surveyed have said they are hopeful that a
A recent addition to this sustainability reporting landscape is the standard will emerge to unify climate risk reporting, for now they
Task Force on Climate-Related Disclosures (TCFD). Managed plan to use multiple data sources to inform their decision-making
by the G20’s Financial Stability Board, an international forum on climate risk.
that coordinates financial authorities to increase the stability of
international markets, TCFD was created to raise market GRESB also recently launched a real estate Resilience Module. Its
awareness of climate-related financial risks and opportunities14 development was motivated by two key factors: to meet growing
and to help drive consistent reporting on climate-related risks demand for information on resilience, and to increase access to
across all industries. information about strategies used to assess and manage risks
from social and environmental shocks and stressors, including the
It is supported by more than 500 firms and associations from impact of climate change.
across different industries globally. It is a voluntary program that
lays out recommendations for consistent disclosures that help
firms understand their financial risk and increase transparency for
investors, lenders, insurers, and other stakeholders.
13CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING
MEASURING AND
MANAGING CLIMATE RISK:
CURRENT BEST PRACTICES
For the most part, leading companies in the that longer-term temperature increases or most noted they have not yet determined how
industry are not establishing new policies increased wear and tear on buildings could to integrate the information presented into
and processes on climate risk. Rather, they have on operating and capital expenditure decision-making processes.
are modifying existing decision-making requirements. The ultimate objective for the
and management processes to add climate investment community is to understand how Interviewees also mentioned that for global
and extreme weather-related factors to climate will affect asset liquidity and, as a investors, variations in the coverage, quality,
those being considered alongside other result, returns, in terms of both income and and methods used to produce data relevant
risks and opportunities. Many interviewees capital growth. to climate risk around the world were a
noted that responding to climate risk will be barrier to understanding the risks. In addition,
a longer-term process, as understanding Several firms described natural catastro- much of the data available relies on historical
improves among their teams and investment phe indices and screenings that they are observations, which can have limited value
committees, and experimental processes are developing to analyze climate risk. In some for predictive modeling looking 10 to 20
formalized. This section summarizes some cases, these exercises are building on past years, let alone 50 to 80 years, into the
of the solutions currently being implemented risk analyses that studied risks of storms, future.
by investors and investment managers, as drought, and other environmental hazards,
well as in-depth case studies drawn from but may not have factored in the likely The aim of these mapping analyses is to
Heitman’s experience. increased frequency and intensity of events pinpoint physical risk, quantify it, and
in the future due to climate change. Some understand the financial impact that climate
Mapping Physical Risks have also taken this a step further to model risk could pose. In the long run, argued an
Many leading investment managers and financial implications, such as the potential interviewee, identifying climate risk could be
institutional investors are undertaking for increased insurance premiums in more impactful in the investment process
flood, resilience, and climate vulnerability high-risk areas, though many interviewees than its current practice of looking at whether
scans of their portfolios. These mapping noted they had challenges associated with a building has a sustainability certification.
exercises seek to identify the impacts of doing this. While sustainability often focuses largely on
physical climate risks on their properties, operations, climate risk addresses broader
including sea-level rise, flooding, heavy Many investors and investment managers trends that could ultimately have a greater
rainfall, water stress, extreme heat, wildfire, are starting to use analytical mapping effect on property valuations.
and hurricanes. Potential impacts being exercises to provide a new way to look at
considered range from physical access and their portfolios and understand the Another benefit of this type of mapping
business disruption for tenants to the effects vulnerabilities of their assets. However, would be to help investors and investment
managers identify locations that may be
affected less by climate change or more
“willTheaffectultimate
resilient to it. These locations and assets may
objective is to understand how climate well benefit from a pricing premium over
asset liquidity and, as a result, returns, in time. Better data and analysis could also lead
terms of both income and capital growth.”
to a larger price differentiation between cities
that have higher climate risks and those with
lower risks.
14CASE STUDY: ALIGNING RISK INVESTMENT HORIZONS
When Heitman began seeking greater climate risk transparency From the available partners in this emerging industry, Heitman
to improve its investment decisions and manage asset- and selected Four Twenty Seven, a provider of market intelligence on
portfolio-level risk, it found that currently available data were not the economic risk of climate change, to screen assets and
granular enough to assess the extent to which an asset is resilient potential new acquisitions and map climate risks around the
in the face of today’s climate change realities. world.
Currently, climate-risk assessment typically relies on insurance These new climate risk mapping tools enable Heitman to screen
models and public data sets, where historical occurrences are its current portfolio and potential new acquisitions using historical
the basis for modeling the risk of natural disasters, though data weather and environmental risk data, as well as forward-looking
availability, accuracy, and transparency vary globally. climate models, to build an overall view of climate-related risks
for Heitman’s properties, encompassing both acute and chronic
Since many insurance premiums renew annually, insurance risks. For example, floods are mapped in 30-meter by 30-meter
companies take a short view and price risk only one year out (98 ft by 98 ft) zones. “A property on one side of the street could
based on probable weather and environmental risk. Institutional have a higher risk score for flooding than the other, reflecting
investors in property must consider longer-term risk that spans differences in elevation or proximity to a local water body,” said
longer holding periods. Laura Craft, head of global sustainability at Heitman.
Heitman turned to scientific climate models that project Each asset is allocated a score from zero to 100 based on
long-term, global climate change impact and help clarify changing multiple dimensions—including risk related to cyclones, floods,
exposure for both acute, extreme weather events and chronic, earthquakes, sea-level rise, heat stress, and water stress—and
industry-disrupting fluctuations, such as rising sea levels. then benchmarked to these dimensions using a proprietary
However, scientific models can be challenging to access and database of over 1 million properties.
apply to a large portfolio of real assets.
Heitman can now use these climate risk mapping tools to gain a
To help address these challenges, Heitman sought expertise from better perspective of the risk profile and exposure of each asset
an emerging industry that combines next-generation climate and portfolio than what is provided through readily available
maps with real estate data, thereby providing them with the best data. Armed with this data, real estate investors can pinpoint
tools to begin effectively assessing and preparing for climate risk. areas most vulnerable to risk and, through further due diligence,
determine if risk factors have been mitigated at the property and
municipal level (see page 17).
Due Diligence and Other Investment asset is located. Factors considered include investment manager has recently
Decision-Making Processes the ability of property owners in that location incorporated a “catastrophe score” into its
Issues such as flood risk have long been part to manage the risks and the ability of the ESG checklist, which addresses flood and
of due diligence for investment decisions. country in which it is located to deal with a wind risk, with climate risk incorporated,
The likely impact of climate change on potential event. The composite score for an alongside risks of earthquakes and terror-
existing environmental risks has not always area, which may range from low to extreme, ism. These scores help determine what the
been incorporated, but many interviewees is considered in the due diligence process. necessary level of insurance coverage should
predicted that this will soon change. To date, reported the interviewee, this be to protect against damage loss. Firms may
process has not resulted in any proposed also include a risk premium in their required
One global investment manager has, in acquisitions being ruled out. returns to account for climate risk. One
recent years, examined each acquisition interviewee noted that transparency indices
against a proprietary environmental risk Other investment managers and institutional often considered in the due diligence process,
tool created by an industry consultant that investors interviewed noted the increasing such as JLL’s Real Estate Transparency Index,
includes, among other risks, a climate use of ESG or sustainability indices during could be updated to explicitly address climate
change risk index. Using modeling, the index due diligence and suggested that these issues.
rates the climate change vulnerability over present a ripe opportunity for more formal
the next 20 years for the area in which the consideration of climate risks. One
15CLIMATE RISK AND REAL ESTATE INVESTMENT DECISION-MAKING
THE REIT PERSPECTIVE: GEOGRAPHIC RISK, ASSET-LEVEL MITIGATION,
AND CITY ENGAGEMENT
A 2018 study by climate analytics firm Four Twenty Seven in In the near-term, REITs investing in resilience can look to
partnership with GeoPhy, a real estate technology company, co-benefits from the investments (including minimized damages
assessed 73,500 properties owned by 321 REITs and found that weather events, long-term operating expense stability, reduced
35 percent of REIT properties globally are geographically exposed utility expenses, and enhanced tenant experience) as well as
to climate hazards, including inland flooding (17 percent), reputational benefits with investors and the cities in which the
typhoons or hurricanes (12 percent), and coastal flooding and REITs operate. Longer-term, many REITs looking to attract
sea-level rise (6 percent).16 large-scale private capital and institutional investment believe
they will be required to show that they have assessed and
This report helped highlight the geographic exposure to worked to mitigate climate risks to pass the investment screens
climate risk of some primarily coastal REITs, but did not for these investors.
assess properties’ current or planned resiliency efforts, or the
investments planned by cities to help mitigate asset-level climate At the city scale, investments made (or not made) by cities and
risks. For REITs looking to reduce their climate risk, asset-level regions will have a significant impact on the future climate risk
and public investment in resilience will all have a significant for REITs and real estate. One global REIT interviewed pointed
impact on their specific climate risks. out that its assets are concentrated in cities that have pledged to
invest more than $5 billion in resilient infrastructure in the next
Investors are beginning to ask REITs how they are incorporating 10 years. Another REIT expressed concern that while they have
climate risk into their investment and development strategies. At invested tens of millions in asset-level resilience, some cities in
the asset level, one challenge is weighing the cost of mitigating which they operate have been slow to commit to infrastructure
climate risk with the benefits to that asset over time. Is the investments that will make these asset-level investments pay off.
market ready to reward proactive investors with better capital
terms, lower insurance premiums, or better tenant attraction and Climate models cannot project whether cities will meet their
retention? Viewpoints from REITs suggest not; several expressed resilience investment plans but as the market starts to see how
frustration that investments in asset-level resilience did not come these preventive investments at the asset and the city levels can
with a clear, consistent decrease in insurance premiums, or any lead to avoided losses, these mitigation activities should help
clear signal that tenants would pay more for (or even prefer) a refine the risk profile of REITs and other real estate assets in
more resilient building. geographies with a higher climate risk.
Another interviewee, an investment manager on future capex, run climate change manager began to move backup generators
for a European firm that invests globally in scenarios, and make sure your data visibility to higher floors and to modify water-pumping
REITs, noted that climate risk analysis in due is good enough to make long-term deci- systems. Similar changes were made by
diligence helped it determine what future sions.” many building owners and managers in
capital expenditure liabilities might be for New York City after Hurricane Sandy.17
companies in which they might consider Mitigation for Assets at Risk
investing. The firm uses climate risk as one Many investment managers indicated they Some interviewees proposed that for assets
of the factors considered when assigning are exploring how climate mitigation in markets or areas flagged as high risk,
grades to the management teams that strategies—such as seawalls, dikes, the due diligence process should include an
determine whether or not it will invest in a building hardening, increased elevation, assessment of the potential need for such
REIT. Although climate risk has not yet been and additional cooling systems—can be capital expenditures, which could then be
the determining factor in deciding against incorporated into properties to improve their incorporated into valuations. One investment
investing in a REIT, this interviewee argued resilience and reduce the risk of losses or manager interviewed is doing so on an ad
that the approach being taken by most REITs business interruption during a major weather hoc basis and commissioning additional
to address climate issues is insufficient, event. For example, after the 2013 floods studies about potential interventions from
stating that “you have to do proper analysis in Alberta, Canada, a global investment engineering consultants where required.
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