The Impact of Climate Change on Real Estate Valuations and Decisions

September 3, 2020

Written by Jonathan Rivera, Director

Climate change risk is not being adequately priced into commercial real estate valuations.  The recent increased frequency and intensity of extreme weather events were accurately predicted by climate scientists over 20 years ago.  Based on recent data and current trendlines, the latest projections point towards an acceleration of these recently observed extreme weather events and rising sea levels over the next several decades.  Due to high demand for coastal properties, a disproportionate share of the nation’s commercial real estate is exposed to climate change risks, and at present, these risks are not fully being addressed.

Climate change is the recent dramatic shift of the planet’s normal climate patterns due to a spike in emissions of carbon dioxide caused by human activity.  The average concentration of carbon dioxide in the atmosphere has increased dramatically over the past 60 years from 316ppm in 1959 to 411ppm in 2019; dangerously close to the 450ppm limit set by scientists to avoid catastrophic damage.  If current trends hold (as shown in the chart below), it is possible that we will reach 450ppm within the next 10 to 20 years.

The result of this exponential growth of carbon dioxide in the atmosphere has been an equally dramatic increase of the average global temperature.  Soaring carbon emissions have created a global greenhouse effect, trapping more and more of the sun’s heat.  The Paris Agreement set 2.0 degrees Celsius above pre-industrial levels as the limit to the global average temperature.  However, we are already past 1.0 degrees Celsius with current projections of 1.2 to 1.3 degrees within the next five years.

Higher global temperatures will cause an increased frequency of extreme weather events that will pose significant risk to real estate in the coming years.  Longer summer heat waves will stretch the capacity of building air conditioners and increase utility costs, extended periods of drought will restrict building water usage and increase the prevalence of wild fires, and stronger and more frequent hurricanes will require a higher resiliency of building materials.

However, of all the climate change enhanced national disasters, none is as acute and directly correlated to global warming as sea level rise.  Increased sea level adversely effects coastal communities with an increased frequency of flooding, as well as significantly higher storm surges. As the average global temperature increased above 1.0 degrees Celsius, the global mean sea level increased nearly 9.0 inches since 1880.  Sustained increases in global temperature have caused the rapid melting of glaciers and polar ice resulting in more seawater.  While at the same time, the increase in heat expands seawater volume.  Furthermore, in the same way that increases in the average global temperature have accelerated in recent years, sea level rise has also accelerated over the past few decades.  According to the National Oceanic and Atmospheric Administration (NOAA), the global mean seal level in 2018 was 3.2 inches above the 1993 average.  As a result, near-term projections forecast elevated increases in sea levels for the nation’s coastal cities. For example, in Boston, sea level rise was 9.0 inches during the past century, and by 2030 sea levels are projected to be an additional 8.0 inches higher than 2000 levels.

The effects of climate change are happening now in the state of Florida.  The state already has higher sea levels than the global average due to typical wind and ocean current patterns.  Furthermore, the average elevation in Florida is only six feet.  These factors, combined with rising sea levels, have resulted in a growing number of properties that have become exposed to the risks of frequent flood damage.

A new phenomenon, called sunny day flooding has also accelerated in recent years.  As the name suggests, this type of flooding occurs without any precipitation and is driven mainly by lunar tides.  The porous limestone that makes up much of the state’s land allows heightened seawater during tidal periods to bubble up out of the ground or come out of city storm drains, filling streets and back yards with seawater.  During July and August of 2019, sunny day flooding broke all historic records for over a week in Miami.  In Key Largo, tidal flooding lasted for nearly three months during the fall of 2019.  With low elevations, porous limestone bedrock, and rising seas, the frequency of sunny day flooding has more than tripled since 1996.  According to First Street Foundation, an organization that quantifies flood risk, losses to real estate values from sunny day flooding in Miami Beach totaled $337 million from 2005 to 2017.

With the recent acceleration of sea level rise, it’s very possible that some areas of Florida will be inundated with permanent flooding by the end of the century.  If current trend lines hold, sea levels in Miami could be as high as three feet by 2070, according to NOAA projections.  As a result, the World Bank listed South Florida as the most economically vulnerable area in the US, and the second most vulnerable in the world to climate change.

Insurance has historically been the main tool for mitigating the risks posed by extreme weather events.  However, insurance premiums are typically based on retroactive data, whereas extreme weather events, increasingly exacerbated by climate change, are expected to continue to ramp up over the next several years.  Furthermore, with the heightened prevalence of flooding in coastal areas, it is likely that a substantial number of properties could become uninsurable.  In addition, it should be noted that insurance does not cover value losses at the time of property reversion or disposition.  With large sea level increases projected over the next ten years, there are significant risks to reversion values at the end of holding periods for a vast number of coastal properties.

Over the past year, the real estate industry has started to address the heightened risks of climate change and several initiatives have taken shape.

  • Early last year, Heitman, in partnership with the Urban Land Institute, released a comprehensive report on specific climate change risks, as well as possible remedies, for commercial real estate investors.
  • In July 2019, Moody’s purchased a majority stake in Four Twenty-Seven, Inc. – a climate research firm.  As a result, Moody’s is now incorporating climate risk data into their municipal bond ratings.
  • PGGM, a Dutch pension fund that is the world’s 12th largest owner of real estate, is working to quantify specific climate change risks of each individual asset of its portfolios.  This data will help to inform PGGM asset managers about future asset acquisition and disposition decisions in regards to their exposure to climate risk.
  • BlackRock, the largest asset manager globally, will put climate change at the center of most investment decisions.  Companies that BlackRock invests in will be required to disclose climate change risks as well as plans to abide by the requirements set forth by the Paris Agreement.  Specific climate risks that BlackRock is currently considering are how the municipal bond market will be affected by cities’ responses to climate change, the reliability of the 30-year mortgage in a time of climate change uncertainty, and the effect on flood and fire insurance in climate susceptible areas.
  • National Real Estate Advisors recently decided to exclude Florida real estate entirely from its investment portfolios.

The time is now for those of us in the real estate industry to work together to create industry-wide norms that contemplate and quantify climate risks in decision making and valuations.  While a handful of leaders have taken some admirable first steps, only a unified industry-wide response and agreed upon education and standards will help prepare us for this growing crisis.  Finally, underwriting for properties in areas that are most vulnerable to climate change will need to start reflecting these increasing risks.