Real estate investors are waking up to physical climate risk, but perhaps not quickly enough. Christopher Walker reports

The Sun Belt states of the US are hot, both literally and figuratively, when it comes to positive migration trends and investment intentions. PwC and the Urban Land Institute’s (ULI) annual Emerging Trends in Real Estate has been tracking their popularity.

The 2022 report found that the number of Sun Belt markets in the top 20 markets for overall real estate prospects had increased from 10 in 2011 to 14.

Real estate investment manager Empira Group recently carried out a study of the Sun Belt states and concluded that the region is above average and extremely attractive to real estate investors, based on fundamental data, market performance of the past 10 years and future growth potential. “Investors should be considering opportunities away from the expensive and saturated metropolitan areas of the west and cast coasts,” says Steffen Metzner, head of research at Empira and author of the study.

According to First Street Foundation, the Sun Belt is expected to be exposed to longer, more extreme temperatures of 125ºF (52ºC) in 30 years’ time. It predicts that an “extreme heat belt”, in which heat indices exceed such temperatures, will expand from 50 US counties in 2023 to over 1,000 by 2053.

Lisette van Doorn, CEO for Europe at ULI, says: “The continued migration to the Sun Belt in the US and the consequent rise in real estate valuations demonstrates that the increasing physical climate risks are not yet reflected in property valuations.” However, the approach among real estate fund managers when considering the physical risks of climate change “has come a long way”, she says. In 2015, physical climate risk was hardly on anyone’s agenda. By 2019, ULI found that there was real concern, “but there was also great difficulty in how to deal with this”. 

The risk of flooding, for example, might be identified, but if it was insured against it was generally seen as a non-issue. “We’ve seen that understanding develop massively, even since 2019, as the owners of real estate seek to go beyond treating physical climate risk as just an insurance matter,” she says 

Some do so with off-the-shelf solutions. CBRE Investment Management uses Moody’s ESG Solutions Climate Risk Tool. “We are screening our portfolios’ and assets’ exposure to climate-related hazards,” says Mari Aanesen, ESG associate at CBRE IM. The risks relate to a 4ºC warming scenario and models exposure levels out to 2040. When considering new assets, CBRE has developed a ‘winning cities’ model, which identifies investments that will be resilient over the longer term.

BlackRock has built its own tool. Since March 2020, its Aladdin Climate technology has used climate science, economics, big data and cloud computing to provide evidence-based insights into physical climate risk. Simon Durkin, head of European real assets research, says it enables BlackRock “to integrate granular, geolocation-specific climate data into our investment processes to better identify potential climate risks”.

Dutch asset manager Van Lanschot Kempen has a joint venture with Munich Re, which takes data from 19 different climate events of the past 50 years and combines it with modelling of future outcomes using two main scenarios – a base-case model of 2ºC warming by 2040, and a bear  case assuming more dramatic climate change. 

Kempen has drawn up a worrying map of the US (see figure). “The climate-risk picture is very clear,” says Egbert Nijmeijer, co-head of real assets at Kempen. “The Sun Belt in the US is largely red [high risk], with some particular areas of concern such as New Orleans and Key West. The further north you get the greener the map becomes.”

Extreme temperatures are a serious risk, and Boston becomes much more attractive than Texas. But that is not the whole story. “If we consider other climate-related events, such as an increase in hurricanes and the rise in sea levels, the impact on valuations is even more dramatic,” says Nijmeijer.

220920_LaSalle_Julie_2844 copy

“We would benefit from standardisation and transparency of how to measure climate risks”

Julie Manning 

“If you own a hotel in Key West where you have been used to one category 3 storm every three years, you have to prepare yourself for a climate situation where you will have a category 5 storm every year. This means the hotel will need to shut down at least once a year, and that there will be a massive increase in repair and maintenance bills.”

Nijmeijer asks: “At what point will that hotel become uninsurable? Because at that point the valuation of the hotel will fall to zero.” 

There has been plenty of discussion within the real estate investment-management industry about decarbonising portfolios and setting net-zero targets. But van Doorn says: “We have not seen many serious discussions on how to incorporate physical climate risk into real estate valuations.”

ULI has produced a paper on the potential for a “carbon bubble”, emanating from the rush to achieve net-zero targets. “You could argue… there is a physical climate-risk bubble that is waiting to happen,” says van Doorn. “There could be a tipping point – for example, a series of category five storms in Florida.”

Nijmeijer says: “Human nature is at the heart of the problem. The human mind cannot simultaneously take on board the short-term advantages and the long-term dangers. An individual will happily buy a residential unit in a location where they may not be able to sell in 15 years’ time. Unbelievably, at the moment many people are paying higher prices for higher risk.”


“The majority of assets we manage have no climate risk or very low climate risk”

Edward Dixon

Is this true also of institutional fund managers? Nijmeijer finds the pace of change painfully slow. “When I look back over the last year it continues to depress me that, although there has been some improvement in the attitude of managers, there are now perhaps 10% who consider physical climate risk compared to say only 2% a year ago. It is, nevertheless, the fact that the overwhelming majority continue to assume that they will simply be able to sell on a risky asset to some other buyer in say five years’ time.”

Among that 10%, some companies stand out. “I can think of one major [investment] house which has simply stopped investing in Florida because it has a 25-year time horizon and says that there is simply too high a risk of a tipping point coming within that,” Nijmeijer says.

The problem is arguably compounded by the valuation industry. “The valuer looks back, and can only look forward in their assumptions if there is a clear regulatory model,” says van Doorn “We don’t know exactly when that will be the case. This is a major issue, especially as climate risk is no longer something of the future – it is happening now with floods and heat waves happening. This has not fully been fully reflected in valuations.”

Less of a problem for Europe?

Simone Pozzato, managing director and fund manager at Hines, believes there is a difference between the importance of physical risk for European real estate fund managers and those in the US. “We are less exposed to extreme climate events, such as the hurricanes, which affect the US,” he says.

Pozzato has observed no significant movement in insurance rates relating to climate for his portfolio, which is invested in 16 European cities. “None of them are a no-go area within Europe,” he says. “A key focus for us is on transition risk, which should hopefully further mitigate physical risk. While I’m very happy to spend whatever is necessary to make a portfolio protected from transition risk, we feel it is too early to have similar calculations on physical risk. It is my sincere hope we never get there with more extreme weather. In my opinion this will mean that all transition efforts have failed.”

Lisette van Doorn (ULI) headshot

“It is quite difficult for real estate owners and managers to get a proper view of risk”

Lisette van Doorn

Ed Dixon, head of ESG for real assets at Aviva Investors, says: “As a real estate investor we are focused on Europe and the UK, so our clients’ assets tend to be more susceptible to transition-risk factors over physical risks. The majority of assets we manage have no climate risk or very low climate risk, in the single digits on percentage terms, as a result.”

However, Aviva Investors is building climate resilience into future developments. “Taking a housing development in the UK, as an example, we’ve elevated the level of habitable rooms and the walkways which access them to minimise the impact of a potential flood,” Dixon says. “For a development in Spain, we’ve included filtered water taps in the design to avoid people needing to rely on bottled water in the event of a heatwave. Small changes like this will be important later down the line when the physical impacts of climate change are felt more frequently and become more severe.”

But Nijmeijer says: “It would be completely wrong to assume that there are not dramatic conclusions for Asia and Europe. If you look at the serious events we have seen in Germany, or consider real estate markets such as the Netherlands where half of the country is below sea level, then you begin to understand that this data will also have significance for Europe.”

Map created by Kempen

Durkin agrees: “We are seeing increasing climate-related event volatility, with wildfires, flooding and drought now being more commonplace in Europe.” Last summer, the European Commission said nearly two-thirds of Europe was threatened by drought – the worst for at least 500 years – and that the heatwave sparked wildfires in 22 of the EU 27 member states, itself adding significantly to smoke emissions.

Parag Khanna, founder and CEO of Climate Alpha, and managing partner of Future Map (see interview, page 52), says: “Often within an investment house there is a conflict between the ESG view, which will tend to predict significant areas of stranded assets, and the investment committee view, which will push back.”

This is definitely not the case at Hines. Pozzato says: “We are very much in tune with our ESG team. We do take physical risk into account when undertaking due diligence on purchasing any assets and the ESG team give us their input this includes obtaining in-depth physical-climate-risk studies.” 

Dixon says Aviva Investors’s approach is “always about giving people the tools and the knowledge to self-serve. The practical execution has to be led by the investment functions, so they get to know the tools and learn to recognise risks.”

For Van Doorn, it is not a question of what is going on in the investment houses, but rather “in the data providers themselves”. Different providers take the same data and hand different conclusions to ESG teams, she says. “If even the ESG team cannot come up with a view of the physical risk with a sense of conviction, then you get an understanding of how much more complicated this situation is.”

Last year, ULI and LaSalle Investment Management worked together on a new report to outline steps that real estate practitioners can take to manage climate risk in their portfolios. “As an industry, we have a lot of work to do,” says Julie Manning, global head of climate and carbon strategy at LaSalle. “We would benefit from standardisation and transparency of how to measure climate risks at both the individual building level, as well as zooming out to the neighbourhood, city, and national levels.

“Our clients need to aggregate climate risk across their managers, but those managers are using a plethora of different data services, so this becomes challenging, if not impossible.

“Increased transparency may also help building owners work together on shared mitigation strategies among neighbours experiencing the same hazards. Merely possessing the best climate data is not a strategic advantage for any investor; the value is what you do with that knowledge to manage and mitigate the risk.”

Van Doorn says: “Our main finding was that it is quite difficult for real estate owners and managers to get a proper view of risk. Current assessments are based on opaque information from data providers. Many use the same data and yet they have very different outcomes for exactly the same building.”

Data can be an issue. Aanesen says: “The models that underpin these products are extremely sensitive to even minor adjustments of the underlying assumptions. We therefore use physical climate-risk models as a first step… and then conduct more in-depth analyses.” Aanesen worries that models fall down on the “efficiency of resilience initiatives”.

Van Doorn agrees. “Investors are looking at the ‘net risk’, which takes into account mitigation efforts.” These can be dramatic at a national level, such as the Netherlands sea defences, but also important at a micro level.”